Friday, 21 August 2009
Fitch Ratings says that it expects the Commonwealth of Independent States (CIS) steel-producing sector to show a slow rebound in 2010.
The agency will continue to monitor six key industry drivers which are likely to influence its ratings for CIS steel producers in 2010, namely the split of export and domestic sales, capacity utilisation, changes in product mix, the efficiency of non-CIS operations, the level and speed of deleveraging and exchange rate impacts.
Due to domestic economic growth, most Russian steel companies were selling 60%-70% of their output to the domestic market by the summer of 2008. However, domestic demand for steel products dropped by 30%-50% during Q408-Q109, forcing companies to shift sales to export markets such as China, the Middle East and Asia.
Export sales currently make up to 50%-70% of companies' production volumes. While Fitch believes this is an appropriate short-term strategy to boost operational and financial performance, the downsides to being an export-focused producer include lower margins, higher demand volatility, potential tariff countermeasures and a potential weakening of demand from key export markets.
Capacity utilisation rates for most CIS steel producers fell to 50%-60% in Q408 from around 90%-95% at the beginning of 2008 due to the fall in demand from end markets. At these levels, some producers may generate negative operating cash flows due to the significant share of fixed costs in their cost structures.
Fitch has noted a gradual improvement of capacity utilization in the past three months which now averages 75%-80% in Russia and 60%-70% in Ukraine. The agency expects capacity utilisation could grow to an average of 90% in Russia and 75%-80% in Ukraine by 2010.
The recovery rate in end markets for long versus flat products represents another factor to watch. Fitch expects that the recovery rate in long product prices and volumes is likely to be slower than for flat products, reflecting the lack of new projects and the difficult financial positions of real estate/development companies.
This expectation has been reflected in the actual steel price evolution to date, however the longer term price development into 2010 remains uncertain with governmental stimulus package spending for infrastructure likely to result in higher demand for long products.
Within Fitch's rating universe, Evraz Group ('BB-'/'B'/Rating Watch Negative(RWN)) is more exposed to long products, while Severstal ('B+'/'B'/RWN), NLMK ('BB+'/'B'/Stable), Metinvest B.V. ('B'/ 'B'/Negative) and MMK ('BB'/Stable) are more focused on flat products.
Evraz Group and Severstal have engaged in an M&A-type expansion strategy in recent years which has resulted in a substantial share of overseas operations. Fitch notes that geographical diversification is an appropriate strategy to expand sales and diversify regional risks, but the downsides include the high cost base of some overseas assets and difficulties with assets integration. The most affected CIS producer is Severstal, whose 2009 EBITDA margin is likely to decline below 10% (FY08: 24%), due to underperformance of its US assets.
Unlike producers with more conservative financial policies, the Evraz Group, Severstal and Interpipe ('CCC'/'C'/RWN) entered the industry recession with higher debt burdens due to the financing of M&A activity and/or technical modernization and are exposed to risks of non-complying to financial covenants, pressure on liquidity and debt refinancing challenges. For 2009 net leverage for Evraz is expected at 2.7x-2.9x (FY08: 1.6x), for Severstal at 6x-7x (FY08: 0.9x), and for Interpipe at 3.4x-3.5x (estimated FY08: 2.8x).
Fitch believes it will also be important to continue monitoring the movement in exchange rates of CIS currencies. So far in 2009 CIS steel producers have benefited substantially from local currency devaluation as export sales are in USD/EUR and the majority of costs are denominated in local currencies.
However, this could not be considered a sustainable benefit, and could reverse, for example, if the Russian rouble were to appreciate due to increasing oil prices (noting the strong positive correlation between the two).
Fitch's overall modelling assumptions are for CIS steel producers' 2009 output to decline 15%-35% and for revenues to decline 45%-65% y-o-y, with an average EBITDA margin of 19% (FY08: 30%).
Looking ahead to 2010, Fitch expects global steel demand to rebound in the first half of the year, as consumer spending and investments strengthen and destocking runs its course. Prices should strengthen from the current low levels, albeit at a slow pace. For 2010, Fitch, on average, expects revenue increases for CIS steel producers of 10%-15% y-o-y and the EBITDA margin is forecast to rise to 22%-24%.
