India Ratings and Research (Ind-Ra) has downgraded Steel Authority of India Limited’s (SAIL’s) Long-Term Issuer Rating to ‘IND AA’ from ‘IND AAA’. The outlook is “Negative”.
The downgrade reflects SAIL’s credit metrics being lower than Ind-Ra’s expectation for 9MFY16. The steep fall in steel prices since January 2015 led to EBITDA losses for the company in 9MFY16 and the consequent worsening of its credit metrics.
Key rating drivers
Improvement in realisations to remain moderate: SAIL’s net sales realisation (NSR) declined 16.7% y-o-y to Rs 33,252 per ton in 9MFY16, driven by a 29% y-o-y increase in imports, excess domestic capacity and moderate consumption growth of 4.7% y-o-y. Ind-Ra, however, expects the net realisation to increase by Rs 3,000 per ton – Rs 4,000 per ton post the introduction of the minimum import price (MIP) for steel in India effective from February 2016.
Lower-than-expected EBITDA/ton: SAIL’s EBITDA/t eroded significantly during 9MFY16 to negative Rs 3,031 from Rs 4,300 in 9MFY15 driven by the steep fall in its NSR, a 2.6% y-o-y marginal decline in sales volume, and high fixed costs specially employee expenses. However, Ind-Ra expects EBITDA/t to improve in FY17 with an improvement in NSR, a volume ramp-up, better absorption of fixed costs and higher contribution margins.
Leverage increases significantly: SAIL’s gross debt increased substantially to Rs 299 billion in FY15 (FY14: Rs 253 billion), and is likely to have reached Rs 330 billion by FYE16 due to the capex undertaken and cash losses incurred. Even after the expected improvement in EBITDA in FY17, the leverage is likely to remain above 5.5x (FY15: 5.93x, FY14: 5.72x), higher than the category medians. The agency believes increase in NSR is necessary for an improvement in SAIL’s overall credit metrics.
Sales volume to increase: Ind-Ra expects SAIL to achieve volume growth of 10%-15% in FY17. Ind-Ra believes that post the implementation of the MIP, imports of steel into the country would decline but most of the other players who have also expanded their capacities would also look at producing incremental volumes. This could lead to higher competition which would manifest itself in aggressive pricing to gain volumes. According to the data released by the Joint Plant Committee, Indian steel demand grew 4.3% y-o-y in FY16. However, domestic producers have not benefited, as the incremental demand was largely met through imports which increased by 20.2% while domestic production declined by 1.1%. Ind-Ra expects steel consumption demand to grow by 6.3%-6.5% in FY17.
Raw material trends mixed, benefits muted: According to industry data, the average cost of coking coal fell to US$84 in 9MFY16 from US$113 in 9MFY15 and SAIL has benefited from the fall in terms of lower raw material costs. However, the fall in iron ore prices has not benefited SAIL as it has 100% captive iron ore linkages. SAIL’s iron ore cost per ton has, in fact, increased because it is required to contribute Rs 3.6 billion annually towards the District Mineral Foundation. Additionally, the increase in clean cess to Rs 400 per ton from Rs 200/t, applicable on coking and thermal coal, will also increase raw material cost.
Status of capex: SAIL is undertaking capex of Rs 618.7 billion for upgradation (Rs 227.4 billion) and expansion (Rs 391.3 billion) of its facilities. An additional Rs 102.6 billion has been earmarked for augmenting raw material availability. At end-December 2015, Rs 690.8 billon of capex had been undertaken which included regular maintenance capex. The benefits of the capex are likely to be visible from FY17. Till the benefits of increased capex begin to reflect by way of significantly higher volumes and improved efficiency, the leverage is likely to remain high.
MIP could be temporary relief: The recent imposition of the MIP on 173 steel products could alleviate the distress faced by steelmakers in the short term as the coverage has been wide and the duty has been defined in absolute terms. Around 80% of SAIL’s products are covered under the MIP and the company has effected price hikes of 10% post the imposition and a further hike of 5%-10% is likely in FY17. However, this will not be enough for a turnaround as steel prices corrected by 35%-40% in 2015. Also, implementing sustained hikes in steel prices would remain challenging because of the commissioning of additional capacity of close to 12 mt in 2016 and the MIP being currently valid till August 2016.
Strong financial support: The Government of India owns 75% of SAIL and it is a strategically important entity. The Maharatna status of the company provides it considerable financial and operational autonomy. In line with its ‘Parent Subsidiary Linkage’ methodology, Ind-Ra has factored into the ratings the potential support of the Indian government to SAIL, if required.