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Moody’s Investors Service today changed Tata Steel’s outlook on its Ba1 corporate family rating to negative from stable, reflecting the change in outlook for Tata Steel UK’s rating (formerly Corus) from stable to negative.

“The change in outlook reflects the more challenging operating conditions now facing Tata Steel UK as a result of the likely dropsdeterioration in demand in Europe &  the UK in the next 18 months, with declining steel prices & reduced production volumes,” says Ivan Palacios, a Moody’s AVP Analyst and lead analyst for Tata Steel.

Moody’s notes that Tata Steel UK has recently announced its decision to reduce its crude steel production over the next three months by up to 20%,  one million tonne which equates to a 5% reduction in annual volumes. The decision was aimed at aligning steel production with demand thereby stabilising steel prices & is in line with similar moves taken by other major steel companies that recently announced production cuts.

“Moody’s considers the credit profiles of Tata Steel and Tata Steel UK to be strongly linked due to the increasing level of operational integration between the two entities and the fact that Tata Steel UK accounts for a substantial proportion of Tata Steel’s operations,” adds Palacios, noting, “For the year ended March 2008, Tata Steel UK contributed more than two thirds of the group’s liquid steel output, and generated 76%  of revenue & 49% of  EBITDA.”

Tata Steel’s rating is two notches higher than the rating of its UK subsidiary, reflecting its stronger business and financial risk profiles, primarily as a result of the sound profitability of the group’s domestic operations. Indian operations should remain relatively resilient to the deterioration in the operating environment, due to its significant degree of vertical integration, globally competitive cost position and the growth prospects for the Indian market.

Nevertheless, relative strength in India may not fully offset the likely sustained compression in profitability of  Tata Steel UK  as a result of declining steel prices and volumes. We can expect further weakening of the group’s credit metrics & more decay in the group’s financial flexibility under the current rating.