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BW Businessworld

Steel: The Big Fat Debt Crisis

The unpaid dues in India’s steel industry are looming large. And even steel behemoths are barely able to keep their heads above water

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Crisis to boom, boom to crisis! It seems to be the official lullaby of the steel sector in India. Way back in 1988, when the Chief Economic Adviser Bimal Jalan wrote to the then Finance Minister S.B. Chavan flagging key sectors that needed to be addressed urgently, steel made to the top of the list. Since then, the banking sector has shown an incredible amount of patience. However, steel companies keep reeling under debt.

The situation is quite critical as they are not even able to service their interest costs. Sample this: there was an aggregate debt of Rs 45,160 crore on the iron and steel industry in 2014 according to the Corporate Debt Restructuring (CDR) Cell’s progress report. The debt amount has increased to Rs 53,580 crore as of March 2016.

Top players in the Indian steel industry include JSPL (Jindal Steel & Power), Essar Steel and Bhushan Steel, which put together account for more than Rs 1 lakh crore in unpaid debts. Once the carrot of captive coal mines was dangled, a lot of unviable projects of these companies started becoming viable. Hefty investments were made, which got caught and the debt saga lingers on till date.

Sailing On…
JSPL is struggling on the border. It operates in long-term products, so the market improvement did not come to its rescue. Still, industry observers say that JSPL has been able to keep its debts level stable and has added new capacity, to be operational in 2017. They are making losses, but somehow managing to keep their head above water. The New Delhi-headquartered company has a slight chance of recovering if it is able to sell off its power assets or offload the non-core assets and deleverage using the cash, as stated by the experts.

JSPL’s fate also depends on the state of the Indian market, which is sluggish at the moment. Chairman Naveen Jindal (in pic) has a tough job indeed.

MIP or the minimum import price, the government’s protectionist tool to safeguard the domestic steel industry, came to the rescue of the companies operating in flat product segment. Despite these measures, these companies too still carry a large debt burden. Top players in this category include Bhushan Steel, Essar Steel, JSW Group and Tata Steel.

Industry experts say that the ones with large debts are facing doom. Sanjay Jain, Senior VP, Research, Motilal Oswal Securities, says, “It is unlikely for these companies to come out of the traps and have sustainable margins, despite these temporary measures.”

And each case is worse than the other. Take for instance, New Delhi-headquartered Bhushan Steel. The company has been nurturing mammoth debt since long. There is a thumb rule in the industry: for every 1 million tonne of fresh steel capacity, you require $800 million to $1 billion of investment. The rate is much higher for total debt that Bhushan Steel and its counterparts have in comparison to the capacity they have commissioned. This means they have hardly any equity left. The math here is startling: 1 million tonne of capacity, $1.2 billion of debt and $500 million of equity! There is a big question mark already. With Ebidta of 15-16 per cent and a debt looming higher than the capacity, the interest will eat up the entire Ebidta, let alone the principal repayment.

Even after selling the crown jewels, the picture has not become rosy, as the exit of revenue generating assets is not helping lower the interest cover ratio for some as it takes away Ebidta too.

As far as Essar Steel is concerned, the debt should not be rising further, as anticipated by the experts, looking at the market improvements. They are better positioned because of their high volumes and the pellet business, in addition to the steel plants, which is quite profitable now.

Banks: A Barren Effort
The debt level has exceeded to such a level that interest’s expense or cost is way above the best case scenario. Jain explains that if the interest rate is higher than the off cycle margin, then one has no choice but to write down the debts. All the RBI’s schemes have been ineffective. “All the restructuring is linked to the rescheduling of the payments,” says Jain. “The point is, how will someone pay the whole debt, if they are unable to pay the interest.”

Now, writing off the debt or taking over the assets is another tricky part. Who will run them? In fact, some sources say that even after taking over the assets, the banks are in no position to run them. Jain says, “We don’t have the institutions to run these companies. Banks are stuck. The other option is ARCs and the change of ownership. The deals are happening in bits and pieces but only a handful of buyers, who want a good bargain price”. The state of some of these assets is so bad that one would need to pay the buyer instead, to take over them, says Kaustubh Kulkarni, Head Investment banking, JP Morgan.

With JSPL, the real issues are how much time lenders are willing to give the company to get back on track, how long the company will take to work out a comprehensive debt restructuring programme, and how much time it will take for the firm to fulfil its plan to sell stakes in some of its operations. Buyers know it is a desperate situation and may drive a much tougher bargain than in normal times.

On the matter of asset reconstruction, analysts at Religare, Parag Jariwala and Vikesh Mehta, in a September 2016 report, say that the haircuts on troubled iron and steel accounts should be 40-50 per cent. The analysts reiterate their statement, ‘One needs to sell an asset when it is sick, not dead.’

Deals: ‘We Come At A Price’!
Jayanta Roy, senior VP with investment and credit rating agency ICRA, says that if an alternative buyer has to come in, it will look very closely at the capital per tonne and show up at a very competitive price. “Everyone wants a discount and lower debts on their books. The assumption built in is that there will be some credit loss. At the moment, the jittery demand and supply needs to be kept in mind,” Roy adds. India has an installed capacity of 125 million tonne and domestic demand of 85 million-90 million tonnes. Therefore, for a buyer to maintain a high utilisation rate, the capital cost will have to be very competitive. Hence, the experts are not seeing any potential buyers and, if any, they ought to come with very strong financial capacity. The steel companies overall have a much stressed balance sheets except for say, Tata Steel and JSW Group.

To top this, the banks have been compelled to carry out forensic audit of these companies, to find out if the funds allocated for particular project, have been diverted. In fancy parlance, ‘gold plating’ of projects is done to show inflated costs and borrow more to use the funds for “other purposes”. So, the lenders are finding it hard to take fresh exposure with serious concerns over the delay in concluding the sale of non-core assets, as in case of JSW-JSPL deal.

The Last Resort
The existing promoters of the steel companies would not be able to take the companies off the debt. Therefore, they will have to sell it off to somebody else. Inefficient players will have to die. Eventually it is up to the bank to take a call sooner or later.

Considering the circumstances, is de facto nationalisation of the steel industry, a solution? This would essentially mean nationalisation of these steel assets since state-owned banks would own a large part of the equity and a PSU (such as Steel Authority of India) would run the operations. At least, the issue of credibility of these deals will get addressed. But is that a durable solution?