OREANDA-NEWS. Fitch Ratings has maintained the Rating Watch Evolving on the 'BB' Long-Term Issuer Default Rating (IDR) of Tata Steel Limited (TSL) and 'B' Long-Term IDR of Tata Steel UK Holdings Limited (TSUKH). A complete list of rating action is at the end of this release.

The steel producers' ratings were placed on Rating Watch Evolving on 1 April 2016 after TSL's announced on 29 March 2016 that it is exploring options for portfolio restructuring in Europe, including the potential divestment of its UK operations. TSL managed to sell a key loss-making asset in May 2016, but the final structure of the group and its debt remains unclear and will affect TSL's ratings.

KEY RATING DRIVERS

Uncertainty for European Operations: TSL announced the completion of the sale of its unprofitable Long Products Europe business centred in Scunthorpe, UK, on 31 May 2016. However, uncertainty remains around the company's plans to restructure its remaining key assets in Port Talbot, UK, and IJmuiden, Netherlands, with issues, including UK pension liabilities, remaining unresolved. TSL is in discussions with strategic players, including thyssenkrupp AG (BB+/Stable), to explore the feasibility of a joint venture for its remaining European business. We assume the status quo remains, and hence, a further restructuring of assets presents a risk to our estimates.

Indian Operations Remain Under Pressure: The profitability of TSL's Indian operations declined by around 35% yoy to INR7,560 per tonne (t) in the financial year ending-March 2016 (FY16), due to weak steel prices and competition from imports. TSL's 1QFY17 EBITDA/t remains significantly less than the FY15 average, although profitability has improved following an upswing in realisations after the government imposed protectionist minimum import prices in February 2016. Domestic demand growth has been anaemic so far in FY17, with consumption over April to August 2016 increasing at just 1.3% (FY16: 5.9%). Meanwhile, producers, including TSL, are looking to increase sales volume following recent capacity expansion.

TSL's profitability could also come under pressure from the sharp increase in international coking coal prices since August 2016. There is also uncertainty on how long regulatory protection from imports will be sustained. The government lowered the number of products under MIP from 173 to 66 in August 2016 and extended the duration until 4 October 2016. Anti-dumping duties have been imposed on the remaining products; however, the duration is six months.

High Leverage: TSL's FFO-adjusted net leverage jumped to 10.9x in FY16, from 6.2x in FY15, due to poor profitability. We estimate leverage will decline over FY17-FY18, but remain relatively high at above 5x. Our forecast factors in improved realisations and better profitability at TSL's overseas operations post-sale of its Long Products Europe business. However, a decline in steel prices and a large rise in input costs are risks to our estimates.

Greenfield Plant Starts Operations: TSL has started commercial operations for the first phase of its greenfield plant at Kalinganagar in Odisha, India, with a capacity of 3 million tonnes per annum (mtpa). TSL expects to ramp up output gradually and is targeting volume of 1 mtpa in FY17. Apart from higher sales, the new plant will improve TSL's product-mix, as it specialises in producing high-grade flat products. It is also one of India's leanest steel plants. Capex is likely to moderate from FY17 with the plant's commencement.

TSL Support for TSUKH: TSUKH has high debt and modest profitability, leading to a weak standalone credit profile. The business also faces weak local demand and high costs. However, TSUKH benefits from strategic ties with its parent, TSL. This provides its IDR with a two-notch uplift in line with Fitch's Parent and Subsidiary Linkage methodology.

Tata Group Support for TSL: TSL's ratings benefit from a one-notch uplift due to potential support from the Tata Group based on TSL's strategic importance to the group.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Sales volume to decline 10% in FY17 due to lower steel production in the UK. Thereafter, volume to grow by around 6% annually as a result of higher production in India.

- Average sales realisation to improve 5% in FY17 and by 3% each year thereafter.

- Consolidated operating EBITDA margin to improve to 10% in FY17 then to 14% in FY18 (FY16: 6%).

- Average annual capex of around INR70bn from FY17.

RATING SENSITIVITIES

TSL

The Rating Watch Evolving will be resolved following a review of TSL's credit profile once Fitch has more clarity around the portfolio restructuring exercise in Europe. An upgrade is probable if the proceeds of potential asset sales are used to repay debt, reducing leverage.

However, if leverage increases due to significant closure costs for the UK operations, Fitch will downgrade the rating.

TSUKH

The Rating Watch Evolving will be resolved following a review of TSUKH's credit profile as well as the linkages between TSUKH and TSL once Fitch has more clarity around the portfolio restructuring exercise in Europe. An upgrade is probable if Fitch concludes that linkage is enhanced or if TSUKH's standalone profile improves. A downgrade is probable if Fitch deems that linkage has weakened.

FULL LIST OF RATING ACTIONS

Fitch has maintained the Rating Watch Evolving for the following ratings:

TSL

- Long-Term Foreign-Currency IDR is 'BB'

- Senior unsecured rating is 'BB'

- USD500m 4.85% senior unsecured guaranteed notes due 2020 and USD1bn 5.95% senior

Unsecured guaranteed notes due 2024 issued by ABJA Investments Co Pte Ltd, a wholly owned subsidiary of TSL, is 'BB'

TSUKH:

-- Long-Term Foreign-Currency IDR is 'B'