Corporates

Metals&Mining India OutlookReport

RatingOutlook

2011 Outlook: Indian Steel

RatingOutlook
Stable Outlook for 2011: Fitch Ratings has a stable outlook for the Indian steel industry in 2011 on the back of increasing demand from the automobile, white goods and construction sectors, coupled with government spending on infrastructure. The fundamentals of the Indian economy remain strong with GDP growing 8.9% yoy in Q310. According to the World Steel Association (Worldsteel), India will become the third largest steel consuming country by 2011 with demand for 68 million tonnes (mt). Fitch expects Indias steel demand to grow at 7%9% over next two years. Pressure on Profitability: The profitability of domestic steel companies came under pressure due to a decline in steel prices in Q310 because of sluggish demand and a rise in input costs. The prices of steel products are expected to increase in 2011 due to a rise in costs and robust domestic demand. However, profitmargin for nonintegrated producers may be adversely affected as full raw material cost pass through could be challenging. On the other hand, producers with captive iron ore and/or coking coal mines could see margin expansion. Overcapacity Concerns: Fitch expects the domestic steel industry to suffer from overcapacity in the mediumtolong term. Several brownfield site investments will be completed over 20112013 adding another 30mt35mt of steel capacity. Domestic steel producers will have to focus on exports to maintain their operating rates to remain profitable. 2011 should not be affected by overcapacity as growth in steel consumption is expected to outpace production. Change in Price Mechanism: In 2010 the global steel industry saw the demise of the annual pricing mechanism for raw material contracts, which were substituted by quarterly pricing contracts. This has led to increased volatility in raw material prices and in turn has increased the unpredictability in profitability of the companies. The unpredictability could further increase if the pricing contract shifts to monthly pricing. Changing Regulations: The Indian government has proposed to amend the Mining and Mineral Act by making it obligatory for mining companies to share 26% of the net profit with the displaced population. If the proposed legislation is implemented, the profitability of steel producers will be adversely affected. However, by making displaced people stakeholders in the project, land acquisition may become easier and steel producers may be able to get faster access to captive raw materials.

S T A B L E E
Analysts
Ashish Upadhyay +91 11 4356 7245 ashish.upadhyay@fitchratings.com Rohit Sadaka +91 33 4006 5885 rohit.sadaka@fitchratings.com Muralidharan Ramakrishnan +91 22 40001700 muralidharan.r@fitchratings.com Rakesh Valecha +91 22 4000 1740 rakesh.valecha@fitchratings.com

RelatedResearch
Applicable Criteria Corporate Rating Methodology (August 2010) Other Research 2011 Outlook: Steel Producers (December 2010) 2011 Outlook: Mining & Base Metals Producers (December 2010) 2011 Outlook: Indian Auto Sector (January 2011) 2011 Outlook: Indian Auto Suppliers (January 2011) Other Outlooks www.fitchratings.com/outlooks

National Rating Outlooks Metal & Mining

(%) 100 80 60 40 20 0 88

WhatCouldChangetheOutlook
The sector outlook could be revised to negative in the event of a sharp decrease in global steel prices due to a return of the recession in the international market, leading to a surge in imports due to robust Indian demand. This would hit the profitability of domestic steel producers. Conversely, the sector outlook could be revised to positive in the case of a sustained recovery in global steel prices resulting in reduced imports and improved profitability for the domestic steel producers.

