Indian Steel Companies: Financial Restructuring key to turnaround"

With non-performing assets (NPAs) gaining prominence in recent times, the spotlight has turned on the
Indian steel industry. This is because Indian banks and financial institutions (FIs) have an exposure of
about Rs 400 billion to the sector, which also accounts for about 15% of their NPAs. In spite of their
fairly strong operations, most Indian steel companies have been unable to service their debt primarily
because their debt obligations are extremely large in relation to their earnings. While these companies
have taken several initiatives to restructure their businesses and improve their operations, so far, they have
been unable to improve their debt-servicing ability by reducing debt levels. CRISIL believes that a largescale financial restructuring that would significantly reduce finance costs and debt levels is essential to
turnaround these companies. The restructuring would have to involve the conversion of a significant part
of the debt to equity and/or writing off the debt. In the process, several hard decisions need to be taken
both by steel companies and FIs in order to revive the sector and ensure its long-term survival.
Over the last few years, the Indian steel industry has gone through some rough times with most domestic
companies remaining in the red. The worrying part is that even in years when steel prices were high, as in
FY2001, most companies failed to report profits. CRISIL has analysed the consolidated financials of five
of Indias large steel companies and whose debt burden is large in relation to their earnings: Steel
Authority of India Limited (SAIL), Jindal Vijaynagar Steel Limited (JVSL), Jindal Iron and Steel Limited
(JISCO), Essar Steel Limited and Ispat Industries, for the last two financial years (FY2001 and FY2002)
and the first quarter of the current financial year (see Table 1). In fact, the last two financial years
represent the two extremes of the steel price cycle. While FY2001 was one of the best years for the
industry in recent times, FY2002 was perhaps, the worst.
The analysis shows that these companies reported losses at the net level irrespective of the level of steel
prices. In fact, the companies in the sample reported cash losses for both years, with SAIL being the only
exception in FY 2001. This is primarily because the total interest and finance costs of these companies in
relation to their operating profits are extremely high. In FY2002, in fact, the interest costs were more than
four times the operating profits. This means that not only were the companies unable to generate cash
flows to repay (reduce) their debt and undertake capital expenditure for even routine maintenance, they
were even unable to even meet their interest obligations. Further, due to their cash losses, their debt levels
only keep increasing, trapping them in a vicious cycle. This reinforces CRISILs view that many of
Indias steel companies have debt levels that their operations simply cannot service, even in a scenario of
high steel prices. CRISILs steel downgrades in the last few years have been primarily driven by this fact.

Table 1: Consolidated financials of five large Indian steel companies (Steel Authority of India Limited
(SAIL), Jindal Vijaynagar Steel Limited (JVSL), Jindal Iron and Steel Limited (JISCO), Essar Steel
Limited and Ispat Industries)
With SAIL
Without SAIL
Q1FY2003 FY2002 FY2001 Q1FY2003 FY2002 FY2001
217
275
263
217
275
263
Average HR coil price $/tonne
Rs.
Billion
66.30 70.27
54.42
206.95
215.99
16.30
Net sales
Rs.
Billion
6.01
7.37
29.27
2.55
3.88 10.47
PBDIT
%
5.9% 14.9%
11.1%
3.6%
13.6%
15.6%
PBDIT margin
Rs. Billion
7.43
31.86
30.51
3.75
16.24 12.99
Interest
Rs.
Billion
8.79
5.52
5.18
20.35
16.95
2.31
Depreciation
Rs. Billion
-6.60
-38.85
-15.33
-3.51
-21.79 -8.04
PAT
%
-12.1% -18.8%
-7.1%
-21.6%
-32.9% -11.4%
PAT margin
Rs.
Billion
-12.99 -2.53
-1.42
-18.50
1.62
-1.21
Net cash accruals
Source: Company and other public reports
Note: The consolidated financials have also been given after excluding SAIL from the sample as due to its much larger size, the
numbers of the sample tend to get skewed towards those of SAIL.
(Key: PBDIT = profit before depreciation, interest and tax; PBDIT margin = PBDIT/net sales; PAT = profit after current tax;
PAT margin = PAT/net sales; net cash accruals = PAT+ depreciation)

Operating margins of Indian companies comparable to those of their international peers

CRISILs analysis further shows that the Indian steel companies operating margins are more or less
comparable to those of a sample of international companies (see Table 2 which gives the consolidated
financials of 10 of the top 20 global steel companies). The key difference between domestic and
international steel companies is that the latter have much lower interest costs than their Indian
counterparts. Interest as a percentage of profit before depreciation, interest and tax (PBDIT) was 432% for
Indian companies in the financial year ended March 2002 while it was only 30% for international
companies in the financial year ended December 2001. This is largely due to the much better capital
structure of international companies and, to a lesser extent, lower interest rates (see Table 3). It may also
be pointed out that the total interest cost of some domestic players is not fully reflected in their profit and
loss (P&L) statement as is evident from the very low interest/average debt ratios for these companies.
This is probably because interest costs have been capitalised. In future, whenever this is fully reflected in
the P&L account, the situation would be even worse.
Table 2: Consolidated financials of 10 leading international steel companies
FY2001
FY2000
Net sales
Bil USD
90.56
98.95
PBDIT
Bil USD
6.47
9.84
PBDIT margin
%
7.1%
9.9%
Interest
Bil USD
1.94
2.00
PAT
Bil USD
-3.62
2.01
PAT margin
%
-4.0%
2.0%
Net cash accruals Bil USD
0.87
7.50
FY2001 and FY2000: Most companies included in the sample follow a financial year ending in December while a few
companies have a year ending in March of the following year
Source: Company reports

