Corporates

www.indiaratings.co.in 17 January 2014

Metals & Mining

2014 Outlook: Steel Producers Modest Demand Growth Unlikely to Improve Credit Profile

Outlook Report

Negative Outlook Maintained: India Ratings & Research (Ind-Ra) has maintained a Negative

Outlook on the Long-Term Issuer Rating of Indian steel producers for FY15 (end-March) due to

their weak credit profile. The agency revised the Outlook to Negative in July 2013 from Stable

in January 2013. The high proportion of Stable Outlooks in the Ind-Ra’s portfolio reflect that the

agency has factored into the ratings the inherent risks in the sector with most issuers being

rated in the non-investment grade (‘IND BB+’ and below). The sector outlook is also negative

as a modest improvement in steel demand from end-user industries would not result in a

significant hike in steel prices in FY15.

Modest Improvement in Demand: Ind-Ra expects domestic steel demand to improve in FY15

on the back of a modest recovery in economic growth and an infrastructure push by the

government of India (GoI). Better GDP growth of 5.6% yoy (Ind-Ra’s estimates) in FY15 (FY14:

4.9% yoy) on the back of a revival in the industry growth of 4.1% yoy (1.7% yoy) would lead to

slightly improved steel demand. World Steel Association has forecasted steel demand in India

to grow at 5.6% yoy in 2014.

Limited Upside in Price: Ind-Ra does not expect a major hike in steel prices in FY15 due to

prevailing overcapacity in the domestic steel industry which would continue to limit the prices

despite a modest improvement in steel demand. The prices would also depend upon a

correction in the present oversupply in global steel market. However, any contraction in steel

demand could pressure steel prices further.

Pressure on Margins: Margins of steel producers would continue to be under pressure given

the high cost of steel production and their limited ability to pass on hikes in costs as only a

modest improvement in demand is expected in FY15. The availability of iron ore should

improve in FY15, limiting hikes in iron ore costs. However, any further rupee depreciation

resulting in an increase in the landed cost of coking coal, which is mostly imported, could

contract profitability margins.

Overcapacity: Steel producers across the globe are grappling with low capacity use levels,

resulting in a high fixed cost. Indian steel producers’ capacity use contracted to below 80% in

FY13. Any increase in the capacity use due to an uptick in demand could be limited by

significant new capacities (about 13-15 million tonnes (mt)), scheduled to start in FY15.

Domestic steel producers will have to increase their focus on cost competitiveness and

efficiency of operations to protect their margins.

Credit Profile: Ind-Ra expects Indian steel producers’ credit profile to remain weak in FY15

due to their large debt for working capital and capex coupled with modest EBITDA margins.

Margins have consistently contracted since FY11 which combined with an increase in debt

have resulted in increased financial leverage. A tightening of credit by Indian banks to the steel

sector due to rising non-performing assets (NPAs) may worsen the liquidity position of steel

producers at the lower end of the credit spectrum given their heavy reliance on bank funding for

operating expenditure and capex.

Rating Outlook

NEGATIVE

(2013 M ID-YEAR :

NEGATIVE )

(2013: STA BLE )

Sector Outlook

NEGATIVE

(2013: NEGAT IVE)

Modest demand growth

Global and regional overcapacity

Weak pricing dynamics

Weak credit profile Related Research

Other Outlooks

www.indiaratings.co.in/outlooks

Other Research

Rating Indian Steel Producers - Sector Credit Factors (September 2012) Go to appendix for list of select rated entities

Analysts

Ashish Upahdyay +91 11 4356 7245 ashish.upadhyay@indiaratings.co.in Rohit Sadaka +91 33 4030 2503 rohit.sadaka@indiaratings.co.in Sankalp Baid +91 22 4000 1792 sankalp.baid@indiaratings.co.in Pavan Kumar +91 44 4340 1724 pavan.kumar@indiaratings.co.in

Corporates

2014 Outlook: Steel Producers

January 2014 2

Outlook Sensitivities

Sustained Improvement in Demand: A Stable Outlook could result from a greater-than-

expected improvement in the Indian macroeconomic environment leading to superior and

sustained growth in steel demand from end-user industries.