2 Positive Stable

10

Negative

Source: Fitch

www.fitchratings.com

4 January 2011

Corporates
KeyIssues
Growth Trajectory Intact: Fitch forecasts Indias GDP to grow at 8.7% in the fiscal year ending in March 2011 (FY11). Fitch expects Indias steel consumption to grow in the shorttomedium term with strong growth in automobiles, white goods, oil and gas, infrastructure and construction. Steel demand will be further boosted by the rural sector on the back of good monsoons, and is set to grow at 7%-9% over the next two years. India remained a net importer of steel during FY10, with net imports of 4.0mt. Moreover, Indias per capita consumption of steel at approximately 47kg compared to global average of 200kg provides a huge potential for growth. Fitch expects India to remain a net importer over the next 12-18 months given regulatory challenges in adding new plant on greenfield sites.
India's Crude Steel Production
(M T) 70 60 50 40 30 20 1 0 0 Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 YTD YTD No v09 No v10

So urce:Wo rldSteel

Production Growth to Accelerate: Fitch anticipates domestic steel production to grow at 8%9% in the shorttomedium term on account of robust domestic demand coupled with the addition of new capacity, and subdued imports. Imports have fallen on the back of a continuous decline (monthonmonth, June to September 2010) in steel production in China due to production cuts to meets its energy efficiency target for 2010. This coupled with the scrapping of export rebates by the Chinese government made steel exports an unviable activity for most Chinese steel producers. Furthermore, consumption of finished steel has grown at a much faster pace than production since 2005. According to the Centre for Monitoring Indian Economy (CMIE), steel consumption has grown at a CAGR of 10.4% since 2005, while steel production has grown at a CAGR of 7.6%. However, with the significant addition of new capacity in the medium term, production growth is expected to outpace consumption growth.
Brownfield Capacity Expansion
(MT) 100 80 60 40 20 0 Increase in FY11 Increase in FY12 Increase in FY13 FY10 FY13 94 66 3.9 12.0 12.5

Risk of Overcapacity: Despite the setbacks suffered by large steel producers in greenfield development due to regulatory hurdles covering land acquisitions and the rehabilitation of settlements, Fitch continues to see the risk of overcapacity in the steel industry in the mediumtolong term. India will see significant capacity addition of about 30mt35mt due to the completion of brownfield sites over 2011 to 2013. The excess supply may put pressure on steel prices, resulting in reduced profitability. However, Fitch expects steel manufacturers to export a substantial proportion of their production to protect their margins and maintain their operating rates by exploiting Indias position as a low cost producer of steel. Fitch notes that the credit metrics of steel companies could deteriorate in 2011 as they take on debt to complete capex, however, will remain commensurate with the outstanding ratings. The domestic steel industry is grappling with various environmental issues. The Ministry of Environment and Forests (MoEF), has issued showcause notices to various companies for violating environmental laws, which has also adversely affected the bigticket projects of both global and Indian steel makers in India. This will further delay the capacity addition in the steel industry and may alleviate some of the overcapacity concerns.

Source: Market

2011 Outlook: Indian Steel January 2011

Corporates
Revenue & Profitability Trends (Top 5 Players)
Revenues (LHS) EBITDA margin (RHS) (INRm) 300,000 200,000 100,000 0 Q3FY10 Q4FY10 Q1FY11 Q2FY11 (%) 40 30 20 10 0

Pricing and Profitability: Steel manufacturers margins in India were adversely affected in Q310 by an increase in input costs and an inability to fully pass on the cost to consumers due to sluggish demand. The prolonged monsoon in India also suppressed the demand for long products due to a slowdown in construction activity. To partially offset the rise in input costs, domestic steel producers raised the prices of flat products by INR1,0001,500 per tonne in September 2010. This was followed by another hike of about 3%4% across all products in October 2010. Globally, contract prices for iron ore and coking coal decreased by 10% in Q410 compared with the previous quarter due to weak demand from China. With the decrease in iron ore and coking coal prices in Q410, and anticipated growth in demand coupled with price increases, the profit margins of major steel producers are expected to improve in Q410. Fitch expects domestic steel prices to rise in 2011 on account of cost push inflation and robust domestic demand. However, the ability to raise prices in the Indian market is limited by the global nature of the market, coupled with oversupply and weak demand in the international market. Sovereign concerns in Europe may also cap the global steel prices as troubled nations in Europe cut spending to contain their fiscal deficits, thus hitting demand. The profitability of steel producers will be adversely affected in 2011 if they are unable to pass on the full increase in input costs.
Key Raw Materials Price Trend (FOB)
(USD/to n) 300 250 200 1 50 1 00 50 0 18 1 8 2001 1 8 2002 19 2003 22 2004 40 42 47 47 56 35 2005 45 50 109 1 18 102 81 69 1 72 128 1 22 61 133 HardCo kingCo al 253 225 200 209 225 Iro nOreFines(63%Fe)

