Fitch Ratings has revised the outlook on Tata Chemicals Limited's (TCL) Long-Term Foreign-Currency Issuer Default Rating (IDR) to positive from stable and affirmed the rating at 'BB+'.

The revision is due to our expectation that TCL's net EBITDA leverage will remain below 2x over the financial year ending March 2023 (FY23) to FY26 (FY22: 1.9x). We also expect its free cash flow (FCF) margin to improve over FY24-FY26, from an average of -2.5% in FY19-FY23, despite high average capex intensity of 10%. TCL could generate better FCF than our forecasts through stronger-than-expected earnings and/or prudent management of its capex programme, which is reflected in the Outlook.

We also believe that TCL's leading market position, cost-competitive operations and the sector's end-market diversification mitigate the risks to its credit profile from its smaller EBITDA scale versus 'BBB-' rated chemical industry peers, which Fitch regarded as a drag on its rating in the past. TCL's cash flows have remained resilient in recent years despite the pandemic-induced demand shock and rising energy costs amid geopolitical pressure, notwithstanding its smaller scale, which is due to the soda ash sector's smaller market size than other chemical and commodity sectors.

Fitch expects TCL's net debt to EBITDA to remain below 2.0x over FY24-FY26, even as EBITDA in some of its regional markets falls from the record high in FY23 while remaining higher than the levels over FY19-FY22. We expect internal accruals to be generally sufficient to cover TCL's annual capex and shareholder distribution needs over FY24-FY26. However, EBITDA that is weaker than we expect and/or higher-than-expected capex could lead to negative FCF over FY24-FY26.

TCL is the world's third-largest soda ash producer. Its soda ash capacity in the US and Kenya - 68% of its total capacity of 4.1 million tonnes - benefits from natural trona deposits, which require low conversion costs and have a lower carbon footprint. TCL's capacity in Gujarat, India (23% of total) is one of the lowest-cost producers of synthetic soda ash, aided by proximity to limestone quarries, economies of scale and an integrated cement plant utilising waste generated from soda-ash manufacturing. These underpin the company's cost competitiveness relative to peers.

Fitch believes TCL's geographically diversified operations and the soda ash sector's varied mix of end-markets reduce the risk of volatility in operating earnings associated with regional downturns and product concentration. TCL's soda ash capacity is diversified across India with 22%, the US 60%, the UK 10% and Africa 9%. The sector has end-uses across multiple non-discretionary (salt, detergents, container glass, glassware and chemical products) and discretionary (flat glass) end-markets.

We expect TCL's soda ash (including salt) sales to fall by 3% in FY24, as the long-term nature of most of its customer contracts in the US and UK will prevent a sharper fall amid our expectation of a recession in the two markets during parts of the year. However, TCL's sales growth should improve to 5% in FY25 as global economic growth slowly recovers, capacity is expanded at its Indian operations and demand from new applications of soda ash in sectors such as lithium carbonate and solar glass continues rising.

TCL's reported EBITDA margins improved to 23% in 9MFY23 from the average Fitch-adjusted margin of 17% over FY19-FY22. We believe this was due to rising demand, tight industry conditions driving higher prices and benefits from well-managed energy costs. However, we expect margins to narrow from FY24 due to risks to growth in the US and UK markets, more balanced industry conditions over the medium term and as current hedging benefits subside. We assume EBITDA margins of 16%-17% over FY24-FY26.

We expect average capex intensity of 10% over FY24-FY26, close to the 11% in FY19-FY23, driven by its target of increasing soda ash and sodium bicarbonate capacity by 30% and 40%, respectively. This is in addition to its ongoing expansion and planned investment in speciality products. We expect TCL's ongoing capex to increase soda ash and sodium bicarbonate capacity by 0.3 million tonnes and salt capacity by 0.33 million tonnes to be completed by FY24.