Tata Steel shares attract investors’ attention after Fitch boosts rating to 'BBB-'

Tata Steel Ltd.'s shares are set to attract attention in Tuesday's, 10 October, morning trading session following an upgrade in its issuer default rating (IDR) by Fitch Ratings. The rating agency raised Tata Steel's IDR from 'BB+' to 'BBB-' while maintaining a stable outlook. Fitch Ratings also increased the rating on ABJA Investment's $1 billion notes, due in July next year and guaranteed by Tata Steel, from 'BB+' to 'BBB-'.

This upgrade from Fitch Ratings is a result of the improved standalone credit profile of Tata Steel, which has moved up from 'bb' to 'bb+'. This improvement is attributed to reduced uncertainty and decreased financial risk associated with its operations in the UK. Tata Steel is planning to replace its blast furnaces with more cost-efficient and environmentally friendly electric arc furnace (EAF)-based steelmaking capacity, which is expected to enhance competitiveness and reduce costs in its UK operations.

Fitch Ratings also pointed out that Tata Steel's IDR benefits from a one-notch uplift due to potential support from the Tata group. Furthermore, the rating agency highlighted the strength of Tata Steel's global cost position, particularly in India, where it enjoys significant raw material sufficiency.

Fitch Ratings anticipates a decline in “Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)” leverage over the next three years, driven by increased capacity, output, and EBITDA. Tata Steel has ambitious plans to double its capacity in India by 2030, but the agency believes that risks to its financial profile are mitigated by its commitment to maintaining a net debt/EBITDA ratio of two times or lower.

The UK assets of Tata Steel have been a weak link in its portfolio in terms of cost position, with a reported EBITDA loss of around £130 million in FY23. However, the company's plan to install an EAF-based steelmaking capacity of 3 million tonnes per annum (mtpa) at Port Talbot, UK, within the next three to four years is expected to transform the UK business, making it profitable even during industry downturns. Tata Steel anticipates a substantial improvement in its cost base in the UK, with a reduction of GBP150-170/tonne (t) compared to the unit loss in FY23.

To support this transformation, the UK government has agreed to fund up to £500 million, approximately 40% of the planned capex of £1.25 billion, while Tata Steel may undergo significant workforce reductions, incurring restructuring costs.

Tata Steel's Indian operations source nearly 100% of their iron ore and 22% of their coal requirements from the company's mines. Additionally, its plants in Kalinganagar and Jamshedpur are among the lowest-cost assets globally, according to Fitch Ratings. This strong cost base in India provides Tata Steel with a significant competitive advantage, particularly during periods of volatile steel prices.

Fitch Ratings expects Tata Steel's consolidated sales volumes to increase by 2% in FY24, rebounding from a decline in FY23 primarily due to lower sales in Europe. Further volume growth is anticipated in FY25 and FY26, driven by the expansion at Kalinganagar.

In terms of EBITDA leverage, Fitch estimates a decline to 2.5 times by FY26, with a continuous improvement beyond FY24's 2.9 times and FY23's 2.8 times.