Fitch Lowers Outlook on ArcelorMittal (MT) to Negative; Reflects Risk of Further Pricing Downside

Fitch Ratings has revised ArcelorMittal S.A's (NYSE: MT) (AM) Outlook to Negative from Stable, while affirming the Long-term Issuer Default Rating (IDR) at 'BB+'.

The Negative Outlook reflects the risk of further substantial downside to pricing, which may negate the company's measures to improve performance and reduce leverage. A key assumption of our rating case is that steel prices will be supported at current levels by either a rationalisation of higher-cost producers or, more likely in the short term, by protectionist measures in AM's key markets.

The rating reflects the company's strong operational diversification, high-quality steel products, strong market share in key markets and vertical integrations, which allows it to retain an average cost position on the global cost curve. In addition, management has laid out cash preservation measures, including suspending dividends, reflecting their commitment to reduce net debt and further support the current rating.

These measures, which should allow gradual deleveraging, are key to maintaining the 'BB+' rating. We will also look at the effect of anti-dumping measures - actual and prospective - by the US and EU authorities to protect domestic steel producers from cheap steel imports.

KEY RATING DRIVERS
Elevated Leverage
Fitch expects deteriorating external operating conditions to temporarily derail AM's deleveraging efforts and projects funds from operations (FFO) adjusted gross leverage to increase to 5.5x in 2015 from 4.8x in 2014. AM is facing competition from increasing Chinese exports at low prices and pressure on order volumes as customers adopt a wait-and-see approach.

The current debt protection measures are elevated for its current rating, which is reflected in the Negative Outlook. However, Fitch projects AM will deleverage in the next two to three years and expects FFO adjusted gross leverage to fall below 3x in 2018, level that is commensurate with a BB+' rating. This is provided AM successfully executes its current initiatives to preserve cash and decrease net debt, and that pricing remains stable.

Difficult Market Dynamics
A drop in domestic demand for steel in China (contraction in real steel demand of 3% up to 4% this year) has led to an increase in exports at low prices. As a result, AM has lowered its 2015 EBITDA guidance twice to USD5.2bn-USD5.4bn, from USD6.5bn-USD7bn at the start of the year.

While we expect to see continued pressure from Chinese exports, which could lead to more downside price risk, we anticipate this will also lead to an increase in protectionist measures against cheaper steel imports. The impact of these trade defence measures is yet to be seen and will depend on a number of factors. As a result, we do not factor in any upside in price from these trade measures.

Underlying end-market demand for AM's products continue to remain neutral/positive for 2016 in the NAFTA and Europe and more difficult in Brazil and some ACIS (Africa & CIS) countries. Fitch expects AM's total steel shipments in 2015 of around 87mt (up from 85mt in 2014). For 2016 we project growth of 0.5%, due to the uncertainty of Chinse steel exports.

Cost-cutting to Support Margins
Fitch considers AM to have an average cost position (higher second quartile) globally, varying across the key regions in which it operates. AM has been successful in its cost optimisation programmes in Europe and in the mining segment where the company reduced its iron ore cash cost by 17% yoy (9M15), higher than its 15% target.

AM is continuing to implement structural improvements to its business to reduce its cash requirements. For 2016, the group expects structural improvements such as a ramp up at Calvert, Brazil value plan, North American restructuring, new iron ore contracts (in S.Africa), coke/PCI upgrades, mining unit cost reductions, South African tariffs and continuing European transformation plans, which will lead to a USD1bn improvement in EBITDA. As a result of these measures, we project an improvement in EBITDA margin of 1% for 2016.

Cash Preservation Measures
In addition to cost-cutting measures, AM has implemented a number of cash preservation measures that will support free cash flow (FCF) and the company's deleveraging strategy. The company announced capex cuts, a suspension of dividends, and asset optimisation. We view the steps that management is taking as positive, reflecting management's commitment to deleverage in the difficult market environment.

These factors, coupled with our expectations of a more stable environment at end-2016 to 2017, will result in FFO adjusted gross leverage of 3x in 2018. This would represent substantial deleveraging from the expected peak of 5.5x in 201, supporting its current 'BB+' rating.

In addition, in January 2016 AM's mandatorily convertible notes (MCNs) of USD2.25bn (value on balance sheet USD1.8bn) will be converted to equity. Previously these MCNs were treated as 100% debt. After 2016, the conversion into equity will lead to a net debt decrease of around USD1.8m (0.4x decrease in FFO adjusted net leverage).

Significant Scale and Diversification
The ratings continue to reflect AM's position as the world's largest steel producer. AM is also the world's most diversified steel producer in product and geography, and benefits from a solid and increasing level of vertical integration into iron ore.

KEY ASSUMPTIONS
- Chinses exports continue to impact the market in 2016: Total shipments to increase slightly by 0.5%, coupled with a slight decline in average steel selling price for 2016.
-Price stabilisation by end-2016/2017
-Continued reduction in cash costs in 2016 to support profitability
-Iron ore costs - USD50/t in 2015- 2016, USD55/t in 2017-2018 and USD60/t long term)
-Capex of USD2.5bn in 2016
-Assets sales in 2016
-No dividends
-MCNs conversion in January 2016

RATING SENSITIVITIES
Positive: Future developments that could lead to the Outlook being revised to Stable:

-Sharper-than-expected cost-cutting, optimisation programmes and price improvements which would translate into stronger cash flow generation and hence more rapid deleveraging toward FFO gross leverage of 3.0x by end-2016.

-EBIT margins of at least 5% (2014: 4.2%)

-Positive FCF across the cycle

Negative: Future developments that could lead to negative rating action include:

- Further material price declines in 2016 vs. 3Q15 prices

- Inability to execute recently announced cost-cutting/asset optimisation initiatives

-EBIT margin below 4%

-Inability to achieve FFO adjusted gross leverage below 3.0x by end-2018

-Persistently negative FCF

LIQUIDITY
At 30 September 2015 AM had a cash position on USD3.5bn and undrawn long-term credit lines amounting to USD6bn. This is more than adequate to cover its short-term debt of USD2.5bn. We view AM's liquidity as strong, given that they are actively managing their debt maturity profile and in April 2015 they refinanced and extended USD6bn of credit lines (USD2.5bn matures in April 2018, USD3.5bn matures in April 2020)

FULL LIST OF RATING ACTIONS

Long-term IDR affirmed at 'BB+', Outlook changed to Negative from Stable
Short-term IDR affirmed at 'B'
Senior unsecured rating affirmed at 'BB+'
Subordinated rating affirmed at 'BB-'

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