Posted on 29 Mar 2021
Fitch Ratings has revised ArcelorMittal S.A.’s (AM) Outlook to Positive from Negative while affirming the steel group’s Long-Term Issuer Default Rating (IDR) and senior unsecured ratings at ‘BB+’. A full list of ratings is provided below.
The Positive Outlook reflects the group’s revised capital-allocation framework addressing shareholder distributions, decisive actions by AM to preserve its financial profile during the pandemic that resulted in absolute debt reduction as well as forecast deleveraging and positive free cash flow (FCF) generation. A faster-than-expected rebound in steel markets, plus announced measures to optimise costs, a streamlined asset base and gains from realisation of organic growth projects, have led to upward revisions of our forecasts.
We expect AM to use cash flow generated during the current market peak in a balanced approach between debt reduction, shareholder returns and investment targets. As AM’s net debt target of USD7 billion already achieved in 2020 is below Fitch-adjusted debt, we would expect the group to continue repaying gross debt and adhere to more stringent debt ratios than its public guidance, which would be commensurate with a rating upgrade.
KEY RATING DRIVERS
Navigating Through 2020: AM addressed pandemic pressures with measures to preserve FCF and strengthen its balance sheet, including USD2 billion common shares and hybrid issuance, dividend suspension and optimisation of fixed costs. Coupled with market recovery these resulted in a stronger performance than we expected with EBITDA of USD4.3 billion in 2020. AM’s reported net debt fell to USD6.4 billion, its lowest ever and below its target of USD7 billion, hence allowing it to recommence shareholder distributions. However, on a Fitch-adjusted basis funds from operations (FFO) gross leverage was 7.4x (5.4x net), largely exceeding our negative rating sensitivity.
Strong 2021 Expected: Steel companies responded to a pandemic-induced fall in demand in a disciplined manner with idling up to 30% capacities or by operating at reduced run rates in 2020. Since lockdowns were eased, capacity restarts have been lagging demand recovery and along with low inventories, led to a shortage in the value chain, translating into a price rally and high margins. We expect the current price gains to be short-lived, but they will support 1H21 results, given European steelmakers’ full order books. We forecast AM’s reported EBITDA at close to USD9.5 billion in 2021 with possible upside depending on the pace of price moderation.
New Financial Policy: The capital-return policy introduced in February completed AM’s capital-allocation framework, which envisages a progressive base dividend of a proposed USD330 million, starting in 2021. After the dividend is paid out, remaining FCF will be divided between share buybacks and retention. Share buybacks are subject to net debt/EBITDA being below 1.5x; otherwise only the base dividend is paid.
Further Debt-Reduction Potential: Fitch expects AM to take a balanced approach to distributing excess cash flows between shareholder returns, capital investments and debt repayment. Strong FCF generation in 2021-2022, coupled with anticipated high cash balances, would allow the group to repay gross debt, which would translate into FFO gross leverage of 2.8x, a level that is commensurate with investment- grade rating. Fitch’s guidance for the investment-grade rating is tighter than AM’s stated financial policy due to debt adjustments of USD8.6 billion, and we would therefore expect AM to pursue more stringent leverage metrics compared with the targeted levels.
Ilva Deconsolidation Credit Positive: The new arrangement between AM and Invitalia, an Italian state-owned company, to form a public-private partnership to recapitalise Ilva will allow AM to deconsolidate the loss-making entity. Invitalia will primarily fund the EUR1.9 billion capex for the asset turnaround while AM’s contribution is expected to be limited to EUR70 million. Ilva will be operated as a joint venture (JV) between AM and Invitalia.
Organic Growth in Focus: Sale of its US assets and the new agreement on Ilva streamline AM’s asset portfolio and allow more focused investments in strategic projects. Key investment projects with a total budget of US1.5 billion include two projects in the growing markets in Brazil and Mexico and recommencement expansion in Liberia that will add 10 million tonnes (mt) iron ore production by 2024. These projects are expected to add USD600 million EBITDA by 2024.
Above-Average Cost Position: CRU estimates that AM’s lowest-cost operations in Ukraine and Brazil sit in the first quartile and higher-cost operations in Europe and NAFTA in the second to fourth quartile. The cost position of its iron ore mines is also above average. During the pandemic AM reduced fixed costs to align with lower production and identified several ways to make permanent fixed-cost reductions by closing less efficient facilities, reducing overheads, insourcing of the repair function and increasing productivity. These measures should reduce costs by USD1 billion in total by 2022.
Environmental Agenda: AM Europe aims to reduce Scope 1 carbon dioxide emissions in steelmaking by 30% by 2030 and to achieve net zero emissions by 2050. In the medium term emissions can be reduced by a higher use of scrap in steelmaking and increased application of carbon capture and utilisation. These are less capex-intensive and expected capex requirements are included in AM’s budget. In the longer run carbon-neutral steelmaking is expected to rely on the direct reduced iron-EAF (electric arc furnace) route based on renewable energy. The cost of such transformation is significant, but given uncertainty around the regulatory framework and availability of technologies, we are not incorporating it into our forecast.
