Rating Methodology for Primary Non-Ferrous Metal Manufacturers

Transcription

1 RATING METHODOLOGY December 2017 ICRA Rating Feature Rating Methdlgy fr Primary Nn-Ferrus Metal Manufacturers This rating methdlgy updates and supersedes ICRA's earlier methdlgy nte n the sectr, published in September While this revised versin incrprates a few mdificatins, ICRA's verall apprach t rating entities in the sectr remains materially similar. Overview Nn-ferrus metals cmprising aluminium, cpper and zinc find wide applicatins in the electrical, cnstructin, packaging, transprt, and cnsumer durable segments. During April 2016 t March 2017 (FY2017), the aggregate dmestic cnsumptin f the abve metals was estimated at ~4.46 millin metric tnne (MMT). Backed by the Gvernment s fcus n public and private sectr investments, dmestic cnsumptin f these nn-ferrus metals is expected t grw by 6%-8% annually ver the next three years. On the supply side, the industry is dminated by a few large players, given the high capital intensity in the business. With a healthy cnsumptin grwth anticipated, these dmestic primary nn-ferrus metal manufacturers have already set up large metal prductin capacities. ICRA ntes that cumulative prductin capacity f the abve three nn-ferrus metals is mre than the current dmestic cnsumptin. Hence, a sizeable prtin f nn-ferrus metal prductin utput is exprted. Rating Methdlgy The bjective f ICRA s rating methdlgy is t prvide a reference tl that can be used t evaluate the credit prfiles f entities engaged in the primary nn-ferrus metal manufacturing business. It aims t help issuers, investrs and ther interested market participants understand ICRA s apprach in analysing quantitative and qualitative risk characteristics that are likely t affect rating utcmes. This methdlgy des nt include an exhaustive treatment f all factrs that are reflected in ratings but enables the reader t understand the rating cnsideratins that are mst imprtant. ICRA s risk analysis framewrk fr the primary nn-ferrus metal manufacturers can be bradly divided int the fllwing factrs» Industry risks» Cst psitin» Scale f peratins and prduct-market diversity» Prject risks» Financial Risk Prfitability Leverage and cash flws Freign currency-related risks Tenure mismatches, and risks relating t interest rates and refinancing Debt servicing track recrd Cntingent liabilities/off-balance sheet expsures Adequacy f future cash flws» Management quality Given the cyclicality inherent in primary nn-ferrus metal sectrs, ICRA s rating methdlgy fr primary manufacturers in these industries lays an emphasis n the extent f the impact f the industry cycle n each manufacturer, which varies significantly in accrdance with its cst structure, since individual players are price takers in glbally-traded base metals. An entity s cst psitin in turn is derived frm the fllwing factrs - cst f raw material and pwer, extent f integratin in metal prductin and technlgy used.

