The benefit of gradual domestic demand growth will be offset by the weak product pricing capability caused by global overcapacity and cheap imports.
NEW DELHI(Commodity Online): India Ratings & Research (Ind-Ra) has maintained its rated steel producers on a Negative Outlook for FY16. The agency expects the credit profile of its rated steel producers to remain weak in FY16 despite a modest recovery in demand.
Majority (82%) of ratings are on a Stable Outlook, with most of them being rated below ‘IND BBB-’ to reflect inherent risks in the steel sector.
The agency expects steel consuming sectors – construction, automobile and mechanical engineering - to grow in FY16 with the softening of interest rates and implementation of government policies on the revival of infrastructure and investment in the country. A better GDP forecast of 6.5% growth in FY16 supported by industrial growth of 6.5% would gradually increase steel demand in the country.
Average prices for steelmaking raw materials are likely to remain low in 2015, in line with 2014 as major global miners are determined to flush small, high-cost producers out of the industry and regain balance in the market. The Indian iron ore mining industry is undergoing a difficult phase given regulatory intervention in various states.
Even though this intervention bodes well for the domestic industry in the long-term, steel producers will continue to face inadequate availability of domestic iron ore in the short term aggravated by addition of capacities during FY16. Domestic iron ore prices would stabilise with policy reforms in the mining sector in the medium term.
Factors such as global overcapacity, import competition, expected fall in raw material prices and addition of capacities during FY16 will prevent a steel price hike despite a recovery in demand. Profit margins in FY16 are likely to remain modest.
This is because of limited ability to hike prices and increase in interest cost with capacities (12-14mt) becoming operational during FY16. Depreciation in currency could pressurize the margins of companies producing flat steel as bulk of coking coal is imported.
Ind-Ra expects a gradual reduction in interest rates by FYE16 (75bp), which should provide some relief in interest costs. Softening of interest rates will support interest coverage. However, the leverage of the companies is likely to remain high. Working capital requirement could increase and thus increase the leverage with additional capacities becoming operational in FY16.
In line with Ind-Ra’s expectation, the credit profile of major steel players weakened during 2014. The agency downgraded six issuers and affirmed 13 steel companies, while maintaining Rating Watch Negative (RWN) for two issuers due to uncertainties regarding regulatory stipulations. Ind-Ra upgraded seven steel producers due to improvements in credit profile while maintaining them below investment-grade ratings due to the risk associated with these entities. 61% of Ind-Ra rated steel companies figure in sub-investment grade.
WHAT COULD CHANGE THE OUTLOOK?
A stable sector outlook could result from a higher-than-expected recovery in demand with improved macroeconomic environment in India and/or a sustained improvement in global steel prices due to the closure of less-efficient capacities and a better market balance. A better sector outlook resulting in a significant improvement in profitability and credit profile would result in a Stable rating Outlook
Ind-Ra-rated steel producers include Steel Authority of India Limited (‘IND AAA’/Negative), Tata Steel Limited (‘IND AA’/Negative), Rashtriya Ispat Nigam Limited (‘IND AA’/Negative), Uttam Galva Steels Limited (‘IND A-’/Stable) and Usha Martin Limited (‘IND A’/RWN).