Detailed Rationale

CRISIL Ratings has downgraded its rating on the long-term bank facilities of ESL Steel Limited (ESL; part of the Vedanta group) to ‘CRISIL AA-’ from ‘CRISIL AA’ and revised its rating watch to 'Rating Watch with Developing Implications' from 'Rating Watch with Negative Implications'. Also, the reaffirmed its ‘CRISIL A1+’ rating on the short-term bank facilities of the company and placed it on ‘Rating Watch with Developing Implications’.

 

The rating action reflects a corresponding rating downgrade on the bank facilities and debt instruments of the parent company, Vedanta Limited (Vedanta), to ‘CRISIL AA-/Watch developing/CRISIL A1+/Watch developing’ from ‘CRISIL AA/Watch Negative/CRISIL A1+’.

 

The ratings of ESL reflect the strong support expected from the parent, Vedanta, and ESL’s strategic importance to the parent. Any adverse change in the credit risk profile of Vedanta is a key rating sensitivity factor for ESL.

 

While steel prices moderated during YTD- current fiscal, it still remained healthy. However, input costs witnessed higher-than-expected volatility during the first half of current fiscal; this resulted in operating profitability remaining lower than expected. Further improvement in operating profitability supported by expected moderation in input costs over the medium term along with healthy domestic steel demand and realization will be a key monitorable.

Analytical Approach

CRISIL Ratings has factored in strong support from ESL’s parent, Vedanta, because of strong business and financial linkages.

 

CRISIL Ratings understands that the parent (Vedanta) is evaluating strategic review of some of its assets, including steel business in ESL. However, Vedanta will extend any need-based support to ESL in the interim, which has been factored in the parent notch-up support to the rating of ESL.

Key Rating Drivers & Detailed Description

Strengths:

• Strong support from Vedanta: ESL’s long-term loans are backed by a corporate guarantee while most of the working capital facilities are backed by a letter of comfort from Vedanta. Furthermore, Vedanta Star Ltd (VSL, erstwhile holding company of ESL) had extended an unsecured loan to ESL, funded through bank term loans raised by it. These bank term loans (now transferred to ESL) were supported by a guarantee from Vedanta, covering the entire principal and interest obligation. Following the merger of ESL and VSL, the guarantee was extended to ESL on similar terms. While the loan agreement provides for the guarantee to potentially fall off three years after the date of first utilisation of the term loan, it will be conditional on ESL meeting certain financial covenants.

 

Given Vedanta’s focus on deleveraging its balance sheet, the parent is exploring divestment of some of its assets including divesting its shareholding in ESL. However, no such option has been finalized and the same is in evaluation stage. Also, according to the Vedanta’s management, it is committed to extend any need-based support to ESL in the interim. Any change in Vedanta’s support philosophy towards ESL will be a key rating sensitivity factor

 

• Improved operating efficiency post takeover by Vedanta; moderation witnessed this fiscal albeit expected to improve going ahead: Since the takeover, Vedanta has improved ESL’s operating efficiency, primarily by increasing plant utilisation, which increased from less than 70% in fiscal 2018 (pre-acquisition) to more than 85% during fiscal 2023. Profitability had witnessed moderation due to volatility in commodity prices, as reflected in lower-than-expected EBITDA and margin (USD 23 per tonne during H1FY2024 vis-à-vis USD 19 per tonne during H1FY2023).

 

While steel prices moderated during YTD- current fiscal, it still remained healthy. However, input costs were high due to higher-than-expected volatility in coking coal and iron ore; this resulted in reduced operating profitability for the first half of current fiscal. Further improvement in operating profitability supported by expected moderation in input costs over the medium term along with healthy domestic steel demand and realization will be a key monitorable. Additionally, the company is set to increase operational capacity from 1.5 million tonne per annum (MTPA) to 3.0 MTPA over the medium term, including downstream capacity, which should also improve profitability.

 

Weaknesses:

• Susceptibility to demand and price risks: Demand for long steel products depends on construction and infrastructure activities and is sensitive to economic cycles. Furthermore, the steel industry is susceptible to volatility in global steel prices. Moderation in demand and steel prices in fiscal 2023, had affected revenue and profitability for the company.

 

• Average financial risk profile, expected to improve over the medium term: While moderation in operating profitability resulted in increased net leverage (ratio of net debt to EBITDA) to ~10 times in fiscal 2023 from ~4 times in fiscal 2022, gross debt remains at similar levels. Furthermore, interest coverage ratio also witnessed moderation from 2 times in fiscal 2022 to 0.8 times in fiscal 2023. That said, with expected improvement in operating performance and moderately low capital expenditure (capex), the debt protection metrics are expected to improve and remain average over the medium term.

