Rating Methodology for Primary Non Ferrous Metals Manufacturers

Transcription

1 September 2015 Backgrund Nn-ferrus metals cmprising aluminium, cpper and zinc find wide applicatins in the electrical, cnstructin, packaging, transprt, and cnsumer durable segments. During April 2014 t March 2015 (FY2015), aggregated dmestic cnsumptin f the abve metals was estimated at ~3.90 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 ~8%-10% 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 the high cnsumptin grwth anticipated, these dmestic primary nn-ferrus metal manufacturers have already set up large metal prductin capacities. ICRA ntes that cumulative prductin capacities f the abve three nn-ferrus metals are mre than their current dmestic cnsumptins. Hence, a sizeable prtin f nn-ferrus metal utputs f the primary manufacturers 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 cmpanies 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 analyzing 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 peratin 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 and Crprate Gvernance Given the cyclicality inherent in base 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 In additin, market psitin derived frm scale f peratin and prduct-market diversificatin, financial health, new prject related risks as well as management depth are als key success factrs. Mrever, raw material security is a key determinant f a player s business perfrmance and, cnsequently, regulatry risk in the Indian mining sectr has emerged as a majr perating risk in recent times. ICRA Rating Services Page 1

2 Key Rating Criteria Industry Risk The nn-ferrus metals industry exhibits cyclical characteristics and vlatile 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 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 at 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 because f the duty prtectins, 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 etc 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. Fr instance, as per the Mines and Mineral (Develpment & Regulatin) Amendment Act 2015 (MMDR), cst f minerals in the cuntry wuld g up due t the impsitin f new levies twards District Mineral Fundatin 2 and Natinal Mineral Explratin Trust 3. Cst Psitin Given the cmmdity nature f 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 materials, pwer, technlgy used and the extent f vertical integratin. Hwever, 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. Surcing f Ore/ and Yield: Entities with captive mines f res, typically, nt nly have a lwer raw material cst but are als secured against raw material availability risks. Mrever, res with richer metal cntent result in a lwer verall cst f metal prductin as cmpared t inferir grades f re. ICRA, therefre, psitively views availability f captive surces f gd quality res t a primary prducer. As per the recently legislated MMDR, mines cntaining res f nn-ferrus metals 4 are expected t be auctined, ging frward. ICRA will mnitr the entities securing mining rights thrugh the auctin rute as well as the cst f acquisitin f such rights, which will be an imprtant driver f future cst f prductin. 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 mst pwer intensive that requires ~15,000 units 5 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, cheap surce f electricity keeps verall prductin csts lw. In India, all the aluminium manufacturers have captive pwer plants fuelled by cal. Hence, assured surce f 1 Dmestic cnsumptin and prductin f nn ferrus metals are bth at ~5% f glbal cnsumptin and prductin in FY An existing/new miner wuld need t pay an additinal duty f upt 100%/33% f the mineral s ryalty, which wuld be used fr develpment f the district affected by mining activities 3 An additinal 2% f existing ryalty f the mineral wuld be levied fr mineral explratin activities 4 The Amendment Act specifically recmmends Bauxite mines fr auctin 5 Stated nrms are representative, actual energy cnsumptin will vary depending upn the quality f re, efficiency f the prcess and equipment 2

3 gd quality cal at cmpetitive rates fr pwer generatin is a key driver f cst efficiencies fr these entities 6. Technlgy: The technlgy used in metal prductin als has a critical impact n verall cash cst 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, 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 tn 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. Additinally, in perids where dmestic nn-ferrus metal capacities tend t be in excess f dmestic demand, prducers are als frced t target the exprt markets s as t achieve better capacity utilizatin. ICRA benchmarks an entity s cash cst f prductin against its peers. Cash cst determines an entity s staying pwer in business because if price falls belw this level, the entity starts lsing cash and ultimately faces a liquidity strain. Scale f peratin and prduct market diversity: A nn-ferrus metal prducer is better insulated frm cyclical vlatility when it has a large scale f peratins and a diversified prduct mix. While size in itself cannt determine a player s cmpetitive advantage, it cnfers upn a cmpany an ability t cntrl csts thrugh greater bargaining pwer against raw material suppliers and custmers, enter int lng-term supply cntracts with large custmers, access funds frm the market at better rates, besides the ecnmies f scale which accrues frm size. Frward integratin by primary players int dwnstream businesses prtects them against the vlatility risks assciated with cmmdity metal prices t an extent. Althugh dwnstream businesses als suffer during perids f stress, such businesses display relatively lwer 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 large prjects in a timely manner. Financial Risk The financial strength f a primary nn ferrus metal prducer is an imprtant rating cnsideratin. While assessing the financial psitin 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 Practices 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. Apart frm balance sheet strengths which determine a player s ability t withstand a deep dwn cycle, ICRA als evaluates the prfitability and cash generating ability f the business as well as ther surces f financial flexibility available t an entity t evaluate its verall financial risk prfile. 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. 6 Given the imprtance f assured supply f cal, aluminium players were amng the mst aggressive bidders in the first tw runds f cal blck auctins held in February April 2015 and secured six cal blcks albeit at high bid prices. While cal availability risks wuld be addressed fr winning bidders, verall landed cst f cal at their plants wuld have a significant bearing n the prfitability f these cmpanies. 3

4 Nevertheless, prducers having cst structures better than the industry median level can generally be expected t remain prfitable acrss cycles. Leverage and cash flws: As with cmpanies in ther cmmdity industries exhibiting cyclical price trends, a lw financial leverage is viewed as a credit quality 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 cverage indicatrs including interest cverage, perating prfit and net cash accruals relative t ttal debt while evaluating the financial health f a primary nn ferrus metal cmpany. ICRA is particularly cncerned with a cmpany s capability t hnur its cntractual bligatins under stress cnditins. The mre rbust a cmpany s perfrmance is likely t be 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, strategic imprtance f the entity t the grup t which it belngs alng with the financial strength f 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 als arise frm unhedged liabilities, especially fr cmpanies 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. 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 cmpanies, 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. Management Quality and Crprate Gvernance 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 are the issuer s likely cash utflws 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 4

5 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 cmpanies 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 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. 5

6 Table: List f Rated Entities in Primary Nn Ferrus Metal Manufacturers as n September 14, 2015 Cmpany Lng term Rating Shrt term Rating Hindustan Cpper Limited [ICRA]AA+(Stable) [ICRA]A1+ Bharat Aluminium Cmpany Limited [ICRA]A1+ 6

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