Stock Fundamentals

As demand cools, debt soars for steel players

Satya Sontanam | Updated on March 23, 2020

The going was okay till FY19, but the tide turned in FY20; now, Covid-19 poses a fresh threat

While the overall track record of resolution under the Insolvency and Bankruptcy Code (IBC) has been weak, steel companies have seen reasonable traction on that front over the past two years. But the optimism among buyers of stressed steel companies appears to have waned, owing to the unfavourable market conditions. Companies that acquired stressed assets — with borrowed funds — now feel the heat in the wake of weak demand.

The steel sector, after putting up a good show in FY19, faced headwinds in the current fiscal due to intensified trade tensions, slump in auto sales and the subsequent slowdown in domestic economy. This has, in turn, impacted the financials of steel companies and their ability to service their debts.

Purple patch till FY19

Tata Steel, looking to focus on its domestic business, has been paring exposure to its overseas subsidiaries, in the past few years. The company took over Bhushan Steel’s assets for ₹35,132 crore in May 2018 under IBC and acquired 72.65 per cent stake in Bhushan Steel through its wholly-owned subsidiary Bamnipal Steel. In addition, Tata Steel also acquired Usha Martin’s steel business in April 2019.

The company’s efforts to restructure its European business through a joint venture with Germany’s ThyssenKrupp did not materialise, upsetting its plan to pare debt of its European business.

Meanwhile, JSW Steel, which had chalked out a high capex plan for organic expansion in India, joined hands with AION Capital to buy 23.1 per cent stake in Monnet Ispat & Energy in 2018.

JSW Steel is also on the verge of taking over the insolvent Bhushan Power & Steel for ₹19,700 crore, which could add to the debt of the company.

Debt levels of these steel companies have shot up to fund their expansion plans. In FY18 and FY19, the total debt of Tata Steel went up by 11 per cent and 9.4 per cent y-o-y, respectively (against an average of 7 per cent in the previous five years). JSW Steel’s debt levels rose by 20 per cent y-o-y in FY19 alone.

The consolidated debt of Tata Steel and JSW Steel as on March 31, 2019, stood at ₹1,00,816 crore and ₹47,396 crore, respectively.

Despite high leverage on balance sheets, they managed to keep most of their debt metrics at reasonable levels till FY19 on the back of healthy growth in revenues and profits.

However, FY20 has not been favourable for the steel industry. As per Moody’s Investors Service, steel consumption growth slowed to about 3.5 per cent for the nine months ended December 2019 from 7.5 per cent growth in the fiscal 2019.

Also, as per data from SteelMint, the benchmark steel prices in India have touched a low of ₹34,500 per tonne from a peak of ₹42,800 a tonne in 2019. While there was some respite for steel prices in December 2019 due to improved sentiments, the rise was tepid. Steel prices currently rule at around ₹38,250 a tonne.

Weakening debt metrics

The total debt/EBITDA (trailing 12 months) — earnings before interest, taxes, depreciation, and amortisation — is a ratio that measures the amount of operating income available to pay down debt. A high ratio indicates that a company has a high debt burden.

In the case of Tata Steel, the debt/EBITDA ratio for the quarter ended September 30, 2019, increased to 4.39 times from 3.40 times recorded in FY19. JSW Steel’s debt/EBITDA ratio, too, increased to 2.82 times for H1FY20 from 2.5 times for FY19.

The increase in debt and the fall in EBIDTA (34-40 per cent y-o-y) during the six months ended September 2019 led to the increase in the total debt/EBITDA ratio for these companies.

The fall in EBITDA has also impacted the interest coverage ratio — EBITDA/interest cost (higher the better).

For Tata Steel, the interest coverage ratio was 3.88 times in FY19; it fell to 1.87 times in the latest December quarter. In the case of JSW Steel, this ratio dropped to 2.31 times in the December quarter, from 2.74 times in FY19.

While both companies expect to repay some of the debt, a look at the net debt-to-operating cash flow ratio (lower the better) suggests that it could be a difficult task.

JSW Steel’s net debt to operating cash flow ratio stood at 9 times in H1 FY20 (up from 3.76 in FY19). This ratio has deteriorated significantly for Tata Steel as it recorded a ratio of 17.52 times for H1FY20 against 5 times in FY19.

Also, recently, Moody’s changed the outlook of JSW Steel’s credit ratings to stable from positive, reflecting the weaker-than-expected operating performance and Moody’s expectation that it will take longer for the company’s credit metrics to improve to the previous levels.

The outbreak of Covid-19 and the expected fall in both global and domestic growth rates are likely to impact the demand and prices of steel, going ahead. This might result in a further decline of the debt-servicing ability of these steel companies.

Published on March 22, 2020

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