Tata Steel-Thyssenkrupp JV seen credit neutral amid high leverage: Fitch

JV to improve Tata Steel business profile by reducing exposure to structural weakness in Europe

Tata Steel's definitive agreement with ThyssenKrupp AG to create a 50:50 steel joint venture (JV) in Europe will improve the former's business profile by reducing its exposure to structural weaknesses in the region. However, the gain will probably be offset by a relatively high level of leverage over the next two to three years due to acquisitions in India to expand market share, Fitch Ratings said in its report on Tuesday.

"We expect to resolve the Rating Watch on the ratings of Tata Steel and ThyssenKrupp after completion of the JV transaction by end-2018," said the agency.

Details revealed by the companies on the signing of the agreement on June 30 largely mirrored earlier guidance, provided in September 2017. The JV will be the second-largest European flat-steel producer with annual shipments of about 21 million tonnes. Tata Steel will transfer around 2.5 billion euros of term debt to the JV, while ThyssenKrupp will transfer pension liabilities of 3.6 billion euros. The JV's intended capital structure has been designed by the two partners to be self-sustaining, with a ratio of term debt to EBITDA in the last 12 months below 2x and targeted cost synergies of 400 million-500 million euros annually to be realised within two to three years.

The liabilities of the JV will not have recourse to the partners, with their cash-flow exposure limited to dividends. ThyssenKrupp presentation indicated a potential for a ramp-up of dividend from the JV to a low-to-mid three-digit amount in euro millions.

However, we have not assumed any material dividend payout for our estimates due to potential restructuring needs at the JV. Fitch will follow the equity accounting treatment of the new entity, rather than proportionally consolidate. "We will also emphasise the significance of Tata Steel's Indian business, which benefits from significant vertical integration, when assessing the business profile of the company," informed Fitch Ratings.

Leverage, however, remains a concern for Tata Steel. It is driven by its recent acquisition of Bhushan Steel, which will increase net debt by around Rs 350 billion, excluding additional working capital debt at Bhushan Steel. "We have assumed EBITDA of around Rs 45 billion from Bhushan Steel in FY20, based on an output of 5 million tonnes and an EBITDA per tonne of around Rs 9,000 for the plant, which does not benefit from the use of captive raw materials," said Fitch.

Tata Steel has also shown interest in acquiring a controlling stake in another steel asset put up for bidding under insolvency proceedings in India - Bhushan Power and Steel Ltd. Due to this, leverage estimates could increase by around over the next two to three years if Tata Steel is successful in its bidding.

Fitch Ratings has assumed a margin in terms of EBITDA per tonne for Tata Steel Indian operations (ex-acquisitions) of around Rs 13,000 in FY19, similar to the FY18 level, dropping slightly to around Rs 12,500 annually thereafter. We have also factored in capex of Rs 90 billion-100 billion annually over the next three years. Our margin assumption is based on expectations of a moderation in steel as well as raw-material prices over the next 12 months. The impact of recent US import tariffs on international steel prices has been muted but we see risks for the industry from a possible escalation of trade disputes, explained Fitch.

The support for Tata Steel's margins due to a drop in raw-material prices from a broader industry downturn will be lower as a significant portion of its cost related to raw-material production is fixed.