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

The downgrade reflects the decline in profitability and rise in leverage during a prolonged period of weak international steel prices, coupled with debt-funded investment in capacity expansion. We expect JSW Steel's leverage to moderate, given that higher capacity is now on stream, and our assumption of a gradual improvement in average selling price (ASP) from financial year 2017 (FY17, ending March 2017) following government measures to support domestic prices. However, there are still risks to ASPs from a premature lifting of regulatory protection and to financial profiles should the company embark on another phase of debt-funded expansion.

KEY RATING DRIVERS
Challenging Market Conditions: JSW Steel's profitability has been severely affected by weak steel prices in 9MFY16. Its consolidated blended EBITDA per unit declined to around INR4,800/ton(t) (USD75/t) from INR7,800/t (USD130/t) in FY15, hit by a INR8,500/t (USD170/t) fall in ASP. The global steel industry is suffering from weak demand and overcapacity, and global capacity utilisation is at a level last seen during the 2008-2009 global financial crisis. Demand growth was tepid in India at 4.7% in 9MFY16, met largely by imports which jumped by 29% yoy.

Supportive Regulation: Some relief has been provided by recent government action such as Minimum Import Prices (MIP) and a 20% safeguard duty (extended until March 2018) to protect domestic manufacturers from import pressure, with domestic steel prices having risen by around INR4,000/t (INR60/t) from the January 2016 lows. Nonetheless, prices are about 20% lower than the average for FY15, and domestic steel capacity is scheduled to jump by about 15 million tons over 2H15 and 2016.

Fitch's forecast assumes that further price hikes will be constrained in the near term, given the heightened competition among domestic producers to support utilisation rates. However, should the government remove the protectionist policies ahead of any significant improvement in the global steel market, this would derail the company's ability to develerage to a level consistent with its current 'BB' rating.

Higher Leverage: We estimate JSW Steel's consolidated FFO net leverage to jump to 6.4x in FY16 from 4.5x in FY15, due to the weak profitability. Leverage should moderate to 5.0x in FY17 and 4.1x by FY18. JSW Steel completed the expansion of its capacity by around 4 million tons per annum (mpta) to 18 mpta in March 2016. The company should benefit from FY17 from the completion of its capacity expansion, with lower capex and contribution to operating cash flows. For our leverage forecasts, we assume a gradual increase in ASPs. Hence, they are subject to the risk of weaker-than-expected steel prices.

Robust Operational Profile: JSW Steel 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, and its market position is supported by a rising share of value-added products. Its highly efficient operations and low costs for energy and labour result in one of the lowest conversion costs globally.

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 the impact to a large extent. In the current scenario, JSW Steel has in fact benefited from the fall in raw material prices compared with integrated players. Lack of domestic mining leases has also insulated the company from political and legal risks related to licence cancellation.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case include:
- Average sales volume growth of 15% in FY17 and FY18, and around 5% annually thereafter. Volume growth would be driven by recent capacity expansion and improving utilisation rates.
- ASP to improve by 3% in FY17, and by 5% over each of the next two years.
- EBITDA margin to improve to 16%-17% in FY17-FY18, from 14% in FY16. EBITDA per ton would bounce back in FY17-FY18 from FY16 lows, but remain below the FY15 level.
- Annual capex of around INR40bn in FY17, and INR25bn thereafter.

RATING SENSITIVITIES
Positive: Developments that may, individually or collectively, lead to the Outlook being revised to Stable include:
- Improvement in FFO net leverage to below 4.0x by FY18
- Ability to generate positive FCF by FY18

Negative: Developments that may, individually or collectively, lead to negative rating action include:
- Inability to improve FFO net leverage to below 4.0x by FY18
- Failure to generate positive FCF by FY18