2 Primary Nn-Ferrus Metals In additin, the market psitin derived frm the scale f peratin and prduct-market diversificatin, financial health, new prject-related risks as well as management depth are als key success factrs. ICRA als views raw material security as a key determinant f a player s business perfrmance and ntes that Gvernment regulatins ften plays a critical rle in determining an entity s access t raw material. Cnsequently regulatry risk in the Indian mining sectr has emerged as a majr perating risk in recent times. Key Rating Criteria Industry Risk The nn-ferrus metals industry exhibits cyclicality in terms f demand and prices, which causes wide swings in the prfitability and cash flws f individual prducers, increasing their business risks. Internatinal Price Trends: Given the relatively small size 1 f the dmestic industry, nn-ferrus metal prices in India are largely benchmarked t the Lndn Metal Exchange prices, which in turn are influenced by the internatinal demand-supply psitin. Hence, ICRA clsely mnitrs the cnsumptin trends in the majr nn-ferrus metal markets as well as the prductin levels f the glbal players. In additin, ICRA als keeps track f the glbal inventry psitin f these metals, which has an effect n their prices in the spt market. Dmestic Demand-Supply Trends: Demand fr nn-ferrus metals in India histrically has cme frm the pwer, cnstructin, autmbile, packaging and cnsumer durable sectrs. ICRA, therefre, evaluates the demand utlk f these majr user industries in rder t assess the adequacy f the dmestic market in absrbing the metal prduced in the cuntry. Metals sld in the dmestic market typically have a premium ver exprt markets, which remain at a level cmparable t cst f imprting the metal frm the verseas market. Since imprts wuld have additinal lgistics and ther imprt related csts, dmestic prices are higher than internatinal prices, thus prviding higher margins. Regulatry Risks: A number f Indian base metal players have captive mines fr their raw material/fuel requirements. Regulatry risks are ne f the key risks in the Indian mining sectr. Cnsequently, ICRA evaluates such risks while analysing a mining cmpany s (including players with captive mines) credit prfile. Gvernment plicies n land acquisitin, envirnmental and frest clearance have a critical impact n the mining sectr. Mrever, prfitability f the dmestic manufacturers is dependent n the applicable ryalties n mining f minerals as well as imprt and exprt duty structures. Cst Psitin Given the cmmdity nature f the nn-ferrus metals business, cst efficiency in the prductin f these metals becmes a key factr determining the prducer s fundamental credit quality. Since all prducers are necessarily price-takers, prfitability f individual players depends upn their respective psitins n the industry cst curve, which is largely determined by their csts f raw material, pwer, technlgy used and the extent f vertical integratin. Within the three metals, cst f pwer is the highest in aluminium n a per tnne basis, given the pwer intensive nature f aluminium prductin, as against higher raw material cst intensity in the case f cpper and zinc. Hence frm a rating perspective, access t captive surce f pwer alng with cal at cmpetitive rates is psitive fr an aluminium manufacturing entity, whereas fr a zinc r cpper manufacturer captive mines with gd quality re is the dminant factr. Surcing Ore: Entities with captive mines f res are secured against raw material availability related risks. Mrever, res frm captive surces have a lwer vlatility in raw material cst. Ores with richer metal cntent result in a lwer verall cst f metal prductin as cmpared t inferir grades f re. ICRA, therefre, views the availability f captive surces f gd quality res t a primary prducer, favurably. 1 Dmestic cnsumptin and prductin f nn-ferrus metals were bth at ~5% f glbal cnsumptin and prductin in FY2017 ICRA Rating Services Page 2 f 6

