Fitch Ratings has affirmed the 'BBB-' international scale foreign currency and local currency issuer default ratings (IDR) for Companhia Siderurgica Nacional (CSN). CSN's national scale rating of 'AA(bra)' was also affirmed. The Outlook for all the corporate ratings is Stable.
CSN's ratings are supported by the company's position as one of the industry's lowest-cost steel producers. CSN's low-cost structure is due primarily to its ownership of the Casa de Pedra mine, one of the world's largest high-quality iron ore bodies (60.4% iron content). The company also benefits from its modern production facilities, vertical integration, diverse product mix and access to low-cost labor. These factors allow CSN to generate positive cash flows during troughs in the steel cycle and economic downturns in Brazil. The ratings also consider the concentrated nature of the Brazilian steel industry, which limits competition based solely upon price. Competition from foreign steel imports into Brazil is minimal. Barriers to entry include the logistical challenges of transporting steel to Brazil and within Brazil, as foreign steel producers have limited access to efficient distribution networks.
Over the past several years, CSN has focused on modernizing and expanding its steel production facilities and divesting its non-core assets. CSN's credit profile will come under pressure over the next four years due to an aggressive capital expenditure program totaling about US$5.0 billion. The planned investments include two main projects: 1) 9.0 million tons of steel slab production capacity expansions via modular investments in six blast furnaces of 1.5 million tons each; CSN would likely invest about US$3.6 billion for an estimated 65%-75% stake in the steel project together with Baosteel, China's largest steel producer, which would potentially take a 25%-35% stake in the production output, and 2) US$1.5 billion to increase iron ore production and exports. The iron ore investments include a US$919 million mine expansion project to increase production at the company's Casa de Pedra iron ore mine to 53 million tons per year by mid-2010 from 14 million tons in 2005. About US$345 million will also be invested to construct two pellet plants each with an annual capacity of 3.0 million tons. To export the increased iron ore production, CSN will invest about US$260 million to expand the export capacity of the Sepetiba port to 30 million tons by mid-2007.
CSN's leverage is currently high for the rating category and the current steel price environment. The affirmation of the existing ratings is based on the expectation that CSN reduces total debt to about US$3.7 billion by year-end 2006 from US$4.7 billion as of June 30, 2006. Credit ratios would then improve to a level that is more consistent with the investment grade rating category at this point in the steel price cycle. The company plans to reduce total debt by about US$1.0 billion by year-end 2006 using its existing cash balances to repay upcoming debt obligations due in the second half of 2006. As of June 30, 2006 and according to Brazilian GAAP financial figures, CSN had total debt of BRL10.4 billion (US$4.7 billion) and cash and marketable securities of BRL4.2 billion (US$1.9 billion), resulting in a total debt-to-EBITDA ratio of 2.6 times (x) and a net debt-to-EBITDA ratio of 1.6x, based on an EBITDA for the last twelve months of approximately BRL3.9 billion (US$1.8 billion).
During the first half of 2006, the company generated EBITDA of BRL1.8 million, a sharp decline from BRL2.5 billion of EBITDA during the first half of last year. The fall in the CSN's cash generation was a result of an accident in January 2006 involving the company's main blast furnace accounting for 70% of total steel production. This accident decreased production by about 1.9 million tons in the first half of 2006 and will likely reduce CSN's full-year 2006 EBITDA to BRL3.8 billion from more normal levels of about BRL4.6 billion as obtained in 2005 and 2004. However, due to the appreciation of the Brazilian real against the U.S. dollar, CSN expects 2006 EBITDA in U.S. dollar terms to be close to the amount generated in 2005 of US$1.8 billion. While the company expects to recover through insurance settlements most of the loss profit associated with the blast furnace accident of about US$575 million, to date, only about US$75 million has been received.
Absent extremely robust iron ore and steel prices, CSN will likely need to take measures such as selling part of its iron ore business and the associated transportation and port infrastructure to a partner and decreasing dividends and share repurchases to maintain its existing ratings. CSN does stand to benefit from the strong price environment for iron ore and the positive outlook for demand over the near to medium term. Iron ore prices rose by about 19% in 2006 and 72% in 2005, and are expected to remain higher than historical levels. Consumers of iron ore face an international market dominated by just a few large rivals and should welcome the opportunity to have CSN provide another source of high-quality iron ore.
Despite the expectation of significant free cash flow generation beyond 2006, debt reduction by CSN will be limited by management's view that its capital structure is close to optimal, the company's aggressive capital expenditure plans, and now, to a lesser extent, the debt-service requirements associated with a related entity of CSN's controlling shareholder, Vicunha Siderurgia S.A. (Vicunha). Vicunha and CSN are indirectly burdened with US$450 million of debt in the form of perpetual bonds issued in 2005 by a Vicunha-related party, a special purpose vehicle called National Steel S.A. Vicunha has a 42.74% stake in CSN but no operating assets to generate cash flow. Although CSN is not obligated to directly service shareholder-related debt, Fitch expects CSN to pay dividends of at least US$120 million to allow National Steel to meet its debt obligations, consisting primarily of interest payments. Brazilian corporate law requires companies to pay dividends of at least 25% of net income.
With annual production capacity of 5.6 million tons of crude steel and 5.1 million tons of rolled products, CSN ranks as one of the largest steel producers in Latin America. The company's fully integrated steel operations, located in the state of Rio de Janeiro in Brazil, produce steel slabs and hot- and cold-rolled coils and sheets for the automobile, construction and appliance industries, among others. CSN also holds leading market shares in the galvanized and tin-mill products segments. In addition to steel, CSN also produces iron ore from its Casa de Pedra mine with a current production capacity of 21.5 million tons.
A comprehensive credit analysis of CSN will be available in the next week from the Fitch Ratings web site at www.fitchresearch.com.
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