Source: Fitch

2000

2006

2007

2008

2009

Q1 0 1

Q210

Q31 0

Q41 0

Q1 11

So urce:Industry

Regulatory Changes: To increase the availability of iron ore to domestic steel producers, the government raised export duties 10% to 15% in April 2010, however, the 5% export duty on iron ore fines remained unchanged. The steel producers demand for a 20% uniform duty on the export of iron ore was rejected by the government as domestic steel producers mostly consume iron ore lumps and a hike in the duty for iron ore fines would not have served any purpose. Fitch believes that unless there is significant addition of pellet plants in the country or India gains technical knowhow to effectively use iron ore fines, export duties on iron ore fines may not see much change from the existing level. Under the draft Mines and Minerals (Development and Regulation) Act, 2010, the government has proposed profit sharing with the people affected by miningrelated operations. Fitch notes that domestic steel producers with captive mines in India do not treat mining as a separate profit centre and various accounting issues will have to be addressed before the act comes into force. The profit sharing will adversely affect the profitability of Indian mining and steel companies. However, on the plus side, it may address land acquisition issues like rehabilitation and resettlement, and thus result in the obtaining of faster raw material linkages. Fitch notes that none of the global steel producers have been able to make significant inroads into the domestic steel industry on their own and the agency expects these producers to enter by having joint ventures with domestic steel producers. The joint venture route is expected to benefit the domestic steel
2011 Outlook: Indian Steel January 2011

Corporates
industry in terms of technological transfer and global steel producers in gaining a foothold in India. To prevent illegal mining, the state government of Karnataka has banned exports of iron ore. The move was challenged in the Karnataka High Court, which upheld the ban. The ban is now challenged in the Supreme Court. Since Karnataka constitutes 25% of the total exports of iron ore from India, the ban will hit the profitability of standalone mining companies with operations concentrated in Karnataka. Moreover, a similar action from other states grappling with illegal mining may pose a serious risk to the viability of mining companies dependent on exports of iron ore.

2010Review
In line with Fitchs expectation, the outlook for the majority of Indian steel companies remained stable in 2010. For the most part, earnings recovered from the weakness experienced during the downturn. Domestic steel prices continued to recover through first half of 2010 but failed to reach precrisis levels. According to Worldsteel, Indias crude steel production grew by 7.4% to 60.69mt during January to November 2010 compared to the corresponding period last year. The domestic growth in steel industry was largely driven by sharp recovery in automobile and white goods and was supported by Indias infrastructure spending. The automobile industry registered a year through 31 October 2010 growth of 33.7% on account of strong demand in both commercial as well as passenger vehicles. Mahindra Ugine Steel Company Ltd (BBB+(ind)/Positive) is on Positive Outlook, which reflects its strong growth in the auto segment, continuous efforts to diversify the customer segment for its alloy steel business and the likely improvement in its profitability. The companies on Negative Outlook (see Annex 1) reflect uncertainty with regard to the timeliness of capex completion and a deterioration in financial leverage. 2010 was a watershed year for the global steel industry as annual contracts for raw material prices gave way to quarterly contracts. Raw material prices also increased through the first three quarters of 2010 and then eased in Q4. The steel industry to a large extent absorbed the new raw material pricing mechanism. India, being mostly dependent on imports for coking coal, is more affected by the volatility in coking coal prices, though domestic ironore prices have also moved in tandem with global prices, albeit at a discount. Brownfield expansion continued to progress in 2010, however greenfield projects grappled with land acquisition, environment and resettlement and rehabilitation issues.

