Source: Fitch Ratings
Fitch Ratings has downgraded ArcelorMittal S.A.’s (AM) Long-Term Issuer Default Rating (IDR) and senior unsecured ratings to ‘BB+’ from ‘BBB-‘. The Outlook on the Long-Term IDR remains Negative. The Short-Term IDR has been downgraded to ‘B’ from ‘F3’.
We believe that AM is well-placed to cope with the impact of the coronavirus pandemic, with very strong liquidity of USD10.4 billion of cash and committed credit lines against a short-term debt of USD2.6 billion. AM has a proven history of taking decisive action to manage crises, and a business that inherently features a countercyclical working capital cycle, which we believe will allow it to be free cash flow (FCF) positive in even the most challenged quarters of this year.
However, with the company well outside its negative rating sensitivity in 2019, and our base case assumption that economic fallout from the coronavirus will extend through most of 2021, translating into material pressure on steel consuming industries, including automotive and construction, we now forecast the company will be outside previous negative rating sensitivities for a ‘BBB-‘ rating until 2022, despite what we have no doubt will be a robust response from the company. This is reflected in the rating downgrade.
The Negative Outlook reflects our belief that the risks to our forecasts are skewed to the downside.
AM is the second-largest steel producer globally by actual output and the largest based on capacity with strong geographic diversification across the major steelmaking regions excluding China.
KEY RATING DRIVERS
Steel Demand Down: The spread of coronavirus pandemic and lockdown measures across Europe, the US and other regions are expected to lead to an economic slowdown in 2020. Fitch anticipates that steel demand will drop as major steel consuming industries were largely affected. With auto sales collapsing, major auto producers announced large scale temporary closures. Several manufacturing activities are under pressure, construction activity is contracting.
Steel Prices to Decline: Fitch expects that steel prices will decline in 2020 despite some growth in 1Q20, primarily due to weakening demand dynamics but also due to expected drop off of key raw material prices. However, destocking achieved last year in Europe and the US should provide some support. Even if the health crisis is contained by 2H20, we anticipate that demand will return to pre-crisis levels only towards end-2021.
Coronavirus-Related Countermeasures: AM along with other steel producers are idling crude steel capacities and finishing lines to align production with demand. This is in addition to temporary production cuts that were in place since last year. At the same time, AM will benefit from government support, placing employees in economic unemployment or temporary lay-offs to reduce fixed costs. We expect the production cuts to be more profound in Europe, which accounts for around half of AM production.
However, it can significantly affect production in other regions as the spread of the virus, especially in the US, has intensified recently. As a result, we also anticipate 2020 capex will be reduced below previous guidance.
Steel Margins Under Pressure: 2019 was a challenging year for steel producers because declining steel prices decoupled from elevated raw material costs. Lacklustre demand, trade tensions and declining industrial production together with slowdown in automotive were driving prices down while raw material prices were supported by multiple supply disruptions. As demand-driven pressure will continue amid the coronavirus spread, we anticipate that steel margins will squeeze further exacerbated by AM’s relatively high cost position on the cost curve.
As a mitigating factor, we believe that government support will offset some fixed costs of temporary closures. In combination with a decline in shipments, we project that AM’s EBITDA will decline by about 15% yoy in 2020, down from USD4.8 billion in 2019.
Leverage Remains High: FFO gross leverage reached 5.6x (4.4x on net basis) in 2019 despite the company’s efforts to preserve cash through lowering capex and asset optimisation initiatives. Amid the current market, we believe that deleveraging will be further delayed due to weaker EBITDA and FFO generation. We project FFO gross leverage materially above our previous negative sensitivity of 3.0x over the next two years. Nevertheless, AM achieved the lowest net debt since the merger of USD9.3 billion (before Fitch adjustments). In February 2020, the management reiterated its commitment to prioritise net debt reduction and stated that the company will achieve USD7 billion target by end-2020.
Ilva Deal Pending: In March 2020, AM and the Ilva commissioners signed an amendment to the lease and purchase agreement for Ilva which implies the new industrial plan for the facility. The government’s equity investment is due to be executed by November 2020, as otherwise AM will be able to withdraw from the deal. The final ownership stake will be subject to an external evaluation. We continue to consolidate Ilva and expect that the plant could continue generating operating losses this year.
AMNS India Completed: In December 2019, AM completed the acquisition of distressed Essar Steel, the fourth-largest Indian steel producer through AMNS India, a 60%/40% AM/Nippon Steel & Sumitomo Metal Corporation joint venture. JV’s performance is robust with EBITDA of about USD600 million at January 2020 run rate and annualised production at 7.4mt. At end 2019, JV’s net debt/EBITDA was about 6x, with no debt maturities in the medium term after the successful refinancing with a USD5.1 billion 10-year term loan.
Fitch expects AMNS to be self-reliant and reinvest internally generated cash flow to finance its turnaround and growth plans of about USD2.6 billion over the coming six years. At the same time, we do not assume any dividend contributions in the rating horizon. AM guarantees about USD3 billion of AMNS debt, which we added to AM’s adjusted indebtedness.
Above-Average Cost Position: CRU estimates that most of AM’s steel mills are spread between the higher second to fourth quartile on the global steel cost curve, varying across the main regions with those in the U.S. and Europe generally operating at higher costs. The position of iron ore mines is also above average. Management has implemented cost-savings measures including Action 2020, aiming at USD3 billion cost reductions over five years, of which USD2 billion has been achieved.
Fitch does not expect any short-term material shift in the company’s cost position and believes that the current cost position provides additional downside risks.
