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Singapore, June 27, 2022 -- Moody's Investors Service has changed the rating outlook on Tata Steel Ltd. (Tata Steel) to positive from stable. At the same time, Moody's has also affirmed Tata Steel's Ba1 corporate family rating (CFR).
"Today's outlook change to positive reflects Tata Steel's track record of delivering a solid operating performance while maintaining conservative financial policies; and the likelihood that upward rating pressure will build over the next 12 months if recent performance and credit metrics improvements are sustained," says Kaustubh Chaubal a Moody's Senior Vice President.
Tata Steel is poised to reduce its debt by at least $1.0 billion in the fiscal year ending March 2023 (fiscal 2023) -- aligned with its publicly articulated capital allocation policy.
"Tata Steel's well-laid-out capital allocation policy that prioritizes debt reduction over capital expenditure and new investments underscores our positive outlook. The substantial debt reduction achieved over the last two years, as well as the reduction to come over the remainder of fiscal 2023, will greatly improve the company's financial flexibility and resilience and position it for an investment-grade rating," adds Chaubal who is also Moody's lead analyst on Tata Steel.
Moody's notes that market conditions will gradually moderate over the next 12-18 months. Even so, the structural improvement in Tata Steel's capital structure, with an absolute gross debt reduction and the substantial cash generated by the company during the last two fiscal years, has created a lasting buffer to the company's key credit metrics and liquidity, reducing the company's overall credit risk.
Rising global interest rates to curb inflation and an increase in Indian steel export taxes have somewhat dampened steel prices. Moody's forecasts for Tata Steel are based on the rating agency's current price sensitivities for steel ($880 per ton for Tata Steel's Indian operations and $1,250/ton for Europe) for fiscal 2023. As for key steelmaking inputs, Moody's has modeled per ton of metallurgical coal at $308 and iron ore at about $100. For fiscal 2024, the agency's forecasts are based on the mid-point of its price sensitivity ranges ($600-$800/ton for steel, $80-$125 for iron ore and $110-$180 for metallurgical coal).
These price sensitivities translate into an EBITDA/ton assumption of $280 for fiscal 2023 and fiscal 2024 for Tata Steel's Indian operations, a 30% decline over fiscal 2022. Given the lack of vertical integration at Tata Steel's European operations and the wide swings in the business' profitability in previous years, Moody's remains cautious in its forecasts and assumes that the business' EBITDA/ton will decline from $180 in fiscal 2022 to around $140 -$150 in fiscal 2023 and further slide to $40 -$50 in fiscal 2024. Also embedded in this assumption is the rating agency's view that inflationary pressures and volatile energy costs will likely prolong through this fiscal year.
Based on these assumptions, Tata Steel's debt/EBITDA leverage should remain comfortably below 1.5x over the next two fiscal years, while it consistently generates positive free cash flow.
Tata Steel's Ba1 CFR continues to reflect these credit strengths: (1) the company's large scale, globally cost-competitive steel operations; (2) its strong position in its mainstay market, India; (3) its European operations' recent profitability improvement, which is structural and permanent; and (4) the company's close association with its parent, Tata Sons Ltd.
On balance, the CFR captures the company's exposure to the inherent volatility in steel prices and spreads, and the historically volatile performance of its European operations.
Tata Steel's liquidity position is good. The company's $3.1 billion in cash and liquid investments at the end of March 2022 and estimated $6.5 billion-$7.0 billion in operating cash flow over the next 18 months till September 2023 should be more than sufficient to meet its $9.0 billion in capital expenditure, announced acquisitions, modest dividends and scheduled debt (including short term debt) repayments over the same period.
Given the inherently volatile steel industry, some unevenness in intra-year working capital is likely, which could lead the company to continue relying on short-term 364-day working capital facilities. Tata Steel's association with the Tata brand enables it to have strong access to domestic capital markets. In addition, the company has longstanding relationships with Indian and multinational banks.
Moody's views the global steel sector as having high environmental risk, particularly regarding carbon transition risk, waste and pollution. Steel companies such as Tata Steel that operate blast furnaces are more exposed to carbon transition risk than electric arc furnace (EAF) producers, although the latter have high electricity requirements. The industry's transition to EAF will be slow and require new capital investment, as well as sufficient scrap supply.
The positive outlook reflects Moody's expectation that Tata Steel will maintain its currently strong credit metrics, namely gross leverage substantially below 2.5x and cash flow from operations (CFO) less dividends/adjusted debt in excess of 35%-40%, over the upcoming 12 months. Moreover, the positive outlook assumes that Tata Steel will retain its good liquidity profile.
The positive outlook indicates that a further track record of good operating performance and conservative financial policy would result in upward rating pressure.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATING
Tata Steel's significantly improved operating performance in fiscal 2022 and continued debt reduction has resulted in credit metrics that are substantially stronger for its rating. Moody's anticipates that steel prices and product spreads will return to normal levels given the government's policies to curb inflation and as supply and demand balances out.
Moody's could upgrade the ratings to investment grade if Tata Steel's adjusted EBIT margin remains well above 10%, its consolidated leverage below 2.5x, while the company generates positive free cash flow; all sustained through the cycle. Conservative financial policies with good liquidity, continued gross-debt reduction and a prudent mix of debt and equity-funded capital spending would also be prerequisites for an upgrade.
While Tata Steel's growing Indian operations will dominate its consolidated metrics, an upgrade to investment grade would require a slightly longer track record of the recent improvement of its European operations.
A downgrade is unlikely in the near term, given the company's recent performance recovery and positive outlook. That said, negative ratings pressure could arise from weaker liquidity or persistently high leverage of above 3.5x on a sustainable basis over the long-term, and if its EBIT/interest coverage falls below 4x. A deterioration in volumes and margins in the company's key operating markets that affect its ability to generate positive free cash flow could also pressure the rating.
The principal methodology used in this rating was Steel published in November 2021 and available at https://ratings.moodys.com/api/rmc-documents/356428 . Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.
Tata Steel Ltd. is a leading steel producer with manufacturing facilities in India (20.6 mt), the UK (5 mt), the Netherlands (7.0 mt) and Southeast Asia (1.7 mt). The UK and the Dutch operations are housed under Tata Steel Netherlands Limited.
Tata Steel generated consolidated revenues and EBITDA of USD32.8 billion and USD8.8 billion, respectively, during the fiscal year ending March 2022.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions .
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Kaustubh Chaubal Senior Vice President Corporate Finance Group Moody's Investors Service Singapore Pte. Ltd. 71 Robinson Road #05-01/02 Singapore, 068895 Singapore JOURNALISTS: 852 3758 1350 Client Service: 852 3551 3077
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