Posted on 17 Oct 2012
Overview
-- Low steel prices have slowed a recovery in NSSMC's earnings, reducing the likelihood that the company will swiftly improve its financial risk profile, which worsened following the merger.
-- We lowered our long-term corporate credit rating on NSSMC to 'BBB' from 'BBB+'.
-- The outlook is stable, reflecting our view that although business conditions are deteriorating, the company's earnings and financial standing will gradually improve after bottoming in fiscal 2012 (ending March 31, 2013) as benefits from the merger eventuate.
Rating Action
On Oct. 17, 2012, Standard & Poor's Ratings Services lowered its long-term corporate credit and debt ratings on Nippon Steel & Sumitomo Metal Corp. (NSSMC) to 'BBB' from 'BBB+'. Low steel prices have slowed a recovery in the steelmaker's earnings, reducing the likelihood that the company will swiftly improve its financial risk profile, which worsened when Nippon Steel Corp. and Sumitomo Metal Industries Ltd. merged earlier this month. The outlook is stable, reflecting our view that although business conditions for the company are deteriorating, its earnings and financial standing will gradually improve after bottoming in fiscal 2012 (ending March 31, 2013) as benefits from the merger eventuate.
Rationale
NSSMC was created on Oct. 1, 2012, through the merger of Nippon Steel and Sumitomo Metal Industries. The resulting entity maintains a "strong" business risk profile, in our view. It has a diverse product lineup, ranging from automotive steel to high-grade seamless steel pipes for the energy industry, and solid customers. We believe the company's profitability will improve compared with those of Nippon Steel alone. NSSMC aims to generate about JPY150 billion a year as a benefit of integration by around fiscal 2015 (ending March 31, 2016). We believe this is highly feasible and have incorporated it into our base case scenario for the company's earnings outlook. In addition, we believe the company is likely to further reduce costs to cope with softening business conditions in Asia.
Nevertheless, the business environment has worsened beyond assumptions we made at the beginning of 2012. We continue to expect the company's consolidated ordinary income in fiscal 2012 to exceed combined premerger ordinary income in fiscal 2011, which declined as a result of the Great East Japan Earthquake and other disasters in March 2011. However, the degree of improvement is likely to be small and fall short of assumptions we made at the beginning of 2012. Domestic demand from the shipbuilding and auto industries has been shrinking. Also, oversupply in East Asia has softened prices and the yen remains at historically high levels; these factors are likely to prolong a squeeze in export margins, which account for about 40% of the company's steel sales. Nonetheless, we believe the company's earnings will improve gradually as merger benefits occur.
Our financial risk profile for NSSMC is "significant," which is weak for the current rating, in our view. It is weaker than that for Nippon Steel owing to the merger; the financial risk profile for Sumitomo Metals was weaker than that for Nippon Steel. The combined premerger ratio of the companies' total debt to EBITDA as of March 31, 2012, was 4.4x (we adjusted both EBITDA and total debt for lease, pension, and other debt-like obligations). We expect the ratio to remain around this level because NSSMC's earnings are weak. The ratio is likely to improve as merger benefits emerge. However, the improvement is likely to take about a year longer than we assumed at the beginning of 2012.
Liquidity
We regard NSSMC's liquidity as "adequate" according to our criteria. We view refinancing risk as low given the company's large committed credit facilities, good access to financial markets, and strong relationships with main creditor banks.
Outlook
The outlook is stable. We believe NSSMC will retain its leading business position in Japan and Asia and gradually improve its earnings and financial risk profile as merger benefits eventuate. The outlook incorporates our expectation that the debt-to-EBITDA ratio for NSSMC will be around 4.5x as of March 31, 2013. We may consider raising the ratings if merger benefits swiftly materialize and the company becomes more likely to improve its earnings and financial risk profile. For instance, if we see a higher likelihood of the debt-to-EBITDA ratio for the company decreasing to below 3.0x on a sustained basis, we may consider an upgrade. Conversely, if we see a higher likelihood of improvement in the company's earnings and financial risk profile slowing further regardless of merger benefits, we will consider a downgrade. For instance, if we expect the debt-to-EBITDA ratio to remain above 4.0x in fiscal 2013 and beyond, we will consider lowering the ratings.