Liquidity: Strong

Liquidity is supported by cash and equivalent of Rs 234 crore as on September 30, 2023. However, any shortfall in accrual against debt obligation was met through cash and equivalent for fiscal 2023. Further, expected support from Vedanta, which has healthy liquidity, provides comfort to the liquidity profile of ESL Steel Ltd

Rating Sensitivity factors

Upward factors:

• Change in the credit risk profile of the parent, resulting in an upgrade in its rating by one notch
• Higher than expected Ebitda on account of strong ramp-up in volume, healthy realisation and significant reduction in cost of production, supporting significant improvement in capital structure

 

Downward factors:

• Weakening in the credit risk profile of the parent, resulting in a downgrade in its rating by one notch
• Lower-than-expected operating profitability, resulting in sustained high leverage
• Change in ownership and support philosophy of Vedanta towards ESL

About the Company

ESL was incorporated in Ranchi, Jharkhand, in December 2006. It was India’s first Chinese technology-based greenfield integrated steel manufacturing facility near Bokaro, Jharkhand. Vedanta, through its wholly owned subsidiary - Vedanta Star Ltd (VSL), acquired 90% stake in ESL, under the Insolvency and Bankruptcy Code (IBC), 2016, for Rs 5,320 crore on June 4, 2018. ESL was delisted and VSL acquired additional shares as buy back under the Securities and Exchange Board of India’s order for exit offer and guidelines. Effective March 25, 2020, as per the scheme of amalgamation approved by the National Company Law Tribunal, VSL merged with ESL. Post the merger, Vedanta now directly holds 95.5% shares of ESL. From the effective date, VSL ceased to exist as an entity and all its assets, liabilities, debts, borrowings now stand transferred to the books of ESL. ESL has operational capacity of 1.5 MTPA and is evaluating a proposal to increase its capacity to 3 MTPA over the medium term.

About the Parent

Vedanta is a diversified metals, mining, power, and oil and gas company. London-based Vedanta Resources Ltd holds 63.9% stake in the company. Vedanta’s operations include copper, iron ore and aluminium assets at Jharsuguda and Lanjigarh in Odisha, and power (2400-MW and 1215-MW captive power plants for the aluminium business). The company also has aluminium operations through its subsidiary, Bharat Aluminium Company Ltd (BALCO). Also, a part of the power business (1,980 MW) is conducted through wholly owned subsidiary, Talwandi Sabo Power Ltd. The oil and gas business has now been merged with Vedanta, and the group operates its zinc business through Hindustan Zinc Ltd (HZL) and Zinc International in South Africa and Namibia. Vedanta holds 95.5% share in ESL.

Key Financial Indicators

Particulars	Unit	2023	2022
Operating income	Rs crore	8002	6624
PAT	Rs crore	-558	-95**
PAT margin	%	-7.0	-1.4
Adjusted debt/ Adjusted networth	Times	0.7	0.6
Interest coverage	Times	0.8	2.0

** Includes non-cash expense of Rs 118.8 crore towards deferred tax in Fiscal 2022

 

ESL reported revenue of Rs 4091 crore and EBITDA of Rs 133 crore for H1FY2024 as against Rs 3443 crore and Rs 82 crore respectively.

Any other information: Not applicable

Annexure - Details of Instrument(s)

ISIN	Name of instrument	Date of allotment	Coupon rate (%)	Maturity date	Issue (Rs crore)	Complexity level	Rating outstanding with outlook
NA	Cash credit*	NA	NA	NA	30	NA	CRISIL AA-/Watch Developing
NA	Cash credit	NA	NA	NA	20	NA	CRISIL AA-/Watch Developing
NA	Non-Fund Based Limit ***	NA	NA	NA	180	NA	CRISIL A1+/Watch developing
NA	Non-Fund Based Limit **	NA	NA	NA	550	NA	CRISIL AA-/Watch Developing
NA	Export Post-Shipment Credit^	NA	NA	NA	75	NA	CRISIL A1+/Watch Developing
NA	Non-Fund Based Limit ^^	NA	NA	NA	100	NA	CRISIL AA-/Watch Developing
NA	Non-Fund Based Limit ^^^	NA	NA	NA	295	NA	CRISIL AA-/Watch Developing
NA	Non-Fund Based Limit &&	NA	NA	NA	204	NA	CRISIL AA-/Watch Developing
NA	Proposed Working Capital Facility	NA	NA	NA	540.2	NA	CRISIL AA-/Watch Developing
NA	Proposed Term Loan	NA	NA	NA	435.2	NA	CRISIL AA-/Watch Developing
NA	Credit Exposure Limits / Loan Exposure Risk Limits	NA	NA	NA	6	NA	CRISIL A1+/Watch Developing
NA	Rupee term loan	NA	NA	Jun-28	2393.6	NA	CRISIL AA-/Watch Developing

*Cash credit has sub limits with non-fund-based facilities of Rs.30 crore

** Includes sublimit of Rs 20 crore cash credit

***Includes sublimit of Rs 180 crore for standby letter of credit for buyer's credit and bank guarantee of Rs 50 Crore

^Export Credit - Pre and Post Shipment. Also, includes sublimit of Letter of Credit/Standby Letter of Credit for Buyer's Credit of Rs 75 crore

^^^ Includes Rs 25 crore derivative limits

^^ Letter of Credit Facility with SBLC limit of Rs 100 crores and Cash Credit limit of Rs 20 Crores as sub limit of the facility

&& Letter of Credit Facility with SBLC limit of Rs 200 crores, Cash Credit limit of Rs 50 Crores, Bank Guarantee of Rs 50 Crores and Export Packing Credit of Rs 200 Crores as sub limit of the facility; WCDL limit of Rs 100 Crores as sub limit of Cash Credit Facility