S&P Cuts ArcelorMittal (MT) to 'BB'; Follows Recent Cut in Expected Iron Ore Prices

Standard & Poor's Ratings Services lowered its long-term corporate credit rating on Luxembourg-registered steel group ArcelorMittal (NYSE: MT) to 'BB' from 'BB+'. The outlook is stable.

We also lowered our issue rating on the group's senior unsecured debt to 'BB' from 'BB+'. The recovery rating remains unchanged at '4', reflecting our expectations of average (30%-50%) recovery prospects in the event of a payment default.

At the same time, we affirmed our 'B' short-term corporate credit rating on ArcelorMittal.

The downgrade of ArcelorMittal reflects our assumption that the group is unlikely to achieve and sustain credit metrics that we see as consistent with a higher rating following the downward revision of our iron ore price assumption to US$65 per ton in 2015 and 2016. Specifically, we forecast funds from operations (FFO) to debt of about 16%, rather than trending toward 20%, as we had anticipated in our November 2014 base case. We now project EBITDA for 2015 at $7.0 billion to $7.3 billion--below our previous expectation of $8 billion.

We are cautious in our assumptions about average steel margins in the next two years. We believe currently lower raw material prices may not result in sustainably higher margins because the supply-demand balance in the steel industry remains relatively weak. Despite the solid order book for automotive steel--notably in Europe, where the major part of ArcelorMittal's steel shipments is to the auto industry; a supportive market environment in the U.S.; and the likely benefits of the continued weakening of the Brazilian real, improvements in the steel segment profit are unlikely to fully compensate for weaker mining profits.

Our view of ArcelorMittal's business risk profile balances the cyclical and capital-intensive nature of the steel sector against the group's large scale and the diversity of its operations. This is supported by ArcelorMittal's partial vertical integration into iron ore and, to a lesser extent coal. Still, at this low point in the cycle, the short-term EBITDA contribution from the group's mining activities will be smaller. The group's business risk profile is constrained by only average operating efficiency and profitability, with recent EBITDA margins just above 8%, notwithstanding the progress made in asset optimization, notably in the European operations.

Our base-case scenario factors in:

• EBITDA of about $7.0 billion-$7.3 billion in 2015 and a comparable figure in 2016;
• Low capital expenditures of less than $4 billion per year; and
• Low dividends of about $0.4 billion per year.

Based on these assumptions, we arrive at the following credit metrics for ArcelorMittal:

• FFO to debt of about 16% in 2015 and 2016.
• An adjusted debt-to-EBITDA ratio of approximately 4x in 2015 and 2016.

The stable outlook captures our view that ArcelorMittal has sufficient capacity to protect credit quality, focus on efficiency improvements, generate at least neutral cash flow and avoid meaningful debt increases over the next two years.

We could revise the outlook to positive if we see a sustained improvement in steel market conditions and margins, or if mining profits recover. This could lead to an improvement in EBITDA and deleveraging. A ratio of FFO to debt consistently at about 20% could support a higher rating in time.

Although not anticipated in the near term, we could lower the rating on ArcelorMittal if there is a sharp drop in demand for steel in the group's core markets. In this case, ArcelorMittal's adjusted FFO to debt would remain well below the 15% that we see as commensurate with the 'BB' rating, and cash flow after investment and dividends could be markedly negative.

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