Key Issues

Demand Growth

Ind-Ra expects India to record better GDP growth of 5.6% in FY15 (FY14 estimates: 4.9%),

mainly on the back of a revival in industry growth of 4.1% (1.7%). This should result in a

moderate uptick in steel demand in FY15, given the high positive correlation of steel demand

with GDP growth. The country recorded GDP growth of 5% in FY13 (FY12: 6.2%), one of the

lowest rates in the last decade. The Indian economic slowdown has resulted in depressed

demand for steel from end-user industries.

According to Joint Plant Committee (JPC), steel production grew 5.2% during the first nine

months of FY14 (9MFY14), while the real consumption of steel grew by a modest 0.6%. Lower

domestic demand coupled with a weak rupee resulted in a sharp decline of 29.2% in steel

imports. However, exports driven by rupee depreciation recorded a jump of 9.5% in 9MFY14.

The real consumption of steel in India grew only 3.3% yoy in FY13 as against 6.9% yoy in

FY12, given the slowdown in end-user industries.

Figure 2

Steel consuming sectors like construction, auto and capital goods continue to underperform.

The construction sector which accounts for bulk of steel consumption (about 60%) recorded a

4.3% yoy decline in growth in FY13 (FY12: 5.6% yoy). The growth further fell to 3.5% in

1HFY14 (1HFY13: 5.1%). The GoI’s plan to invest USD1trn in the infrastructure sector could

boost steel demand provided it is timely implemented.

The auto sector with the exception of the two-wheeler segment continues to record a decline in

sales volume. According to Society of Indian Automobile Manufacturers, passenger as well as

commercial vehicle sales declined by 8.6% yoy during April-December 2013. High interest cost

has also stemmed demand revival. The capital goods sector continues to show a contraction

since FY11; for April-October 2013, the sector registered a 0.2% yoy decline in sales. Growth

in consumer durables continues to be hammered by the persistent high inflation and high

interest costs.

0

5

10

15

20

25

30

35

FY08 FY09 FY10 FY11 FY12 FY13

Bank Credit (Steel & Iron-ore) GDP Steel Consumption(%)

Growth Trend

Source: Ind-Ra, RBI, JPC

Figure 1

Corporates

2014 Outlook: Steel Producers

January 2014 3

Figure 3

Steel Prices

Ind-Ra does not expect a significant price hike in steel prices in FY15. The consistent demand

slowdown in the end-user industries globally has resulted in an oversupply in the steel industry,

leading to depressed steel prices. The domestic steel market is also grappling with

overcapacity and any uptick in demand will result in the use of spare capacities. Moreover, new

capacities of around 13-15mt, scheduled to start in FY15, will also pressurise steel prices. Steel

producers are price takers with prices being determined by variations in end-user demand. This

limits the ability of the companies to pass on cost increases to customers. As a significant

improvement in the domestic steel market remains uncertain, domestic steel producers will be

focussed on efficient cost control to mitigate the risk of a prolonged price recovery.

Figure 4

Indian steel producers increased steel prices in August and September 2013, but subdued

demand from end-user industries prevented a sustained increase in prices. Rupee depreciation

did provide some support to the prices as imported steel mainly flat steel became costlier than

domestic steel, given its import price parity. Steel companies also tried to increase exports as

steep rupee depreciation rendered Indian steel prices relatively competitive globally.

