Tata Steel rating raised to 'BB-' on deleveraging and strong operating momentum, Outlook Stable

Rating Action Overview

- We believe Tata Steel Ltd.'s debt levels will decline materially over the next two years due to strong cash flow and the company's stated intention to reduce debt.

- In our base case, we expect Tata Steel's adjusted debt to decline by about 30% by March 2023 from the March 2020 level of about Indian rupee (INR) 1 trillion, leading its credit metrics to steadily improve.

- On April 6, 2021, S&P Global Ratings raised its issuer credit rating on Tata Steel and its subsidiary ABJA Investment Co. Pte. Ltd. to 'BB-' from 'B+'. We also raised the long-term issue rating on the senior unsecured notes issued by ABJA.

- The stable outlook reflects our expectation that Tata Steel will adequately deleverage over the next two years and build comfortable headroom at the current rating level.

The benefits of strong cash flows and management's commitment to lower debt should help Tata Steel to materially deleverage over the next two years. We estimate our adjusted debt levels for Tata Steel will decline by about 30% by March 2023 from about INR1.1 trillion in March 2020. About half of this decline is expected to have been delivered in fiscal 2021 (year ended March 2021). Tata Steel has committed to reducing absolute debt levels by at least US$1 billion per year from fiscal 2022. Our base case shows that the company's free operating cash flows will be adequate to facilitate this reduction over the next two years, even with our revised capital expenditure (capex) estimates of about INR90 billion per year, up from INR50 billion-INR60 billion in fiscal 2021. We believe Tata Steel will moderate its investment plans, if required, so as to meet this objective. The company reported sizable debt reduction in fiscal 2021, thanks to stronger cash flow generation, recent equity raising of about INR33 billion, and working capital improvements of about INR120 billion. However, we treat as debt substitution some of Tata Steel's working capital-related debt reductions in fiscal 2021, such as INR60 billion in export advances and securitization of receivables at Tata Steel Europe (with a facility size of £475 million). This implies a comparatively lower level of deleveraging compared with the company's reported numbers.

We expect strong operating momentum over the next 12-18 months to facilitate debt reduction. Tata Steel has guided to price increases of INR6,000-INR7,000 per ton in the fourth quarter of fiscal 2021, on the back of already high prices and margins in the third quarter. In the third quarter, the Indian operations reported average EBITDA/ton of about INR19,000, exceeding our mid-cycle estimate of about INR13,500-INR14,000. Consequently, we anticipate that the company can maintain strong operating momentum over the next couple of quarters at least. Our base case assumes moderation in steel prices over fiscals 2022 and 2023, such that the Indian operations' EBITDA/ton gradually will decline to about INR16,000 by fiscal 2023. In our view, steel prices could moderate over the next two to three years as output ramps up globally following disruptions due to COVID-19. Long product prices in India have already moderated following the resumption of smaller capacities. Under these assumptions, we estimate Tata Steel can generate aggregate EBITDA of more than INR600 billion and free operating cash flow of about INR150 billion over fiscals 2022 and 2023.

Volatility in earnings, and hence, credit metrics constrains a higher rating for now. We estimate Tata Steel's debt-to-EBITDA ratio will decline to 2.5x-3.0x in our base case by fiscal 2023 and the ratio of funds from operations (FFO) to debt should improve to 20%-25%, compared with our earlier estimates of 4.0x-4.5x and about 15%, respectively. A key risk to these estimates is the level of steel prices. If steel prices were to drop to mid-cycle levels by fiscal 2023, we estimate the company's FFO-to-debt ratio to be 15%-17%, and it has the potential to drop further to 13%-14% at the bottom of the cycle. We note the company's EBITDA in fiscal 2020 was about half our current estimates for fiscals 2021 and 2022, with a ratio of FFO-to-debt being 6%, indicating the extent of volatility seen lately. That said, material deleveraging has lowered downside rating risk, in our view. The likelihood is reducing that credit metrics will weaken to levels seen in previous downturns.

Shares of TATA STEEL LTD. was last trading in BSE at Rs.862.85 as compared to the previous close of Rs. 867.4. The total number of shares traded during the day was 913689 in over 12422 trades.

The stock hit an intraday high of Rs. 882.3 and intraday low of 858.15. The net turnover during the day was Rs. 794154985.

Source : Equity Bulls

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