Table 3: International steel companies: Better capital structure

Total Debt
Networth
Gearing
Average Interest / Debt

International sample
Dec 2001
$ 27.7 billion
$ 33.3 billion
0.83
7.02%

Domestic sample
March 2001
Rs. 305.5 billion
Rs. 67.3 billion
4.54
10.4%

Note: The samples are the same as used earlier

Source: Company reports

Thus, the main problem facing the domestic steel industry is its huge debt burden and not its operations.
And it is this high debt burden that needs to be addressed to revive the sectors fortunes. In order to ensure
that the steel companies in CRISILs sample can service their debt in a worst-case scenario such as
FY2002, it is evident that at the least, their interest outflow will have to be reduced significantly. But it is
not possible to reduce the debt level of these companies using their cash flows from operations. Some
companies have attempted to reduce their debt by generating cash from the sale of assets and non-core
operations (see Table 4). For instance, SAIL sold its four power plants and leased out company-owned
residential apartments to employees, generating more than Rs. 12 billion in the process. In addition, sale
of its oxygen plant and some other non-core assets are on the anvil.
Table 4: Cash flows generated from asset restructuring: A drop compared to the total debt
Company

Initiative

SAIL

Sale of four power plants and leasing of

houses
Hiving off of its pellet business into a joint
venture with Stemcor of UK viz., HyGrade
Pellets Limited (HGPL).
Offloading of additional 24% stake to
Praxair in its 50:50 JV Jindal Praxair for
oxygen plant.

Essar Steel

JVSL

Approximate cash
flow generated
Rs. 12 billion

Total debt

Rs. 1.8 billion

Rs. 52 billion

Rs. 140 billion

N.A.
Rs. 46 billion
(Estimated to be less
than a billion)

Source: News articles

But such measures are not adequate to bring down the companies debt to sustainable levels. Thus, the
only option is to restructure their debt in a manner that would result in significant debt reduction. This
could be done in various ways but the most prominent ones would have to entail lenders writing off some
of the debt and/or converting the debt to equity.
So far, however, most debt restructuring initiatives have focused on rescheduling the steel companies
debt repayments and lowering their interest rates. This overlooks the fact that the current debt levels are
unsustainable and hence, merely rescheduling debt will only prolong the inevitable default. This brings
into greater prominence the need to lower debt through financial restructuring.
Sustainable debt
The starting point in any debt restructuring plan would have to be an assessment of the quantum of debt
that these companies can service on a sustained basis. Further, the steel industrys capital intensity would

have to be factored in while determining sustainable debt levels. Steel companies need to undertake
significant capital expenditure on just routine maintenance, which, given their weak cash flows, many
Indian companies are currently cutting down on.
A company like Tata Iron and Steel Company Limited (TISCO), for instance, spends at least Rs. 2 billion
to Rs. 3 billion per annum on just routine maintenance. Routine capital expenditure required in the
companies in our sample could be in the range of about Rs. 8 billion to Rs10 billion a year, which has
significant implications on the availability of free cash flows to service the debt.
The average steel price over a price cycle between November 1998 and December 2001 was about
$250/tonne of hot-rolled (HR) coils. The steel industrys fundamental problems of huge over-capacity and
fragmentation are likely to ensure that steel prices would remain range-bound in future as well and are at
best expected to reach the levels seen in FY2001, when HR coils touched $320-330 /tonne. Thus,
assuming an average HR coil price of around $250 to $260/tonne in future, CRISIL estimates the average
PBDIT of the sample of companies chosen to be about Rs. 20 billion to Rs 22 billion per year. Of this,
ideally, about Rs. 8 billion would have to be spent on routine capital expenditure. Thus, the companies in
CRISILs sample would have a cash surplus of only around Rs. 14 billion to service both their interest
and annual principal repayments when the total debt on their books is a huge around Rs. 300 billion
today.
Further, in order to ensure that these five companies sustain interest payments even in the worst years,
their sustainable interest burden cannot be more than approximately the PBDIT of 2002, which is only
about Rs. 8 billion. If the balance is to be used to repay debt, then the repayments per year would be:
Average PBDIT sustainable interest assumed routine capital expenditure
= (22-8-8) = Rs 6 billion
Thus, at best, Rs. 6 billion of debt can be redeemed per year by the five companies in our sample, in
addition to the Rs. 8 billion of interest payments. If the lenders wish to reduce their exposure to these
companies from say, the present Rs. 300 billion to Rs. 150 billion, it would take these companies almost
25 years to do so. In addition, the interest yield (interest per annum on outstanding debt) would be
abysmally low as the interest per year has been assumed to be only Rs. 8 billion per year. This
underscores the magnitude of the problem facing both steel companies and FIs and the extent of the debt
that needs to be restructured or retired by some means.
Options other than writing off debt
Before looking at writing off debt, lenders can consider some other options. The most popular option
used, even internationally (see table 5), is converting debt to equity. This is an attractive enough option
even if it reduces the promoters holding to extremely low levels as in the case of NTS Steel
Group/Millennium Steel (Table 5). An equity stake would ensure that the lenders have a share of the
companys profits (assuming the debt restructuring results in profits) over a long period of time, enabling
them to recover some of the hit that they may have to take during the restructuring exercise.
Besides, this would result in the lenders increasing their participation in the companys management. This
can have at least two benefits. One, since the lenders are likely to be common across companies, they can
co-ordinate production and marketing strategies across these companies. For instance, they could
coordinate a production cut during a recession, which is likely to benefit all the companies involved. The
other benefit is that greater involvement of lenders in management would result in better balance sheet
discipline. In the past, there have been cases when funds have been diverted into projects undertaken by
group companies, which can be avoided if lenders are actively involved in managing these companies.