31.8 32.645.8 49.4

53.1 57.8 56.669.0

73.6 76.7 71.0 72.3

0

20

40

60

80

100

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Nov 12 Nov 13

India's Crude Steel Production

(million ton)

Source: World Steel

-10

-5

0

5

10

15

20

FY09 FY10 FY11 FY12 FY13

Basic Goods Capital Goods Intermediate Goods Cosumer Goods Total

(% Growth)

Index of Industrial Production (IIP)

Source: CSO

Corporates

2014 Outlook: Steel Producers

January 2014 4

Figure 5

Iron Ore

Globally, Ind-Ra expects iron ore prices to moderate in FY15 due to strong production

increases in Australia. However, Indian prices for iron ore will continue to reflect the

inadequate domestic supply of iron ore. A partial improvement in supply from Karnataka due to

a ramp up of iron ore production post lifting of the ban by Supreme Court will provide some

relief. The prices could firm up if the demand-supply gap widens due to a regulatory

intervention in Odisha and/or more-than-expected steel demand. According to Fitch Ratings,

the base case assumption for iron ore prices (62% fines CFR China) is USD110/t in 2014

dropping to USD90/t in the long term. Average iron ore prices remained relatively stable in

2013 with occasional increases due to a contraction in supply. About 1.6t of lump iron ore is

required to produce 1t of crude steel through the blast furnace (basic oxygen furnace) route.

Figure 6

Coking Coal

Over 90% of India’s requirement for coking coal is met through imports. However, the landed

price of coking coal for Indian steel producers will remain high given the significant rupee

depreciation since FY13. Any further rupee depreciation could increase the cost of production,

thus driving down the margins. According to Fitch, hard coking coal prices will be about

USD160/t on average over the next 12 months, recovering in the long term to USD175/t, given

the rebound in Australian supply due to a ramp up of new projects.

The average quarterly contract price for hard coking coal (HCC, ex-Australia) declined about

25% yoy to USD159/t in 2013; however, the depreciated rupee offset some advantage that

could have accrued on account of the reduction in input costs. About 0.6t of coking coal is

required to produce 1t of crude steel through the blast furnace (basic oxygen furnace) route.

36,000

40,000

44,000

48,000

52,000

Sep 11 Nov 11 Jan 12 Mar 12 May 12 Jul 12 Sep 12 Nov 12 Jan 13 Mar 13 May 13 Jul 13 Sep 13 Nov 13

Hot Rolled Coils (2mm, Mumbai) MS Rounds (Round 16mm, Mumbai)(INR)

Steel Price Trend

Source: CMIE

0

2,000

4,000

6,000

8,000

Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Apr 12 Jul 12 Oct 12 Jan 13 Apr 13 Jul 13

Fines Lumps(INR/ton)

Average Iron Ore Prices (>65% Fe)

Source: Indian Bureau of Mines

Corporates

2014 Outlook: Steel Producers

January 2014 5

Figure 7

Mining Issues

The iron ore mining industry went through a difficult phase in 2012 and 2013, given regulatory

interventions in various states which resulted in the inadequate availability of iron ore despite

abundant quality reserves in India. The supply of iron ore should improve gradually, given the

lifting of mining ban on category-A (with minor or no irregularities) and category-B mines in

Karnataka. However, the Supreme Court has imposed an annual ceiling of 30mt of iron ore

production in the state. After the lifting of ban, around 17 mines produced about 20-25mt

(including ore produced by NMDC Ltd) of iron ore in 2013. This is insufficient to meet the 35-

40mt requirement of the state. The supply should progressively improve as miners obtain

various statutory approvals and operationalise the mines.

Odisha could also have to face inadequate availability of iron ore if the Justice Shah

Commission’s recommendation on seeking fresh approvals for environment clearance for

operating mines in the state is accepted. Mining activities have come to a halt in Goa following

the Supreme Court’s ban on mining. However, this had a minimal impact on the Indian steel

industry as the ores produced in Goa were mostly exported, given their low grade which is not

used by the domestic steel industry. In November 2013, the court allowed e-auction of around

11.5mt of the iron ore stock produced before the ban came into effect.

Credit Profile

Ind-Ra expects domestic steel producers’ credit profile to remain weak in FY15 due to

continuous pressure on margins coupled with expectations of only modest improvement in

steel demand. Consequently, it would be challenging to significantly hike steel prices and pass

on increases in input cost. A decline in coking coal prices would have provided some respite;

however, a sharp rupee weakening has offset some of the advantages that could have accrued

due to lower coking coal prices.

