Fitch Affirms China Steel Corporation's High Rating

Fitch Ratings affirmed China Steel Corporation's (CSC) National Long-term Rating at 'AA (twn)' with a Stable Outlook and National Short-term Rating at 'F1 + (twn)'. At the same time, Fitch has affirmed CSC's senior unsecured rating at 'AA (twn)'.

The CSC rating is three notches lower than Taiwan's Best Risk (AA /Stable), based on a top-down approach in line with Fitch's government-related rating criteria combined with national scale rating criteria. The top-down approach reflects CSC's strong strategic and operational ties with the government.

KEY RATING FACTORS
Moderate Ownership, Strong Support: Fitch rates the status, ownership and control of CSC as Moderate, as the largest and most controlling shareholder of the company is the government of Taiwan through the Ministry of Economy, which owns 20% of the shares. The ministry appoints the chairman of the CSC and holds three of the 11 seats on the board of directors.

Fitch rates CSC's support and expectations as “strong” despite little government financial support as the company maintains a high level of free cash flow (FCF). We anticipate CSC's full government support should the need arise due to the company's importance to the steel industry in Taiwan, which affects other industries that use steel as a raw material. In addition, CSC is the only company legally permitted to build and operate steel blast furnaces in Taiwan, and plays a pivotal role in helping Taiwan maintain high self-sufficiency in steel.

Strong incentive to support: CSC's position as a government-backed monopoly in steel production allows the company to capture a large share of around 70% of the domestic steel market. Therefore, Fitch rates the financial implications for the Taiwan government in the event of a CSC default as “strong”. We believe that CSC's default will significantly limit funding for other state-owned companies.

We also assess CSC's default as having “moderate” socio-political implications, as we believe that the shortage of domestic steel will be difficult to quickly fill by domestic competitors or imports, given CSC's dominant market position. In addition, the shortage of steel will have significant spillover effects on Taiwan's export-oriented economy.

Low cost, free cash flow generation: CSC has consistently higher EBITDA margins than its regional counterparts due to low costs, vertical integration and focus on high value added products. CSC is the largest steel producer in Taiwan and the only vertically integrated producer. In addition, CSC steel mills were placed in the first quartile of the CRU flat and long steel cost curve in 2021.

CSC has a strong record of generating free free cash flow due to its competitive cost position, limited capital expenditure and efficient working capital management. The CSC posted positive free cash flow despite weak earnings during the 2014-15 steel price crash and the recent coronavirus pandemic. We expect free cash flow to remain positive between 2021 and 2024 as market conditions become more favorable.

Stronger financial profile: CSC's financial profile has improved in light of the rapid recovery in market demand following the pandemic and the associated sharp rise in steel prices. Fitch predicts that CSC's EBITDA margin will grow more than 20% in 2021, up from about 10% in 2020, based on strong performance in the first three quarters. This will lead to an improved leverage profile, with Fitch expecting FFO to fall below 3.5x during 2021-2024 from 7.0x in 2020.