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Fitch Ratings has affirmed China Steel Corporation’s (CSC) National Long-Term Rating at ‘AA(twn)’ with a Stable Outlook and National Short-Term Rating at ‘F1+(twn)’. Fitch has also affirmed CSC’s senior unsecured rating at ‘AA(twn)’.
CSC’s National Long-Term Rating reflects its high strategic and operational linkages with the Taiwanese government (AA/Stable) and low default risk relative to domestic issuers.
KEY RATING DRIVERS
State Ownership, Incentive to Support: The Taiwanese government, via the Ministry of Economic Affairs, holds a 20% stake in CSC and is the largest and controlling shareholder. The ministry appoints CSC’s chairperson and holds three of the 11 seats on the board of directors. The government has extended significant policy support to CSC so that it is the only company that is legally allowed to construct and operate steel blast furnaces in Taiwan and has a dominant market share of 70%.
We expect full government support for CSC, if needed, because of the company’s importance to Taiwan’s steel industry despite receiving little financial support recently. The steel industry affects other industrial sectors that rely on steel as a raw material, especially given Taiwan’s export-oriented economy. We also believe CSC’s default would significantly limit funding for other state-owned companies.
Dominant Low-Cost Producer: CSC’s EBITDA margin is consistently higher than those of regional peers due to its low-cost position, downstream vertical integration with a focus on high value-added products. CSC is Taiwan’s largest steel producer and the only one that is vertically integrated, giving the company a significant cost advantage over other steelmakers in Taiwan. CSC’s steel plants were placed in the second quartile of CRU’s cost curve for flat and long steel products in 2022.
Negative FCF, Increasing Leverage: CSC has a good record of free cash flow (FCF) generation, but we expect FCF to turn negative in 2022 on lower EBITDA generation due to low steel prices, and a large dividend payment associated with its strong performance in 2021. As a result, we expect its EBITDA net leverage to increase to 3.4x in 2022 (FY21:1.4x).
We also expect the EBITDA margin to improve in 2023 because raw material prices, such as iron ore and coking coal, are set to moderate based on Fitch’s price assumptions. We therefore expect FCF generation to improve, but its net leverage level will remain above 3.0x over 2023-2024 due to its relatively high dividend payout ratio. Even so, the company has strong financial flexibility, with EBITDA interest coverage over 10x times in the past four years benefiting from low borrowing costs.
DERIVATION SUMMARY
The two-notch difference between the National Ratings of CSC and state-owned peer CPC Corporation, Taiwan (AAA(twn)/Stable), reflects the latter’s higher government ownership and more significant policy role. We also deem CPC’s core business of oil and natural gas as more strategic than steelmaking.
Furthermore, CPC is Taiwan’s largest distributor of key refined-oil products and is responsible for importing crude oil and gas to satisfy domestic energy demand.
The one-notch difference between the ratings of CSC and Taiwan High Speed Rail Corporation (THSRC, AA+(twn)/Stable) reflects the latter’s significant financial implications of default, as the Ministry of Transportation and Communications will assist THSRC if the company fails to meet scheduled loan repayments. This mechanism enhances THSRC’s government ties, while THSRC is regarded as a proxy funding vehicle.
KEY ASSUMPTIONS
Fitch’s Key Assumptions Within Our Rating Case for the Issuer:
– No additions to steelmaking capacity in the near term;
– Revenue to decrease by 12.8% in 2022 and 11.1% in 2023, with minimal movements thereafter;
– EBITDA margin to decrease to 14.7% in 2022 (2021: 23.8%), followed by gradual increase to about 18.5% in 2025;
– Capex of about TWD31 billion-37 billion a year over 2022-2025;
– Disciplined dividend payment based on performance;
– No major M&A for 2022 and beyond.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
– Strengthened probability of government support.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– Lower probability of government support.
For Taiwan’s rating, the following sensitivities were outlined by Fitch in its rating action commentary on 7 September 2022
Factors that could, individually or collectively, lead to negative rating action/downgrade:
-Structural Features: Deterioration in cross-strait relations sufficient to undermine Taiwan’s economic or political stability.
-Public Finances: An adverse macroeconomic or financial shock that weakens medium-term growth prospects and negatively affects public-debt dynamics.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
-Structural Features: A sustainable resolution of cross-strait tensions that significantly reduces the possibility of economic and political shocks.
LIQUIDITY AND DEBT STRUCTURE
Adequate Liquidity: Total readily available cash was TWD42.8 billion at end-September 2022, compared with short-term debt of about TWD130 billion. CSC had unused banking facilities with the outstanding amount exceeding TWD120 billion, according to management. CSC also has easy access to cheap domestic funding via banking facilities and credit markets because of its government ties.
ISSUER PROFILE
CSC is the largest integrated steel producer in Taiwan and the only one with its own blast furnace. It has consolidated annual crude steel capacity of around 16 million tonnes, which accounts for over 70% of the domestic steel market.
Source: Fitch Ratings