Indian steel producers’ financial leverage is high due to high debt for funding capex and high

working capital requirements coupled with moderate profitability. However, the liquidity of large

steel producers is adequate. Small and medium steel producers are also dealing with tight

liquidity apart from high leverage. The liquidity concerns are also compounded by steel

producers’ capex resulting in negative free cash flows. Rupee depreciation has also resulted in

high financial leverage for steel producers, with significant unhedged foreign currency liabilities

limiting their financial flexibility.

The Indian steel industry is one of the largest borrowers from the domestic banking system;

any limited availability of credit given rising NPA levels of banks could further affect the liquidity

of domestic steel producers at the lower end of the credit spectrum. The iron and steel sector is

the largest contributor to the stressed assets of the Indian banking system. According to the

Corporate Debt Restructuring cell as on 30 September 2013, the iron and steel sector

contributed 21.3% (INR418.12bn) to total stressed assets (INR1,962.67bn) under the debt

restructuring mechanism.

0

100

200

300

400

Q110 Q410 Q311 Q212 Q113 Q413

(USD/ton)

HCC Price Trend (FOB)

Source: Industry

Corporates

2014 Outlook: Steel Producers

January 2014 6

The cost of funding working capital requirements remains high, given high interest rates. While

higher-rated issuers invariably have access to bank funding and capital markets in certain

cases, most issuers in the ‘IND A’ and below categories rely largely on bank financing and are

severely affected by high interest costs.

Long-term Fundamentals Intact

The long-term fundamentals of Indian steel demand remain intact. The per capita use of steel

in India at 57kg (2012) is quite less than the world average of 217kg, indicating huge potential

steel demand in India. However, a recovery in domestic steel demand in FY15 would be a

gradual one rather than V-shaped.

2013 Review

2013 was a difficult year for Indian steel producers. During the year, Ind-Ra took negative

rating actions on six steel companies and revised the Outlook on one to Negative from Stable

due to greater-than-expected liquidity issues and high financial leverage. However, the agency

affirmed the ratings of 15 steel companies while the ratings of 12 steel companies were

upgraded.

Companies with a Negative Outlook (see Annex 1) are affected by uncertainties regarding

timely completion of capex and deterioration in financial leverage. Steel Authority of India

Limited’s (‘IND AAA’) Negative Outlook reflects uncertainties associated with its deleveraging

from FY15 after the expected completion of its on-going capex. Tata Steel Limited’s (‘IND AA’)

Negative Outlook reflects the agency’s view that profitability pressures for the company will

persist, given the challenging outlook for the global steel market. Usha Martin Limited’s (‘IND

A+’) Negative Outlook reflects its elevated credit metrics. Uttam Galva Steels Ltd's (‘IND A’)

Negative Outlook also reflects its high financial leverage due to debt-funded capex.

Corporates

2014 Outlook: Steel Producers

January 2014 7

Annex 1: Ratings Headroom for Select Steel Producers

Figure 8 India – Select Steel Producers’ Ratings Headroom and Ind-Ra’s FY15 Expectations

Relative to FY13

Long-Term Issuer Rating/Outlook Profitability

a Capex FCF Credit metrics

b

Ratings Headroom

Steel Authority of India Limited (SAIL) IND AAA/Negative Improve Similar Weaken Improve Low Tata Steel Limited (TSL) IND AA/Negative Improve Increase Weaken Improve Low Rashtriya Ispat Nigam Limited (RINL) IND AA/Stable Improve Increase Weaken Weaken Low Uttam Galva Steels Ltd. (UGSL) IND A/Negative Similar Lower Improve Improve Low Usha Martin Limited (UML) IND A+/Negative Improve Lower Improve Improve Low ISMT Limited IND A-/Negative Improve Lower Improve Improve Low

a EBITDA margin b Total adjusted net debt/EBITDA Source: Ind-Ra

Corporates

2014 Outlook: Steel Producers

January 2014 8

Annex 2: Key Financial Trends of Select Ind-Ra-Rated Steel Producers

Figure 9

Figure 10

Figure 11

432

1,473

91

406

1,024

98

427

1,188

105

463

1,329

133

446

1,334

121

0

300

600

900

1,200

1,500

1,800

SAIL TSL RINL

FY09 FY10 FY11 FY12 FY13

Revenue Trend

(INRbn)

