Moody's Investors Service has revised ratings outlook on Tata Steel and Tata Steel UK Holdings (TSUKH), from negative to stable.
"The change in the ratings outlook from negative to stable reflects our expectation that the benign operating environment and recovery in the financial performance of TSUKH and Tata Steel over the last few quarters, will continue over a longer term, leading to a sustained improvement in its credit metrics," said Kaustubh Chaubal, a Moody's vice president and senior analyst, the agency reported.
Strong growth prospects - in particular, in its key operating markets of India, Europe and South East Asia - with apparent steel consumption slated to grow, amid capacity removals in China, bode well for Tata Steel.
Moody's expects China's steel production capacity to continue declining, with the government's implementation of supply-side reforms and environmental protection measures. These measures have forced the closure of inefficient mills, prompted consolidation which has led to a decline in Chinese exports.
As for demand, Moody's expects India's steel consumption to grow in the mid-single digits in 2017 and 2018, on the back of economic activity with expected GDP growth in the range of 7.3 per cent to 7.5 per cent. Besides, implementation of the goods and services tax (GST) in July would help the organised sector, and the main beneficiaries would be strong brand recall players like Tata Steel, said the agency.
In Europe - which is Tata Steel's second largest market by volume - sustained demand from key user industries, such as automotive, construction and capital goods, will lead apparent steel consumption to grow by an estimated 2 per cent in calendar 2017 and by 1.5 per cent in 2018.
As a result, consolidated Ebitda/tonne will average at Rs 7,500 - 7,900 in FY2018, higher than the stable outlook trigger of Rs 7,000.
Moreover, with half the sales volumes from the highly profitable Tata Steel India (TSI) - that generates Ebitda/tonne in the Rs 10,000 - Rs 12,000 range - will drive a meaningful improvement in consolidated earnings. The absence of any large capital expenditure and investment needs, will improve free cash flow generation and allow deleveraging.
Following Tata Steel's signing of the memorandum of understanding (MoU) with Thyssenkrupp AG in September, Moody's expects Tata Steel to enter into a definitive agreement for a joint venture (JV) of its European business by March 2018 and its subsequent consummation by March 2019. The transaction is at an early stage with a possible closing, which is subject to due diligence, approvals from respective shareholders and antitrust authorities.
Moody's view that Tata Steel will maintain a cautious approach when evaluating expansions or potential acquisitions, is what pushed this change in the ratings outlook. Large debt-funded investments, if any, could weigh on the ratings. That said, given the significant improvement in operating and financial metrics, there is sufficient headroom under the ratings.
In light of the significant improvement in operating and credit metrics, upward ratings pressure is likely to build over the next 12-18 months.