Tata Steel UK Holdings Limited -- Moody's lowers Tata Steel UK's ratings to B3; Changes Tata Steel Ltd's outlook to negative

At the same time Moody's has changed the outlook on the Ba3 corporate family rating of India-based Tata Steel Limited ("TSL") to negative from stable.

RATINGS RATIONALE

"The downgrade of TSUKH's ratings reflects our expectation of further weakness in the operating environment facing the European steel industry, for which Moody's has a negative outlook," says Alan Greene, a Moody's VP and Senior Credit Officer. "The weak industry fundamentals in Europe, driven mainly by the depressed economic environment in the region, are raising significant challenges for TSUKH, and will likely lead to slower recovery in its operating and financial profile," says Greene, adding, "as such, TSUKH's debt coverage metrics are no longer consistent with the previous B2 rating."

"The change in TSL's rating outlook to negative from stable reflects the weakened credit profile of TSUKH, which is a very substantial subsidiary of TSL," continued Greene who is also Moody's Lead Analyst for Tata Steel. TSUKH has more than 50% of the group's overall steel production capacity, and its weakened financial performance weighs heavily on the consolidated group.

"The change in TSL's outlook to negative also considers our view that steel supply/demand fundamentals in India will soften, as the Indian economy undergoes a period of slower growth, and domestic capacity continues to be added, albeit the country remains a net importer of steel," says Greene.

TSL is investing heavily in new Indian steel capacity and, as a result, the company will be unlikely to generate free cash flow at the standalone entity level in the near term. This, coupled with possibility of further capacity cutbacks and losses in Europe and downward pressure on Indian steel prices, will likely heighten financial leverage to a level that would position the TSL group weakly within its Ba3 corporate family rating.

"The Tata Steel group currently is a blend of a highly profitable Indian steel operation producing 7 million tonnes per annum (mtpa) of steel and a barely profitable European business running at 14 mtpa, with some support from SE Asia operations running at 2 mtpa," says Greene.

The group is investing both to increase its Indian output and to improve cost efficiency in its European operations. "While this makes business sense, the outlook for the European steel industry remains extremely weak," says Greene, adding, "we expect consolidated credit metrics to deteriorate further in the current financial year (FYE 31 March 2013) despite the 1 million tonne of incremental output from its expanded plant at Jamshedpur."

Tata Steel's strength in India stems from its self-sufficiency in raw materials -- fully in iron ore and some 50% self-sufficient in coal. By contrast, the European operations rely on imported, seaborne raw materials. Moody's notes that considerable focus is being given by Tata Steel to securing raw materials, primarily for its European operations and it has made significant investments in Canada and Mozambique, the benefits of which should flow through in 2013 and beyond.

TSUKH's B3 rating factors in two notches of support from TSL, reflecting TSUKH's strategic importance within the group and the support it is likely to receive in case of need. TSL has demonstrated strong support for its European subsidiary on a number of occasions, including equity injection and working capital support.

Moody's understands that TSUKH has complied with its loan covenants as at March 2012. However, this is predominantly due to Tata Steel group involvement in supporting TSUKH's working capital requirement through a range of measures, such as procuring raw materials for TSUKH and purchasing its receivables. As incremental capacity comes onstream in India, the Group's capacity to provide such support will likely increase.

The outlook for both ratings is negative given the outlook for steel in Europe and the constraints this is placing on the Group's overall financial profile, despite the capacity additions being made in India, that should enhance overall profitability in due course.

Both ratings are unlikely to go up in the near future, but could return to a stable outlook. The financial metrics Moody's would consider are as follows. For TSUKH, Moody's would look for positive free cash flow generation (i.e operating cash flow less dividends and capex) and for Adjusted debt/EBITDA to fall below 7.0x on a sustained basis. For TSL, Adjusted debt/EBITDA would be expected to fall below 3.5x to 4.0x and EBIT interest coverage improve to at least 3.0x on a sustained basis.

Negative rating pressure could develop in the event of a worsening in the operating environment beyond Moody's current expectations. The rating for TSUKH could be considered for a downgrade if EBITDA remains negative in FY13 or if a revised level of support from the Group is apparent or the assumptions behind our expected recovery rate are further pressured.

The rating for TSL could go down if Adjusted debt/EBITDA exceeds 5.0x or if EBIT interest coverage falls below 2.0x to 2.5x on a sustained basis.

The principal methodology used in rating Tata Steel Limited and Tata Steel UK Holdings Limited was the Global Steel Industry Methodology published in January 2009. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Tata Steel UK Holdings is the 100%-owned subsidiary of Tata Steel Ltd and is the holding company for the European steel operations that principally comprise the former Corus Group. Tata Steel Ltd, is an integrated steel company headquartered in Mumbai, India. The Tata Steel Group is the world's 12th largest steelmaker producing 24.03 million tonnes of crude steel in FY2012.

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