S&P Global Ratings has revised the outlook on Tata Steel to ‘positive’ from ‘stable’ on the back of continuing strong cash flows, while reaffirming its ‘BBB-‘ rating.
The Tata Group company is expected to generate substantial free operating cash flows over the next two years owing to continuing strong steel prices. The resilience of the company’s credit metrics to steel price cycles has also strengthened following a significant reduction in debt over the past 18 months. S&P estimates Tata Steel’s adjusted debt-to-Ebitda (earnings before interest, tax, depreciation, and amortisation) ratio to stay below 2.5x at the bottom of the cycle.
“We are therefore revising our rating outlook on TataSteel and its subsidiary ABJA Investment Co. Pte. Ltd. to positive from stable. At the same time, we are affirming our ‘BBB-‘ long-term issuer credit ratings on the two companies and the ‘BBB-‘ long-term issue rating on the senior unsecured notes that ABJA issued,” the ratings firm said in a note on Friday.
The positive outlook reflects the potential for an upgrade for TataSteel over the next 12-24 months if the company continues to reduce leverage and improves its resilience to steel price cycles, it said.
Tata Steel’s strong free operating cash flows over the next two years will strengthen its credit profile. It is estimated that the company will generate $3-4 billion of free operating cash flows annually over the next two years, given continued strength in steel prices. “This is based on our estimate of Ebitda/ tonne for the Indian operations averaging about Rs 20,000 over the next two years. This is about 40% higher than typical levels in the past,” the S&P note said.
Cash flows will also aid in further debt reduction in the absence of increased investments or shareholder returns. Tata Steel intends to increase its capacity in India to 40 million tonne by 2030 from about 25 million tonne at the end of FY24. The company has indicated that it could accelerate some capital expenditure given current conditions in the steel industry.
“Even in such a scenario, we believe Tata Steel’s credit metrics will strengthen, though the pace of deleveraging may be slower than in the past 18 months. Besides, the increase in scale without material incremental debt will enhance the company’s credit profile in the longer term,” it said.
Tata Steel’s adjusted debt as of March 31, 2022, is down by close to 45% from about Rs 1.1 trillion a year earlier. The reduced debt and the positive operating outlook should keep its ratio of funds from operations to debt above 75% over the next two years.
At the normal level of steel prices, it is estimated that the company’s Ebitda per tonne will be about Rs 14,000 per tonne, compared with Rs 19,000- Rs 23,000 per tonne in S&P’s base case.
The company has deleveraged sharply over a short period, with an adjusted debt-to-Ebitda ratio of 1x as of March 31, 2022, compared with about 6.6x as of March 31, 2020.
“We expect Tata Steel’s credit metrics to be above our upgrade trigger even if steel prices normalise over the next two years. However, the cushion remains limited against unforeseen debt-funded investments and steel price downturns. Therefore, the company’s continued commitment to operate at a lower leverage would be key to a higher rating,” it said.