OREANDA-NEWS. Fitch Ratings has revised JSW Steel Limited's (JSW Steel) Outlook to Negative from Stable, while affirming the Long-Term Issuer Default Rating (IDR) at 'BB+'. The agency also affirmed JSW Steel's senior unsecured rating and the rating on its USD500m 4.75% senior unsecured notes due 2019 at 'BB+'.

The revision in the Outlook reflects the risk of further declines in pricing, which would make it difficult for the company to improve performance and reduce leverage. JSW Steel's financial profile weakened amid challenging conditions for Indian steel producers in 2015 and high debt levels as the company expands capacity. A key assumption of Fitch's rating case is that steel prices will recover modestly in the financial year ending 31 March 2017 (FY17) in response to improving steel demand in India.

The rating reflects the company's strong market position and highly efficient operations, which allow it to maintain low costs. Fitch expects JSW Steel's financial profile to improve significantly in FY17 and FY18 with the benefits from capex driving higher sales volume and improvement in profitability. The better sales and profitability are key to maintaining the 'BB+' rating.

KEY RATING DRIVERS

Challenging Market Dynamics: Fitch expects the pressure on JSW Steel's profitability to continue in the near term. Indian steel makers have been battling an influx of cheaper steel mainly from China and muted demand. JSW Steel's consolidated blended EBITDA per tonne fell to INR5,328 (USD82) during the six months ending 30 September 2015 (1HFY16) from INR9,080 a year earlier. However, the government imposed a 20% duty on imports of certain steel products from 14 September 2015 for 200 days, which has provided temporary relief to Indian steel producers. We consequently expect the company's blended EBITDA per tonne to improve during 2HFY16.

Fitch expects JSW Steel's profitability to improve modestly in FY17, supported by moderate improvement in Indian steel demand. However, we expect Indian steel imports to remain high during 2016 and steel prices to continue to be low; and JSW Steel's EBITDA per ton is likely to remain below INR7,000.

Temporary Rise in Leverage: JSW Steel's financial profile has weakened because of a fall in profitability and increasing debt levels due to its ongoing capex. We expect the company's FFO net leverage to rise to around 5.4x during FY16 (FY15: 4.5x), which is high for its current rating. However, Fitch projects JSW Steel will deleverage in the next two to three years and expects FFO net leverage to fall below 3.5x in 2018, bringing it to a level commensurate with a 'BB+' rating. This is provided there is no further softening of steel prices or increase in imports.

Capex Nearing Completion: JSW Steel's expansion of its capacity to 18 million tonnes per annum (mpta), from 14mtpa now, is nearing completion. The company expects to complete its expansion to 18 mtpa by 4QFY16. Fitch expects JSW Steel to report free cash flows from FY17 once the capex completes and benefits from the larger capacity start flowing. We expect this to aid the deleveraging efforts.

Leading Market Position: JSW Steel has a leading market position and is among the largest steel producers in India. The company has a dominant market share in southern and western India where its plants are located. JSW Steel's market position is also supported by its increasing share of value-added products, which is likely to improve its profitability over the medium term.

Efficient Operations: JSW Steel's highly efficient operations and low costs for energy and labour support its low steel conversion cost. The company has among the lowest conversion costs globally, which underpins profitability despite the lack of vertical linkages.

Absence of Vertical Linkages: JSW Steel has minimal vertical integration for both iron ore and coking coal. This results in higher costs compared with some of its peers, because it needs to purchase these raw materials. However, the company's low conversion costs have mitigated this to a large extent, and JSW Steel has benefited from the fall in commodity prices. JSW Steel has also diversified its raw-material sourcing to minimise the impact on operations from supply disruptions.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for JSW Steel include
- Iron ore prices in line with Fitch's mid-cycle assumptions of USD50/tonne during 2016 and USD55/tonne in 2017 and soft steel prices
- Completion of expansion to 18 mtpa by 4QFY16
- No major capex after the expansion to 18mtpa
- Volume growth of over 5% in FY16 and over 10% in the next two years

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to the Outlook being revised to Stable include:
- FFO net leverage improving to 3.5x or below on a sustained basis
- Improvement in EBITDA/tonne to around USD100 in FY17 and further to around USD120 thereafter on a sustained basis (FY15: USD116)
- Free cash flows turning positive by FY17.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO net leverage exceeding 3.5x on a sustained basis
- Weakening profitability resulting in sustained EBITDA/ tonne of below USD120 beyond 2017
- Free cash flows remaining negative over the cycle.