Excluding SAIL, the other four companies in CRISILs sample have an exposure of about Rs. 15 billion
to group companies.
Yet another option that can be explored is bringing in strategic partners. For instance, Kalyani Steels
Limited transferred its high value-added steel business into a separate company and subsequently, sold
26% in the new company to Carpenter Technologies Inc., which was brought in as a strategic partner.
This resulted in a cash inflow of about Rs.0.65 billion for Kalyani Steels, which it used to repay a
significant part of its then outstanding debt of about Rs.2.3 billion.
Since domestic steel companies are operationally sound, such joint ventures can be explored, which could
result in a reasonable funds infusion to retire debt. But this option can only be exercised when there is
clarity on the debt restructuring scheme and when there is confidence that it will result in a financial
turnaround. Otherwise, no investor would be willing to take a strategic stake only to be saddled with debt.
Table 5: Some international examples of debt restructuring
Company
Sheffield
Steel
Corporation, USA

Initiative
Result
Sale of corporate assets.
The company has come
$91 million of debt out of a total of about $ 150 million out of chapter 11
converted to equity
bankruptcy

$ 30 million accrued interest written off by investors.

NTS Steel Group, NTS was merged with the steel plants of leading Reduction in debt by
Thailand
industrial conglomerate Siam Cement to create equity swap. Created a
Millennium Steel, which now controls 25% of larger entity through the
merger
to
service
Thailands steel production.

NTS went through an expensive debt- equity swap as remaining debt.

part of the process, reducing the promoters holding in
the merged entity, Millennium Steel, to a mere 2-3%.
Weirton
Steel Exchanging $261 million of its outstanding debt for $146 Reduced debt by about
Corporation, US
million of new secured notes and shares of non-dividend $115 million
paying preferred stock.
Source: News articles

Table 6: Options considered by Indian companies

Company
Essar Steel

Initiative
In 2001, extended average maturity of its debt to eight years from three years. Has been
trying to buy back floating rate notes (FRNs) at a discount.
JISCO
Rescheduling payments and lowering interest rates
JVSL
Plans to convert part of its debt to equity and 0% preference shares at par
Has reduced interest rates for part of the debt
Ispat Industries Plans to convert Rs. 5.1 billion of debt to Rs. 3.1 billion of equity and Rs. 2 billion of
1% preference shares
SAIL
Waiver of Steel Development Fund loans of about Rs. 50 billion in FY2000 by the
government. But there has been no major benefit as there was no significant cash
outflow from SAIL on these loans.
Source: News articles

Rewarding the defaulter?

The option of writing off a part of the steel sectors debt typically leads to the poser: Isnt this akin to
rewarding a defaulter or potential defaulter, especially since the financial mess in some cases has been
caused by mismanagement? At the same time, it has been observed that companies that have met their
debt obligations on time have found it harder to negotiate lower interest rates than companies that have
defaulted. All that can be said in this regard is that having invested huge amounts in companies that are
not able to service their debt, perhaps, the best option open to lenders to recover at least some of their
money is to assist in a financial turnaround strategy. They would have to partly write-off the debt in the
process and take a one-time hit. But the companies too could be losers since such measures could
potentially reduce their ability to access funds from the same lenders in future.
Conclusion
Most Indian steel companies have unsustainable debt levels. With cash flows from operations being
woefully inadequate to service these loans, debt restructuring that could include large write-offs or
conversion of debt to equity seems essential to turnaround these companies. Given the magnitude of the
problem and the large amount of debt, FIs and banks would be required to take some tough decisions, and
quickly at that if the steel sector has to become profitable in future.