Rating Rationale

Strengths
* Superior market position is backed by ability to manufacture higher grades and value-added products. JSPL makes specialised structural steel (medium and light structural mill and railway and universal beam mill) and high-grade plates (with application in boilers for power plants and defence equipment), which are relatively less vulnerable to demand slowdown. While the long products segment is fragmented, JSPL can command premium due to its superior product profile and established brand. Ramp-up of one of the most cost-effective blast furnace-basic oxygen furnace plant in Angul will further strengthen market position over the medium term.

* Improving operational efficiency: Per tonne operating profitability for the company's Indian steel operations significantly improved to around Rs 13,300 per tonne during the first-half of fiscal 2019 from Rs 7,300 per tonne in fiscal 2016. This is largely driven by steps taken to improve logistical linkages for raw material sourcing and control over fixed overheads. Ramp up of angul operations, cost reduction measures such as implementation of two additional coke oven batteries and improved mining operations in Mozambique will further improve the operating efficiency. Proximity of plants to coal and iron ore mines, captive power units, and railway sidings; and nearness to Paradip port also support the operating efficiencies. Better capacity utilisation may also lead to a higher operating margin because of higher fixed-cost absorption. Consolidated operating margin should sustain at 23-25% over the medium term.

* Well-diversified operations: In addition to steel operations in India, JSPL benefits from the diversity offered through its 3,400 megawatt (MW) independent power plants (IPPs) in Tamnar, Chhattisgarh; and steel manufacturing operations in Oman through Shadeed Iron & Steel Company (Shadeed). Operations at Shadeed benefit from improving utilisation at 80-85% and efficiencies through proximity to gas source. Though only 30% of the IPPs' capacities are tied up with power purchase agreements (PPAs), these capacities benefit from their low capital costs, with current debt per MW at only Rs 2.24 crore. The consequent low cost of generation and hardening of merchant rates are likely to benefit power operations over the medium term.

Weaknesses
* Weak, albeit improving, financial risk profile: Though debt is sizeable, debt/EBITDA levels improved to around 4.7 times during the first-half of fiscal 2019 from 13 times during fiscal 2016 on the back of better domestic operating performance and steps taken to improve capital structure (equity infusion and divestment of non-core assets). However, debt levels are expected to remain high due to low cash generation in entities in Australia and Mauritius with debt/EBITDA of around 4.5 times by end of fiscal 2019. Sale of land in the Australia and debt refinancing in the Australian entity will remain a key monitorable.

* Susceptibility to demand and price risk: Demand for long steel products depends on the level of construction and infrastructure activities and any movement in economic cycle. Furthermore, the steel industry remains exposed to global steel prices, which declined significantly in fiscal 2016 and impacted realisations of players in the domestic market. However, steel realisations have recovered from fiscal 2017 following government's protective measures (anti-dumping duty and minimum import prices) and improved global steel prices. The prices remain elevated during the first-half of fiscal 2019 with strong domestic demand led by pick-up in the infrastructure, automotive, and affordable housing segments. Any significant change in demand and pricing scenario will remain a key monitorable.

* Low raw material linkage, partially offset by proximity to raw material sources: JSPL's existing captive iron ore mines meet only one-fifth of its total iron ore requirement. Furthermore, absence of long-term PPAs for around 70% of power capacity in Tamnar exposes the company to off-take risk and to volatility in merchant rates. Moreover, this capacity is susceptible to fuel risk due to absence of fuel linkages (after de-allocation of its coal mines pursuant to the Supreme Court order in September 2014). Nonetheless, secured coal linkages in the recent past to the extent of 5.39 million tonnes for the captive power plants and sponge iron plants and also the proximity of steel and power plants to coal and iron resources lends comfort. Ability to tie in these resources for the long term will remain a monitorable.