Source: Ind-Ra, annual reports

0

5

10

15

20

25

FY09 FY10 FY11 FY12 FY13

SAIL TSL RINL UGSL UML(%)

EBITDA Margin Trend

Source: Ind-Ra, annual reports

-2

0

2

4

6

8

10

FY09 FY10 FY11 FY12 FY13

SAIL TSL RINL UGSL UML(x)

Leverage Trend

Source: Ind-Ra, annual reports

Corporates

2014 Outlook: Steel Producers

January 2014 9

Appendix

Figure 12 Select Issuer Ratings Issuer Rating/Outlook (Current) Rating/Outlook (End-2012)

Adhunik Alloys and Power Limited IND BBB-/Stable IND BB+(Suspended) Adhunik Corporation Limited IND BB+/Stable IND BB/Stable Adhunik Industries Limited IND BB+ /Stable IND BBB-/Stable AGR Steel Strip Private Limited IND BB+/Stable IND BB/Stable Ambica Steel Limited IND BB+/Positive IND BB+/Positive Anuradha Steels Private Limited IND BB-/Stable NR Aradhya Steels Private Limited IND BB-/Stable IND D Aruna Alloy Steels Private Limited IND BB+/Stable IND BB+ / Stable Asian Colour Coated Ispat Limited IND BBB-/Stable IND BBB-/Stable Balmukund Sponge & Iron Limited IND BBB-/Stable NR Beekay Steel Industries Limited IND BBB-/Stable IND BB+/Stable Bhushan Power & Steel Limited IND A-/Stable IND A-/Stable Bonai Industrial Company Ltd IND AA/Stable IND AA-/Stable Feegrade & Company Pvt. Ltd IND AA/Stable IND AA-/Stable Global Castings Private Limited IND BB-/Stable NR Goyal Energy & Steel Pvt. Ltd IND BB-/Stable IND BB-/Stable ISMT Limited IND A-/Negative IND A/Stable M/s Mangilall Rungta IND A/Stable IND A-/Stable Mahindra Sanyo Special Steel Private Limited IND BBB/Stable IND BBB/Stable Mortex Coke Industries IND BB/Stable NR Neo Metaliks Limited IND BB/Stable IND BB+/Stable Niros Ispat Private Limited IND BB- /Stable IND B+/Stable Radha Smelters Limited IND BB+/Stable NR Radha Steels IND BB-/Stable NR Rashtriya Ispat Nigam Limited IND AA/Stable IND AA/Stable Rungta Mines Ltd IND AA+/Stable IND AA/Stable Rungta Sons Pvt. Ltd IND AA/Stable IND AA-/Stable Sagar Roofings Private Limited IND BB+/Stable IND BB+/Stable Sagar Steels IND BB-/Stable IND BB-/Stable Sai Sponge (India) Limited IND BB-/Stable IND BB-/Stable Shankara Infrastructure Materials Ltd IND BBB+/Stable NR Shree Shakambari Ferro Alloys Pvt Ltd IND BB-/Stable IND BB-/Stable Sowbhagya Ispat India Private Limited IND BB-/Stable IND BB-/Stable Sri Langta Baba Steels Pvt Ltd IND BB-/Stable IND BB-/Stable Steel Authority of India Limited IND AAA/Negative IND AAA/Stable Tata Steel Limited IND AA/Negative IND AA/Negative Tirumala Balaji Alloys Private Limited IND BBB-/Stable IND BBB-/Stable Usha Martin Limited IND A+/Negative IND A+/Negative Uttam Galva Steel Limited IND A/Negative IND A/Negative

Source: Ind-Ra, NR – Not rated

Corporates

2014 Outlook: Steel Producers

January 2014 10

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