The rating on Steel Authority of India Ltd reflects the company's good market position and diverse customers in India and its favorable cost position due to its captive sources of iron ore. SAIL's good access to funding as a government related entity is an additional rating strength.
The company's deteriorating credit measures and weak operating efficiency partly offset these strengths. A delay in the completion of SAIL's capital intensive expansion plans and the challenging steel industry conditions have weakened the company's credit protection measures.
However, we assess SAIL's business risk profile as satisfactory. The company is the largest integrated steel producer in the country, although other steel producers are increasing capacities. We expect SAIL's market position to improve after it completes its expansion, which would add about 7 million tonne of steelmaking capacity over the next 1 to 2 years. Of this expansion, about 4 million tonne capacity is likely to be added by March 2013, taking the company's steelmaking capacity to 18 million tonne. SAIL also benefits from its focus on the Indian market, where demand is growing at a faster pace than in the global market.
SAIL's backward integration supports its favorable cost position. The company meets its entire iron ore requirements and 60% to 65% of its power needs from captive sources. Such integration helps offset SAIL's weaker operating efficiency due to its lower labor productivity, above average coking coal consumption, dated technology, limited value added production and sales of semi-finished goods. SAIL plans to address many of these efficiency issues through its capital expenditure for modernization.
We expect the company's operating performance to improve in the fiscal year ending March 31st 2013, and beyond on account of improving operating efficiency, capacity expansion and some improvement in the industry. SAIL's operating performance in the first quarter of fiscal 2013 is weaker than our expectation, with EBITDA margins down to about 16% from about 18% last in the corresponding period in fiscal 2012.
In accordance with our criteria for government related entities, our view of a moderate likelihood of extraordinary government support is based on our assessment of the following SAIL characteristics:
1. Strong link with the government. We expect the government to retain its majority ownership in SAIL. The current holding is 85.6%. In our view, the government is able to exert strong influence on the company's strategy through the appointment of its board.
2. Limited role in the Indian economy. SAIL does not provide public services and its market share in the domestic steel industry is about 18%.
We assess SAIL's liquidity to be adequate, as defined in our criteria. We expect the company's sources of liquidity to exceed uses by more than 1.2x in fiscal 2013. Our liquidity assessment is based on the following factors and assumptions:
1. SAIL's liquidity sources include a cash balance of INR59 billion as of June 30th 2012.
2. Sources also include our expectations of FFO of about INR 50 billion over the next 12 months.
3. The company's uses of liquidity mainly include capital expenditure of about INR 70 billion, which we believe the company would incur even during a period of stress and a modest projected dividend of about INR 13 billion over the next 12 months.
4. SAIL has scheduled long term debt of about INR 2 billion maturing over the next 12 months.
5. We expect the company's net sources of liquidity to remain positive even if EBITDA declines 20%.
SAIL has about INR 45 billion in short term borrowings under local and foreign currency working capital facilities. We believe the company would be able to roll over the short-term debt, given its strong banking relationships.
In fiscal 2014, we expect sources to cover only 50% of uses. However, we expect SAIL to tie up adequate funds for its capital expenditure. We believe the company has strong access to funding, particularly from the domestic capital markets and local banks. This is because of SAIL's leading position in terms of production in India's steel industry and its government parentage.