3 Primary Nn-Ferrus Metals Energy Csts: Pwer cst is the ther majr driver f verall cst efficiency f nn-ferrus metal manufacturers. Amng the three metals, aluminium prductin is the mst pwer intensive which requires ~15,000 units 2 f electrical energy fr 1 MT f aluminium prductin, as against ~1,100 units fr prductin f cpper and ~3,500 units fr zinc. Typically, pwer and fuel csts f an integrated aluminium player accunt fr arund 25% f its perating incme as against arund 15% and 8% fr an integrated cpper and zinc player, respectively. Hence, the cheap surce f electricity keeps verall prductin csts lw. In India, mst aluminium manufacturers have captive pwer plants fuelled by cal. Hence, assured surce f gd quality cal at cmpetitive rates fr pwer generatin is a key driver f cst efficiencies fr these entities 3. Prductin Technlgy: The technlgy used in metal prductin has a critical impact n the verall cst 4 f prductin f nn-ferrus metals. Fr instance, recent capacities cmmissined by the aluminium players have superir energy efficiency and are less plluting. Mrever, a mdern plant typically uses allied facilities fr by-prduct recvery 5, which prvides an extra avenue f incme t the manufacturers, thus bringing dwn prductin csts n a net basis. Cntributin Analysis: ICRA assesses the cntributin margins per tnne f metal sales, which captures the verall cst efficiency f the prducer vis-a-vis the prevailing metal prices. While perfrming this analysis, grss and net cntributin levels are measured per unit f sales. All the three nn-ferrus metals being glbally traded, ICRA believes that a primary metal prducer, ntwithstanding duty prtectins, needs t be glbally cst cmpetitive fr it t remain prfitable acrss business cycles. ICRA, therefre, benchmarks the cmpany s cash cst f prductin against its glbal peers. In ICRA s pinin, cash cst determines an entity s staying pwer in business because if prices fall belw this level, it starts lsing cash and ultimately faces a liquidity strain. Scale f peratins and prduct-market diversity A nn-ferrus metal prducer is better insulated frm cyclical vlatility when it has a large scale f peratins and has a diversified prduct mix. While size in itself des nt drive a player s cmpetitive psitin, it cnfers upn a cmpany the ability t cntrl csts thrugh greater bargaining pwer against raw material suppliers and custmers. It als helps it enter int lng-term supply cntracts with large custmers and access funds frm the market at better rates. Frward integratin by primary players int dwnstream businesses prtects them against the vlatility assciated with cmmdity metal prices t an extent. Althugh dwnstream businesses als suffer during perids f stress, such businesses display relatively lwer price cyclicality cmpared t pure primary metal businesses. Besides, since different dwnstream prducts find applicatins in different industries, frward integratin int mre value-added prducts enables a cmpany t lwer its dependence n any particular user industry r custmer. Prject risks Primary nn-ferrus metal capacities are highly capital intensive. Given the high capital intensity f prjects, ICRA critically evaluates the varius risks assciated with large prjects, including cmpletin risk, funding risk, technlgy risk and fftake risk, and examines the impact f the same n the entity t ascertain its credit rating. ICRA als factrs in the past experience f the management in cmmissining 2 Stated nrms are representative, actual energy cnsumptin will vary depending upn the quality f re, efficiency f the prcess and equipment 3 Given the imprtance f assured supply f cal, aluminium players have bid aggressively fr bth captive cal blcks as well as cal linkage auctins in the past tw years r s. 4 As per nmenclature in the cmmdity space, cst f prductin is reprted in three frms, viz. C1, C2 and C3. C1 cst is the direct cst f prductin, which represents the cash cst incurred at each prcessing stage frm mining till metal prductin. Mines and plant verhead csts are als included in C1 cst. C2 cst = C1 cst + (depreciatin, depletin and amrtizatin). C3 cst = C2 cst + net interest charges + crprate csts + ryalties + R&D csts 5 By prducts frm smelting and refining f cpper are sulphuric acid and precius metals, and frm refining f zinc are precius metals. There is n majr by-prduct frm smelting f aluminium ICRA Rating Services Page 3 f 6

4 Primary Nn-Ferrus Metals large prjects in a timely manner. A typical nn-ferrus metal prject requires a large capex with technical cmplexities invlved in implementing the prject. Cnsequently time and cst verruns are key risks in implementatin f such prjects. Financial Risk While analysing the financial risk prfile, ICRA evaluates the verall balance sheet strength f the entity, which determines a player s ability t withstand a deep dwn cycle. In additin, ICRA als evaluates the prfitability and cash-generating ability f the business as well as ther surces f financial flexibility available t an entity. The bjective here is t assess the present as well as future expectatins f