The rating on BlueScope Steel Ltd. reflects our view of the company's "fair" business risk profile and "aggressive" financial risk profile. In our opinion, the company enjoys strong brands and a leading market share in Australia. Further, broad geographic diversity through the company's businesses in Asia, New Zealand, and the U.S. help offset the weakness in its loss-making Australian operations. Partly offsetting these strengths are Bluescope's exposure to industry cycles, cost pressures from volatile raw material prices, and weak financial metrics in year ended June 30, 2012.
We view positively Bluescope's restructuring of its business operations in view of the challenging market conditions. The company has made significant progress in restructuring the Coated and Industrial Products Australia (CIPA) business, especially in the shutting down of one blast furnace in 2011. In June 2012, it completed the sale of its North American insulated panels business for US$145 million, and in August, announced a proposed US$1.36 billion joint venture with Nippon Steel Corp., which later merged with Sumitomo Metal Industries Ltd. to become Nippon Steel & Sumitomo Metal Corp. (NS, BBB/Stable/--). Should the joint venture (JV) be successfully implemented, Bluescope will receive about US$540 million in proceeds from NS, and benefit from access to new market segments such as home appliances and whitegoods.
Bluescope's key financial metrics in fiscal 2012 were weak for the rating, reflecting challenging conditions in the steel industry and significant restructuring underway. Adjusted funds from operations (FFO) to debt was negative 17.3% and debt to EDITDA was 10.7x. However, Bluescope's adequate liquidity and modest balance-sheet gearing of 33.5% are mitigating factors. We believe Bluescope's successful restructuring of the Australian operations, combined with completion of the joint-venture arrangements and the recent decline in key raw material prices, will help key credit metrics to rebound in fiscal 2013 to levels expected for the 'BB' rating. That's notwithstanding ourexpectation of further difficult macroeconomic conditions during fiscal year ending June 30, 2013. We consider the use of the proceeds from the joint-venture deal will be an important rating factor. Under our base-case forecasts--assuming execution of the NS JV and hot rolled coil spreads of about A$265 per tonne--we expect adjusted FFO/debt in the low 20% range and debt/EBITDA about 3.0x. This supports our view of an aggressive financial profile.
We consider that BlueScope has "adequate" liquidity, as defined in our criteria. This assessment is despite our expectation that sources of liquidity will exceed uses by more than 2x in fiscals 2013 and 2014-a level that is more than sufficient for its short-term needs. Several factors constrain its liquidity, in our view. For example, the company had to amend its financial covenants to undertake the CIPA restructuring. Our liquidity assessment incorporates the following factors:
-- Sources of liquidity include our estimate of cash balance of about A$215 million and unused credit facilities of about A$1.4 billion as of June 30, 2012;
-- Sources also include our FFO forecast of more than A$250 million in fiscal 2013;
-- Uses of liquidity include capital expenditure of more than A$250 million and no debt maturities in fiscal 2013; and
-- We believe that the company has some headroom under its current financial covenants.
The recovery rating is '5' on the proposed senior unsecured U$S300 million debt issue by Bluescope's finance subsidiaries, Bluescope Steel (Finance) Ltd. and Bluescope Steel Finance (USA) LLC. Due to the prior ranking of the sizable senior secured debt in our recovery analysis, we expect the senior unsecured debt to realize an average recovery in the order of 10%-30% following a hypothetical default.
In our opinion, the most likely hypothetical default scenario would involve further deterioration in steel market conditions, inability to restore financial profile following significant restructuring of the business, combined with failure to execute the proposed NS JV. We assume this would occur around 2014 in this simulated default scenario.
The stable outlook reflects our view that the company's leading market share in Australia and global diversity will assist in maintaining its business risk profile. It also incorporates our expectation of Bluescope successfully completing the restructuring of its Australian operations, which will improve its future operating efficiency and profitability. We have also factored in our expectation that the proposed joint venture with Nippon Steel will be successfully implemented, and that the company will achieve an adjusted FFO/debt of more than 20% in fiscal 2013.
The rating could be lowered if the joint venture does not proceed or if Bluescope is unable to restore its key metrics in fiscal 2013 to those in line with our expectations. An adjusted FFO/debt of 15% or below would be a trigger for a downgrade.
Upward rating transition is limited by the company's industry and competitive position. Any upgrade would require a significant and sustained improvement in Bluescope's financial risk profile, evidenced by adjusted FFO/debt approaching 35% and positive free operating cash flow. This could result from an improved product portfolio with a weighting to higher value-added products, which would reduce exposure to volatile raw material prices and improve its earnings stability.
Related Criteria And Research
-- Key Credit Factors: Methodology And Assumptions In The Metals Industry, June 22, 2009
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Bluescope Steel Ltd.
Counterparty credit rating BB/Stable
BlueScope Steel (Finance) Ltd.
BlueScope Steel Finance (USA) LLC
Senior unsecured BB-
Recovery rating 5