TRIS Rating Co., Ltd. has downgraded the company rating of Sahaviriya Steel Industries PLC (SSI) to “BBB-” from “BBB” and has changed the rating outlook to “stable” from “negative”. The downgrade reflects TRIS Rating’s expectation of SSI’s weakened operating performance over the next several quarters amidst weak demand, high inventory costs, and negative market sentiment due to a slowdown in the world economy. The ratings are constrained by a high level of competition from both local and overseas steel manufacturers, the cyclical nature of the steel industry, short-term customer contracts (one to three months), and limited operating diversity. The ratings however are supported by SSI’s leading position in the domestic hot-rolled coil (HRC) market, its strong relationships with customers, and a variable cost structure that enhances production flexibility.
The “stable” outlook reflects TRIS Rating’s expectation that SSI will continue to manage inventory carefully amidst extreme price volatility. The company is also expected to generate adequate cash flow to service its debt obligation.
TRIS Rating reported that though SSI’s operating performance in the first nine months of 2008 was better than expected, the full year performance is likely to weaken due to the contraction of steel prices since the third quarter. The solid performance in the first six months was supported by a robust steel price and the benefit of having low cost inventories with approximately three months turnover carried from 2007. Consequently, funds from operations (FFO) and operating margin improved to Bt2,285 million, 11.10%, compared with Bt643 million, 6.37%, in the same period of the previous year. Sign of weakening performance began to be seen in the third quarter due to a sharp decline of the metal spread and sales volume. The metal spread in the third quarter dropped by 26% from the second quarter and the sales volume contracted by 45% as customers held back on purchasing, expecting the negative price trend to continue. The company also delayed sales as prices dropped below costs. The operating margin in the third quarter dropped to 4.17%, compared with 12.15% in the second quarter. Due to a sharp drop of steel prices, SSI had to set a provision for diminution in value of inventories totaling Bt1,358 million in the third quarter. Fortunately, during the year the company procured raw materials carefully. SSI’s slab inventories dropped significantly from 240,560 tonnes as of December 2007 to 117,467 tonnes as of September 2008. Though most of SSI’s borrowing was used to fund working capital, outstanding debt as of September 2008 increased by Bt4,726 million to Bt16,614 million from Bt11,888 million as of December 2007. This was due to the effect of higher steel prices and additional debt to fund an acquisition of Thai Cold Rolled Steel Sheet PLC’s (TCR) shares. As of September 2008, FFO to total debt and total debt to capitalized ratio were 13.18% and 42.09%, respectively. With expected lower revenue and earnings, and a rigid margin, cash flow protection measures are likely to weaken. The company may have a narrow cushion relative to its financial covenants, especially under the debt service coverage ratio (DSCR), which SSI has to maintain at not lower than 1.25 times in relation to any semi-annual period. As of September 2008, the DSCR ratio was 1.59 times. Based on good relationship with lenders, should the company breached financial covenants, lenders should be willing to waive covenants.
TRIS Rating said, there are three manufacturers of HRCs in Thailand. SSI is the market leader in terms of production and sales volume. Unlike integrated steel mills and mini-mills, SSI does not manufacture steel, but processes semi-finished steel slabs into flat-rolled coils. SSI owns a single production facility located close to a deep-sea port in Prachuap Khirikhan province. The sea port location was strategically chosen to cut transportation costs for both raw materials and finished steel products. Its domestic clients accounted for 93.86% of total shipments in the first nine months of 2008. The Thai steel industry is somewhat protected by government policies. Local producers benefited from anti-dumping (AD) tariffs ranging from 3.45% to 128.11% on products imported from 14 countries. While, the AD expired in May 2008, the Committee on Dumping and Subsidies is currently considering whether to extend the measures. However, local producers are prone to be negatively affected by the influx of low cost steel from countries not subject to anti-dumping tariffs, particularly China.
SSI’s operational risk stems from its concentration of operation in a single production facility, which means that any unplanned shutdowns could impact cash flow stability. In addition, the lack of vertical integration and product diversity exposes the company to the volatility of supply and demand for slabs and HRCs in the world market. SSI’s business model to stock a broad range of slabs to meet customers’ needs exposes it to inventory holding risk and a high working capital requirement. Nonetheless, SSI benefits from a cost structure with high variable costs, which allows for production flexibility. The company can adjust its production schedule to match the market environment, said TRIS Rating. -- End
Company Rating: Downgraded to “BBB-” from “BBB” Rating Outlook: “Stable” from “Negative”
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