Capturing Growth Potential in India: AM has a 60% share in AMNS India JV with Nippon Steel & Sumitomo Metal Corporation that acquired the distressed Essar Steel. Essar is the fourth-largest Indian steel producer with up to 7.5 mt capacity and high self-sufficiency in iron ore and pellets. In 2020 Essar produced 6.6 mt crude steel and generated EBITDA of USD679 million. Net debt /EBITDA was around 6x, with no debt maturities in the next four years under its USD5.1 billion 2030 term loan facility. AM guarantees USD3.1 billion of AMNS’s debt, which we add to AM’s adjusted indebtedness.
We expect AMNS to be self-reliant and to reinvest internally generated cash flow to finance its turnaround as well as its growth plans (of about USD2.6 billion) over the coming five years. At the same time, we do not assume any dividend contributions over the next four years.
Significant Scale and Diversification: AM is the world’s second-largest steel producer by actual output and installed capacity with a leading position in its key regions. AM is the world’s most diversified steel producer by product type, industrial application and geography. It benefits from vertical integration into iron ore. It also has a strong product mix, with a significant share of high value-added products, being the global leader in automotive steels.
DERIVATION SUMMARY
AM is the second-largest global steel producer with 71.5 mt of output in 2020 and ranks behind only China Baowu Steel Group Corporation Limited (A/Stable; ‘bbb’ Standalone Credit Profile), which has become the largest producer through a series of consolidations. AM is the largest steel producer in Europe, accounting for around 20% of the market, has over a 30% market share in Brazil, over 50% each in Canada and Africa and is the fifth-largest steel producer in the CIS. It is also exposed to developing Indian, Chinese and US markets via JVs.
AM’s peers include China Baowu Steel Group Corporation Limited, Gerdau S.A. (BBB-/Stable), PAO Severstal (BBB/Stable), PJSC Novolipetsk Steel (NLMK) (BBB/Stable), PJSC Magnitogorsk Iron & Steel Works (BBB/Stable) and EVRAZ plc (BB+/Stable).
Baowu’ rating is supported by substantial operating scale, strong profitability, low-cost operations, cash flow generation, an adequate financial structure and state support. The rating also takes into account its lack of raw material self-sufficiency and lower diversification. Similarly to AM, Baowu is largely exposed to the automotive sector with AM being the largest steel supplier to automotive with around a 17% global market share while Baowu ranks third.
Gerdau is smaller in scale than AM. It is geographically diversified across the Americas and its EAF mini-mills-based profile provides high operating flexibility. The ability to source scrap, largely internally, allows it to lock in stable margins between scrap and steel prices. Gerdau, like ArcelorMittal Brazil, has a leading position on the Brazilian steel market. Gerdau’s leverage profile compares favourably, following the company’s asset-divestment strategy that led to a material reduction in gross debt, with leverage expected at around 2.5x in the next three years and tested commitment to a sound financial structure.
Russian peers PAO Severstal, NLMK and MMK 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 US. 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 US dollar and lower energy costs. Their leverage profiles are some of the strongest in the steel industry, supported by conservative financial targets, with FFO gross leverage below 1.5x.
KEY ASSUMPTIONS
– Iron ore and coking coal prices in line with Fitch’s commodity price assumptions. Iron ore: USD125/t in 2021, USD90/t in 2022, USD80/t in 2023 and USD70/t afterwards. Coking coal: USD135/t in 2021-2022, USD140/t in 2023 and thereafter
– Mid-single digit decline in steel shipments in 2021 due to the sale of US assets and deconsolidation of Ilva, followed by low double-digit growth until 2023
– EBITDA margin in the steel segment to retreat from the peak of 2021 towards a normalised level
– Capex of around USD3 billion per year in the next four years
– Progressive increase in dividend and half of FCF (AM’s definition) to be used for share buybacks as projected net debt/EBITDA remains within its target
– Working capital accumulation in 2021 and partial reverse in 2022
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
– FFO leverage sustainably below 2.8x (gross) and 2.3x (net)
– Deployment of excess cash towards gross debt reduction and commitment to a revised capital- allocation policy with a balanced approach between deleveraging and shareholder returns
– EBITDA margin above 10% on a sustained basis
– FCF (post dividends) margin above 2% on a sustained basis
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– Since the rating is on Positive Outlook, negative rating action is unlikely at least in the short term. However, inability to reduce FFO leverage to below 2.8x (gross) and 2.3x (net) would result in the Outlook being revised to Stable
– FFO leverage sustained above 3.8x (gross) and 3.3x (net) would put negative pressure on the rating
– EBITDA margin below 8% on a sustained basis
– Persistently negative FCF (post-dividend)
– Failure to carry out debt reduction due to large debt-funded M&A, aggressive capex, increased shareholder distributions or a weaker steel market
Source:Fitch Ratings
