Ukraine-based vertically integrated steel producer Metinvest rated 'B-', outlook stable - S&P
S&P Global Ratings has assigned its 'B-' long-term corporate credit rating to Metinvest B.V., the holding company of a group of mostly Ukraine-based vertically integrated steel and mining assets, the outlook is stable, reads a report on the rating agency's website.
"Metinvest, with operations in Ukraine and abroad, is a midsize producer with steel capacity of 8.3 million tonnes (Mt). This compares with rated peers in Europe, the Middle East, and Africa, such as Severstal (11.6Mt), Evraz (13.5Mt), and SSAB (8Mt). Metinvest had revenues of $6.2 billion and S&P Global Ratings-adjusted EBITDA of $874 million (excluding contributions from joint ventures) in 2016. The company's iron ore production was about 30Mt in 2016, and a substantial part of group earnings derived from third-party sales of iron ore," according to the report.
"Established in 2006, Metinvest is a private company, majority owned (71.2% as of June 30, 2017) by System Capital Management (SCM), a large Ukrainian financial and industrial group that had consolidated 2016 revenues of $11.4 billion. SCM's credit standing does not currently constrain the ratings on Metinvest, in our view. We note that a shareholder agreement requires unanimous decisions by shareholders and a eurobond and pre-export finance (PXF) documentation limits dividends. We note the ongoing legal proceedings between SCM Group and Raga Establishment Ltd. Metinvest does not expect any impact on its business from these proceedings. The current rating on Metinvest assumes that SCM Group will maintain its current shareholding in the company. Our assessment of Metinvest's business risk profile as vulnerable takes into account the very high risk of operating in Ukraine and high earnings volatility over the past two to three years, hampered by the loss of assets and receivable impairments in Ukraine. We also consider the volatile global steel markets, the company's focus on commodity steel grades, and its relatively high-cost mining assets. These risks are partly mitigated by improving steel margins and access to European markets by way of rolling mills based inside the EU," S&P experts said.
"The company's vertical integration gives it the flexibility to alter its product mix and redirect volumes for internal use or export depending on market prices. The company is self-sufficient in iron ore (267% during the first nine months of 2017) and coke (116%), and, to a lesser degree, in coking coal (about 30%) from its U.S.-based subsidiary United Coal. Metinvest's rolling mills in Italy, the U.K., and Bulgaria somewhat enhance its competitive advantage over other exporters, as these are not subject to EU import duties. That said, the company has a high concentration of assets in Ukraine, which weighs on its business risk profile, in our view. This risk materialized in the loss of several of its production assets in Eastern Ukraine last year and significant receivable impairments in 2016 (related to receivables that had been due for over five years)," they stated.
"Of the revenues generated in the first nine months of 2017, 74% came from international sales, mostly in Europe, where market conditions improved and steel prices were supportive over the period. This compares with the Ukrainian steel market, which has seen crude steel production decrease since 2013, due to unfavorable market conditions and lower domestic demand, amid the economic crisis and conflict in the Eastern Ukraine. We expect Metinvest will report stronger profitability in 2017, with an S&P Global Ratings-adjusted EBITDA margin of 15-20% (assessment includes the distribution of third-party production, which slightly depresses margins) on more supportive steel, iron ore, and coking coal prices. However, the company's historically volatile profitability in the steel segment particularly following the depressed iron ore and steel environment in 2014-2016, constrains our assessment. We see Metinvest's mining cash cost in the fourth quartile (CFR China basis) as higher than levels at rated peers like Ferrexpo PLC and Metalloinvest. Our assessment of Metinvest's financial risk profile balances the company's current and expected funds from operations (FFO) to debt above 30% with the company's typically volatile earnings, the high levels of catch-up capital expenditures (capex) we expect in the next few years, and lower price assumptions for iron ore in 2018 and 2019. The cash sweep mechanism and the dividend restrictions under the eurobond and PXF documentation provide comfort and visibility on financial policy in terms of expectations of deleveraging and lack of dividend payments," reads the document.
"We expect 2017 to be a good year for Metinvest, buoyed by higher prices, which will likely allow the company to achieve S&P Global Ratings-adjusted FFO to debt of about 35%, compared with below 20% in 2016, and adjusted debt to EBITDA of around 2.0x, compared with 3.4x at end-2016 and around 10.0x at end-2015. Under our forecast of somewhat lower iron ore prices and debt, but higher pellet premiums and capex, we expect FFO to debt in the 35-40% range in 2018," according to the agency.
"In March 2017, the company completed its debt restructuring of its eurobonds and PXF facilities. Post restructuring, the capital structure consists of $1.2 billion eurobonds, $1.1 billion PXF facilities, trade finance, other debt (leasing and export credit agency financing), and $0.4 billion shareholder loans (SHL) - excluded from S&P Global Ratings-adjusted debt. The restructuring agreement resulted in an improved capital structure, with maturities extended to 2021, and has strengthened the company's liquidity position. The new loan has a two-year quasi-grace period, during which only 30% of interest payments and no principal repayments are made, unless the cash balance exceeds $180 million. In addition, the loan documentation restricts Metinvest from paying dividends unless certain conditions are met, including consolidated net leverage below 1.5x (defined as per loan documentation) and at least 55% of bonds and PFX amounts outstanding as of the restructuring that must have been repaid," S&P said.
"As of June 30, 2017, S&P Global Ratings-adjusted debt for Metinvest was $2.95 billion. We also include in our measure of adjusted debt $276 million of defined benefit pension obligations, $115 million of trade receivables sold, $54 million of asset retirement obligations, trade finance, and other debt (leasing and export credit agency financing). We exclude the shareholder loan of $443 million in our adjusted debt calculation, since this is subordinated, has no ongoing debt service requirements, and matures after other debt obligations," it stated.
"The stable outlook reflects our base-case expectation that Metinvest will be able to improve and sustain higher margins in 2017 and thereafter, from a low base in 2015. We expect high planned capex to constrain free operating cash flow generation over the same period, however. We also assume that Metinvest will maintain adequate liquidity. Furthermore, we take into account that Metinvest's majority shareholder SCM will pose no constraint on Metinvest and that there will be no further geopolitical risk escalation in Ukraine. The rating on Metinvest is currently not constrained by our view of the sovereign's creditworthiness," the report says.
"We expect that the company will maintain adjusted FFO to debt of over 20% under normal market conditions and could withstand a weakening to 12% under a lower commodity price scenario. We could lower our rating on Metinvest if its steel margins fail to stabilize in 2018, as we expect in our base case, because this would lead to higher leverage than we currently forecast. A deterioration in the company's liquidity could also lead us to review the rating. Moreover, a weakening of the credit profile of the SCM group could squeeze the current 'B-' rating," according to the document.
"Given the debt restructuring and changes in the business in 2017, a potential upgrade would hinge on the company demonstrating, over the next 12-18 months, operating performance in line with our base case. The credit quality of the controlling shareholders and maintenance of sufficiently robust liquidity to withstand a sovereign default are also factors we would consider before taking a positive rating action," the experts summarized.