the financial psitin and the financial risk prfile f the entity. This sectin prvides a brief summary f the parameters ICRA cnsiders t be imprtant while analysing an entity s financial risk prfile. Fr a mre detailed descriptin, readers may refer t the nte titled, Apprach fr Financial Rati Analysis published n ICRA s website: Prfitability: Prfitability f a primary prducer is primarily a functin f its cst structure and prduct mix. Hwever, nn-ferrus metal being a cyclical industry, prfitability varies significantly alng the cycle. Nevertheless, prducers having better cst structures than the industry median level can generally be expected t remain prfitable acrss cycles. Leverage and debt cverage indicatrs: As with entities in ther cmmdity industries exhibiting cyclical price trends, a lw financial leverage is viewed as a credit psitive fr primary nn-ferrus metal players. Besides prtecting the cash flws f players by impsing a lwer debt service burden, especially during perids f cyclical stress, a lw gearing als imparts greater financial flexibility t primary nn-ferrus metal prducers t access funds frm institutinal surces. Besides capital structure, ICRA pays special attentin t leverage ratis, which are an indicatr f the degree f financial flexibility that an entity enjys, as reflected by its gearing (rati f Ttal Debt t Tangible Net Wrth) and Ttal Debt t OPBITDA multiple. Lw gearing and lw Ttal Debt t OPBITDA ratis, resulting frm healthy net wrth and prfitability, imply financial flexibility available in terms f raising funds frm external surces fr meeting funding requirements and is a credit psitive. ICRA is particularly cncerned with a cmpany s capability t hnur its cntractual bligatins under stress cnditins. The mre rbust a cmpany s perfrmance under a range f reasnable prjectins; the better it is frm a credit evaluatin perspective. ICRA als critically lks at ther surces f financial flexibility available t an issuer, which culd be in the frm f, amng thers, availability f a prtfli f liquid financial assets, unused bank lines, etc. Prmter strength: An entity als derives financial flexibility being part f a large grup. Hence ICRA evaluates the strategic imprtance f the entity t the Grup t which it belngs, alng with the financial strength f the Grup entities. Freign currency-related risks: The manufacturing csts f a dmestic primary nn-ferrus metal prducer are incurred primarily in the dmestic currency (except cst f imprted cal and scrap), while selling prices are, even if the cmpany sells its prduce within the cuntry, linked t the exchange rate, being typically benchmarked against the landed cst f imprts. The freign currency risk can rise frm unhedged liabilities, especially fr entities with liabilities denminated in a nn-inr currency. ICRA analysis als fcuses n the hedging plicy f the issuer cncerned in the cntext f the tenure and nature f its cntracts with clients (shrt term/lng term, fixed price/variable price). Tenure mismatches, and risks relating t interest rates and refinancing: Large dependence n shrtterm brrwings t fund lng-term investments can expse an issuer t significant re-financing risks, especially during perids f tight liquidity. The existence f adequate buffers f liquid assets/bank lines t meet shrt-term bligatins is viewed psitively. Similarly, the extent t which an issuer culd be impacted by mvements in interest rates is als evaluated. ICRA Rating Services Page 4 f 6

5 Primary Nn-Ferrus Metals Debt-servicing track recrd: The debt-servicing track recrd f a cmpany is an imprtant input fr any credit rating exercise. Any delays r defaults in the past in the repayment f principal r interest payments reduce the cmfrt level with respect t the primary nn-ferrus metal player s future debt-servicing capability and willingness. Cntingent liabilities/off-balance sheet expsures: ICRA evaluates the likelihd f devlvement f cntingent liabilities/ff-balance sheet expsures and the financial implicatins f the same. Adequacy f future cash flws: Since the prime bjective f the rating exercise is t assess the adequacy f the issuer s debt-servicing capability, ICRA draws up prjectins n the likely financial psitin f the issuer under varius scenaris. Besides, ICRA takes int accunt the cmmitments f the cmpany twards ther Grup entities, new ventures, and its investments in subsidiaries/spvs. Accrdingly, future cash flws are prjected after taking int accunt the cmpany s capacity utilisatin levels and the likely prices f