Nerves of steel

Spreads on high-yield companies have come under pressure following the recent turbulence in the credit market. But despite a rise in the cost of financing for high-yield names, Keith Nichols, corporate treasurer of Anglo-Dutch steelmaker Corus, says his company has already met its funding requirements for the coming year. By Hann Ho

The debt investors and shareholders of Corus must have developed nerves of steel in the past five years. The Anglo-Dutch company has seen its share price see-saw dramatically over the past few years, while the recent volatility in the credit markets has injected fresh doubts into the minds of high-yield investors. But despite the widening in credit spreads, the steelmaker has met its funding needs for the coming year, having taken advantage of the strong appetite for high-yield bonds at the end of 2004 to tap the capital markets.

Corus was formed in 1999 after the merger of British Steel and Dutch steel group Hoogovens. Its share price plunged to just four pence in early 2003, while the cost of default protection spiralled to almost 2,500 basis points in March that year. Its poor performance was attributed to weak underlying cashflows and doubts over Corus's ability to raise sufficient financing to cover its UK restructuring programme (a costly capital expenditure plan designed to improve operational efficiency, to be completed by 2007).

Since then, however, the company has put in place a plan to steer it back to long-term financial health, reaping a positive result with the group's first operating profit of £582 million in 2004, of which £435 million was made in the second half (following a loss of £208 million in 2003). Costs have been slashed, leading to an improvement in underlying sustainable earnings – earnings after stripping out exogenous factors – of around £340 million. That's halfway towards its goal of £680 million, according to ABN Amro equity analyst Michael Sones.

The company has been fortuitous, too, having benefited from surging world steel prices in 2004, and also from its timing in tapping the capital markets. In September 2004, Corus issued €800 million of 7.5% bonds, maturing in 2011, which Moody's upgraded by one notch to Ba3 with a positive outlook in March. It has also increased its debtor securitisation programme by £60 million to £275 million, with the maturity extended by two years to 2009, and has a positive liquidity profile, with a €800 million undrawn secured credit facility until 2008.

"At that time, the credit market had a real appetite for our sort of risk and our sort of company, while sub-investment-grade yields were coming down. We got our timing virtually spot-on," says Keith Nichols, Corus's corporate treasurer in London. The average duration in the firm's 2004 annual report is 5.4 years, which means there will be no duration-related refinancing issues for at least another year. "Once duration gets down to four years, we'll start to take proactive steps. We will not be looking at any pre-funding strategies until 2007," explains Nichols.

The company is not out of the woods yet, however. The steel industry's exposure to China is a major source of price instability. China accounted for 28% of total global demand in 2004, according to the International Iron and Steel Institute, an industry association body in Brussels. However, the rate at which China is sucking in steel imports appears to have slowed dramatically. ABN Amro's Sones estimates that China currently has an annual net steel import rate of 2 or 3 million tonnes compared with around 27 or 28 million tonnes last year. Any recovery in surplus steel capacity will push prices down – they have already fallen by over 20% since the beginning of 2005.

And with other exogenous factors, notably Standard & Poor's downgrading of General Motors and Ford debt on May 5, which triggered a bout of increased market volatility and exerted upward pressure on the cost of financing for sub-investment-grade companies, there could be uncertainties ahead for the high-yield sector.

"I think the markets will remain volatile well into the second half of the year," says Nichols. "The uncertainty surrounding the euro caused by the 'no' votes [by France and the Netherlands over the draft EU constitution] isn't helping. But I am pleased to see our bonds trading back down to the levels before the GM and Ford downgrade."

The implication of the current market volatility on Corus's debt is uncertain. The company does not need to revisit its debt position for another year, but if steel demand takes a turn for the worse and high-yield credits continue to slide in the coming year, the environment could become more difficult if Corus seeks to refinance in the middle of 2006.

Nichols, however, remains bullish. He concedes that Corus's recovery has been eased by benign market conditions, but says the fundamentals of the firm are in a much healthier state than they were two years ago. "You always go down faster than you go up – there's always a time lag in proving you're on a sustainable recovery path."