Significant Scale and Diversification: The ratings reflect AM’s position as the world’s second-largest steel producer by actual output and the largest based on capacity, the market leader in Europe and NAFTA. AM is the world’s most diversified steel producer by product type and geography, and benefits from a solid level of vertical integration into iron ore. In addition, we note a strong product mix with over 50% relating to high value-added products.
AM is the second-largest global steel producer with total output in 2019 at 89.8mt. The company has the top position in Europe, Americas (about 20% on the European and the U.S. markets) and Africa and is the fifth-largest steel producer in the CIS. AM’s peers include China Baowu Steel Group Corporation (A/Stable; bbb standalone credit profile), Gerdau S.A. (BBB-/Stable), PAO Severstal (BBB/Stable), PJSC Novolipetsk Steel (NLMK) (BBB/Stable) and EVRAZ plc (BB+/Stable).
Baowu has become the largest steel company globally after its merger with Magang Group Holding Co. Its rating is supported by its substantial operating scale, strong profitability, cash-flow generation and an adequate financial structure. The rating is constrained by its lack of raw material self-sufficiency and lower level of vertical integration and diversification compared with similarity rated global steel peers.
Gerdau is smaller in scale than AM. The company is geographically diversified across the Americas and its electric arc furnace (EAF)-based profile provides high operating flexibility. Gerdau compares favourably in terms of leverage profile following its asset divestment strategy that has led to a material reduction in gross debt with leverage expected at around 2.5x.
Russian peers PAO Severstal, NLMK and PJSC Magnitogorsk Iron & Steel Works (MMK) (BBB/Stable) are less geographically diversified, with the sales of Severstal and MMK focused on the domestic market (60%-70% share of domestic sales), while NLMK’s sales are spread across Russia, Europe and partly the U.S. AM has a higher value added and more sophisticated product mix than the Russian companies. The three Russian peers sit in the first quartile of the global steel cost curve due to higher raw materials integration, domestic currency weakness against the dollar and lower energy costs. Their leverage profile is one of the strongest across the steel industry with FFO gross leverage at below 1.5x on a sustained basis.
-Iron ore and coking coal prices in line with Fitch’s commodity price assumptions. Iron ore: USD75/t in 2020, USD60/t in 2021 and afterwards. Coking coal: USD140/t in 2020-2023
-Low double-digit decline in steel shipments in 2020 due to lockdown measures with gradual recovery afterwards
-EBITDA margin in steel segment under pressure in 2020-2021 before material recovery, thereafter
-Reduction in capex and dividend in 2020 and 2021 based on Fitch’s estimate
– Gradual increase in capex towards USD3.5 billion in 2022
-Working capital release in 2020 and reverse in 2021
-Completion of assets optimisation programme in 2020-2021.
Factors That May, Individually or Collectively, Lead to Negative Rating Action/ Downgrade
– FFO gross leverage sustained above 3.8x and 3.3x on net basis
– EBITDA margin below 8% on a sustained basis
– Persistently negative FCF (post dividend)
– Failure to carry out debt reduction as committed due to large debt-funded M&A, aggressive capex, increased shareholder distributions or weaker steel market environment
Factors That May, Individually or Collectively, Lead to Positive Rating Action/ Upgrade
The rating is on a Negative Outlook, therefore, positive rating action is unlikely in the short term. However, the company’s ability to maintain FFO gross leverage below 3.8x on a sustained basis would lead to the Outlook revision to Stable.
– FFO gross leverage sustainably below 2.8x and 2.3x on net basis would lead to an upgrade.
– EBITDA margin above 10% would also support an upgrade.
– FCF (post dividends) margin above 2% on a sustained basis.
BEST/WORST CASE RATING SCENARIO
Ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings fitchratings
LIQUIDITY AND DEBT STRUCTURE
Strong Liquidity: As of FY19, AM had USD10.4 billion of liquidity including USD4.9 billion of readily available cash and fully available USD5.5 billion long-term committed revolving credit facilities that mature at end-2024 (apart from USD0.1 billion that mature at end-2023). This compares with about USD2.6 billion of short-term debt maturities.
The company has good capital market access, evidenced by the successful issuance of EUR750 million 1% notes due 2023 and EUR750 million 1.75% notes due 2025 in November 2019. Fitch also forecasts that the company will generate positive post-dividend FCF in the next three years.
AM has a Commercial Paper Programme with a total amount of EUR1.5 billion, of which USD1.2 billion was utilised at end-2019.
SUMMARY OF FINANCIAL ADJUSTMENTS
– Fitch has reclassified leases as other liabilities, effectively reducing balance-sheet debt by about USD1.1 billion at end-2019. Furthermore, Fitch has reclassified USD343 million of depreciation of right of use assets and USD98 million of interest on lease liabilities as lease expenses, reducing Fitch EBITDA by USD441 million in 2019
– Fitch has adjusted balance-sheet debt as at end-2019 by including the utilised amount of the true sale of receivables programme of about USD4.4 billion
– USD1 billion mandatory convertible bonds reclassified as debt instead of non-controlling interest and other liabilities reported in the financial statements
– Fitch has adjusted EBITDA by non-recurring impairment charges of USD2.7 billion in 2019
– Fitch added debt of third parties and AM’s joint ventures (excluding Calvert JV) guaranteed by AM of USD3.7 billion to AM’s debt
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG issues are credit neutral or have only a minimal credit impact on the entity(ies), either due to their nature or the way in which they are being managed by the entity(ies).