raw material and finished prducts, the grwth it envisages, debt repayment schedule, its funding requirements and the funding ptins available t it. These cash flws are then used t determine the cmpany s future debt-servicing capability under varius scenaris. The ratis used t assess cash flws are Fund Flw frm Operatins (FFO), interest cverage, FFO debt cverage, and FFO capital expenditure cverage. Accunting plicy and internal cntrl: While assessing the credit risk prfile f a primary nn-ferrus metal prducer, ICRA reviews the Accunting Plicies fllwed by the cmpany, Ntes t Accunts, and Auditrs Cmments that are part f the Annual Reprt. Any deviatin frm the Generally Accepted Accunting Practises is nted and the financial statements f the issuer are adjusted t reflect the impact f such deviatins and als t cmpare mre meaningfully against peers in the industry. Management Quality All ratings necessarily incrprate an assessment f the quality f the issuer s management, as well as the strengths/weaknesses arising frm the issuer s being a part f a grup. Als f imprtance is the issuer s likely cash utflw, arising frm the pssible need t supprt ther Grup entities, in case the issuer is amng the strnger entities within the Grup. Usually, a detailed discussin is held with the management f the issuer t understand its business bjectives, plans and strategies, and views n past perfrmance, besides the utlk n the (issuer s) industry. Sme f the ther pints assessed are:» Experience f the prmter/management in the line f business cncerned» Cmmitment f the prmter/management t the line f business cncerned» Attitude f the prmter/management t risk-taking and cntainment» The issuer s plicies n leveraging, interest risks and currency risks» The issuer s plans n new prjects, acquisitins, expansin, etc.» Strength f the ther entities belnging t the same grup as the issuer» The ability and willingness f the grup t supprt the issuer thrugh measures such as capital infusin, if required Summing Up ICRA s credit ratings are a symblic representatin f its pinin n the relative credit risk assciated with the instrument being rated. This pinin is arrived at fllwing a detailed evaluatin f the entity s business and financial risks, its cmpetitive strengths, its likely cash flws ver the life f the instrument being rated, and the adequacy f such cash flws vis-a-vis its debt servicing bligatins. As highlighted in the nte, ICRA s apprach t rating primary nn-ferrus metal prducers incrprates bth quantitative and qualitative factrs, sme f which are used t assess ther cmmdity sectrs, which display cyclicality. While the frmer includes, amng thers, an assessment f cash flw generatin under nrmal and stress scenaris, cst cmpetitiveness and financial strength, the latter includes market psitin, management strategies fr managing cyclical dwnturns and an verall apprach twards investment and grwth. ICRA Rating Services Page 5 f 6

6 Primary Nn-Ferrus Metals ICRA Limited CORPORATE OFFICE Building N. 8, 2 nd Flr, Twer A; DLF Cyber City, Phase II; Gurgan Tel: ; Fax: inf@icraindia.cm, Website: REGISTERED OFFICE 1105, Kailash Building, 11 th Flr; 26 Kasturba Gandhi Marg; New Delhi Tel: ; Fax: Branches: Mumbai: Tel.: + (91 22) /53/62/74/86/87, Fax: + (91 22) Chennai: Tel + (91 44) /9659/8080, / 3293/3294, Fax + (91 44) Klkata: Tel + (91 33) / / / , Fax + (91 33) Bangalre: Tel + (91 80) /4049 Fax + (91 80) Ahmedabad: Tel + (91 79) /5049/2008, Fax + (91 79) Hyderabad: Tel +(91 40) /7251, Fax + (91 40) Pune: Tel + (91 20) /0195/0196, Fax + (91 20) Cpyright, 2017 ICRA Limited. All Rights Reserved. Cntents may be used freely with due acknwledgement t ICRA. All infrmatin cntained herein has been btained by ICRA frm surces believed by it t be accurate and reliable. Althugh reasnable care has been taken t ensure that the infrmatin herein is true, such infrmatin is prvided 'as is' withut any warranty f any kind, and ICRA in particular, makes n representatin r warranty, express r implied, as t the accuracy, timeliness r cmpleteness f any such infrmatin. Als, ICRA r any f its grup cmpanies, while publishing r therwise disseminating ther reprts may have presented data, analyses and/r pinins that may be incnsistent with the data, analyses and/r pinins presented in this publicatin. All infrmatin cntained herein must be cnstrued slely as statements f pinin, and ICRA shall nt be liable fr any lsses incurred by users frm any use f this publicatin r its cntents. ICRA Rating Services Page 6 f 6