2011 Outlook: Indian Steel January 2011

Corporates
Annex: 1
National Ratings Coverage
Adhunik Alloys & Power Limited Adhunik Corporation Ltd Adhunik Industries Limited Adhunik Metalliks Limited Ambica Steels Limited Aradhya Steel Pvt. Limited Aruna Alloy Steels Pvt Ltd. Asian Colour Coated Ispat Limited Austral Coke & Projects Ltd Balasore Alloys Limited Bhaskar Shrachi Alloys Limited Bhushan Power & Steel Limited Bhushan Steel Limited Bonai Industrial Company Limited Brahmani River Pellets Limited CG Ispat Private Limited (CGIPL) Cosmic Ferro Alloys Ltd Emerald Mineral Exim Pvt. Ltd. Feegrade & Company Private Limited Gallant Ispat Limited GontermannPeipers (India) Limited Govinda Impex Limited Hansa Metalliks Ltd. ISMT Ltd Mangilall Rungta Mahindra Ugine Steel Company Ltd. P.S. Krishnamurthy Steels Private Limited PSL Limited Rabirun Vinimay Pvt. Ltd. Rashmi Metalliks Limited Rashtriya Ispat Nigam Limited Rungta Mines Ltd (RML) Rungta Sons Pvt Ltd Sai Sponge (India) Limited Shivam Meltech Pvt. Limited Shri Bajrang Power and Ispat Limited Shri Bajrang Metallics and Power Ltd Shri Mahavir Ferro Alloys Private Ltd. Sri Gayatri Minerals Pvt. Ltd Steel Authority of India Limited Tata Steel Limited Thangam Steel Limited Tirumala Balaji Alloys Private Limited Trimex Mineral Private Limited Usha Martin Limited Uttam Galva Steels Ltd. (UGSL) Vikash Metals and Power Limited Zion Steel Ltd
Source: Fitch

LongTerm National Ratings BB+(ind) BB(ind) BBB(ind) BBB(ind) BB+(ind) BB(ind) BB+(ind) BBB(ind) BBB+(ind) B+(ind) B+(ind) A(ind) A(ind) AA(ind) BB+(ind) BB+(ind) BB+(ind) B(ind) AA(ind) B+(ind) BBB+(ind) B(ind) BB(ind) A(ind) A(ind) BBB+(ind) BB+(ind) A(ind) BB(ind) BB+(ind) AA(ind) AA(ind) AA(ind) BB(ind) B(ind) BBB+(ind) BBB+(ind) BB(ind) BB+(ind) AAA(ind) AA(ind) BB+(ind) BB+(ind) B(ind) A+(ind) A(ind) C(ind) B+(ind)

Outlook Stable Stable Stable Stable Stable Stable Stable Stable Rating Watch Negative Stable Stable Stable Stable Stable Negative Stable Stable Stable Stable Negative Stable Stable Stable Negative Stable Positive Stable Stable Stable Stable Stable Stable Stable Stable Stable Stable Stable Stable Stable Stable Stable Stable Stable Negative Stable Stable Stable Stable

2011 Outlook: Indian Steel January 2011

Corporates

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS . IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE.
Copyright 2011 by Fitch, Inc., Fitch Ratings Ltd. and its subsidiaries. One State Street Plaza, NY, NY 10004.Telephone: 18007534824, (212) 9080500. Fax: (212) 4804435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings, Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitchs factual investigation and the scope of the thirdparty verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of preexisting thirdparty verifications such as audit reports, agreedupon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent thirdparty verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitchs ratings should understand that neither an enhanced factual investigation nor any thirdparty verification can ensure that all of the information Fitch relies on in connection with a rating will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings are inherently forwardlooking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings can be affected by future events or conditions that were not anticipated at the time a rating was issued or affirmed. The information in this report is provided as is without any representation or warranty of any kind. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion is based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at anytime for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of Great Britain, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.

2011 Outlook: Indian Steel January 2011