18:20 24.04.2018

Fitch rates Metinvest's new bonds 'B'

9 min read
Fitch rates Metinvest's new bonds 'B'

Fitch Ratings has assigned Metinvest B.V.'s (B/Positive) new 7.75% $945 million senior unsecured notes due 2023 and 8.50% $648 million senior unsecured notes due 2026 final ratings of 'B'/'RR4', according to a posting on the rating agency's website.

"The assignment of final ratings follows the receipt of documents conforming to information already received. The final rating is in line with the expected rating assigned on March 19, 2018. The proceeds from the new notes will be used to repay around $1.070 million of outstanding notes due 2021, reduce the notional amount outstanding under the pre-export finance (PXF) facility to $765 million, pay for transaction costs of the refinancing and contribute $90 million additional liquidity for Metinvest's operational requirements," reads the report.

"Fitch believes that Metinvest's operational profile is consistent with a 'BB' category rating. However the ratings are constrained by the operating environment in Ukraine. For Fitch to consider an upgrade over the next 18 months the group needs to maintain comfortable liquidity and adopt supportive financial policies, including on shareholder distributions and growth capital expenditure that would allow for positive free cash flow (FCF) generation on a sustained basis," Fitch experts stated.

Metinvest B.V. is the parent of a Ukrainian vertically integrated group of steel and mining companies (jointly referred to as Metinvest).

"The refinancing has raised additional liquidity for operational purposes, providing incremental funding alongside internal cash flow generation, trade finance lines and factoring. Maturities have been extended with the $765 million PXF facility amortising over four and a half years, $117 million of bonds falling due in 2021, $945 million of bonds due in 2023 and $648 million of bonds due in 2026. The resulting liquidity headroom and moderation of refinancing risks are the reason for the positive outlook," the document reads.

"Metinvest has removed the inter-creditor agreement, amended and extended the PXF facility as well as issued new bonds. All coupons have been reset at market rates and are paid in cash. The bonds are plain vanilla instruments without meaningful protection for bondholders. The PXF facility continues to benefit from financial and other covenants as well as security related to assignment of off-take contracts and various bank accounts. As long as the PXF facility remains outstanding bondholders benefit from the tighter documentation put in place by the bank lenders. However, it could be renegotiated or re-financed over the medium term," according to the statement.

"Metinvest's Foreign-Currency Long-Term IDR is one notch above Ukraine's Country Ceiling of 'B-' due to the issuer's ability to service hard currency external debt service from recurring hard currency cash flow generation and available liquidity. Following the refinancing Metinvest's hard-currency external debt service ratio is above 1.5x at least until the end of 2020, which under Fitch's criteria would allow an IDR up to two notches above the Country Ceiling," Fitch said.

"In 2016 and 2017 Metinvest reported sizeable working capital outflows of $600-700 million partially due to Metinvest acting as a working capital provider for its joint venture the Zaporizhstal Group, in which it holds 49.9%. Metinvest acts as an input provider and trading agent for the Zaporizhstal Group, selling steel input materials to the JV, buying back processed products and reselling such inventories. The resale margin forms part of Metinvest's consolidated EBITDA," the experts added.

"At end-2017 trade receivables exposure to Zaporizhstal (net of trade payables) increased by $400 million. Management has confirmed that this is a non-recurring event. We will reassess the impact on the rating if the trade balances between Metinvest and its JV remain significant, restricting Metinvest's FCF generation," the report says.

"Metinvest has been able to maintain market share and supply to domestic and foreign customers despite the conflict in Eastern Ukraine. Also, despite the seizure of assets located within the non-controlled areas and representing 5% of the group's 2016 EBITDA, the detrimental effects of the conflict have materially reduced since the Minsk II protocol, particularly since March 2017. This has translated into a gradual recovery of the Ukraine's economy, with 2018 and 2019 GDP growth now expected at 3% and 3.5%, respectively. Foreign capital is flowing back into the country, as illustrated by Metinvest's successful refinancing," the document reads.

"Increased steel and iron ore prices contributed to Metinvest's improved EBITDA margin of 20% in 2017 against 14% in 2016, translating into $1.7 billion Fitch-adjusted EBITDA vs. $900 million in 2016. Overall, Fitch assesses Metinvest's steel and mining segments as being able to generate an average 15% EBITDA margin over 2018-2020 and positive FCF. This is estimated to lead to an increase in leverage to around 2.8x gross funds from operations (FFO) adjusted leverage in 2018-2020, against 1.7x in 2017. The forecast already factors in a correction in raw materials prices anticipated by Fitch following several quarters of recovery since H2, 2016 and extended maturities following completion of the refinancing," the agency said.

"Fitch believes that Metinvest's financial profile should remain largely stable over 2018-2020, benefiting from a recovery in steel market conditions since Q2, 2016, and assuming no further operational disruptions. Forecast stable earnings are in part due to the group's currency exposure supporting profitability with a largely foreign currency-denominated revenue base and a mostly local currency-denominated cost structure," it stated.

"Metinvest's ratings continue to reflect the group's scale as one of the largest Commonwealth of Independent States (CIS) producers of steel and iron ore, with more than 276% self-sufficiency in iron ore and 30% in coking coal (vs. 55% before the conflict). The ratings also factor in Metinvest's close proximity to Black Sea and Azov Sea ports. According to CRU, Metinvest's steel assets have a cash cost below $400/tonne and are positioned at the end of the first quartile of the hot rolled coil (HRC) cost curve, while the group's mining assets suffered from prolonged under-investment and are now positioned in the fourth quartile of the global iron ore cost curve," Fitch said.

"The EU anti-dumping tariffs on imported HRC had a moderate negative impact on Metinvest's flat steel sales to Europe from the Illich Steel Mill. According to Metinvest's estimates, annual EBITDA loss is in the low double-digit millions. Management does not expect new U.S. anti-dumping measures to hurt profitability as Metinvest mostly exports pig iron to this country (sales included around 100kt of flat and long products to the United States in 2017). However, any indirect implications, such as potential new tariffs introduced by the EU in response to the U.S. measures, could significantly impact the group's results," the report says.

"Metinvest has a weaker credit profile than the major CIS steel peers, notably PJSC Novolipetsk Steel (BBB-/Stable), PAO Severstal (BBB-/Stable) and OJSC Magnitogorsk Iron & Steel Works (MMK, BBB-/Stable). While the group has a comparable 42% share of high value-added products in sales to 47% for MMK, 44% for Severstal and 40% for NLMK, its under-invested assets located in Ukraine lead to higher cash costs for its steel products. Furthermore, the conflict in Eastern Ukraine disrupted the supply of coal to Metinvest's steel plants, significantly increasing the company's coking coal procurement costs compared with its Russian peers. The ratings also incorporate the refinancing risk and liquidity constraints Metinvest has been facing since 2014 vs. its CIS steel peers. Metinvest's ratings also take into consideration higher-than-average systemic risks associated with the business and jurisdictional environment in Ukraine. No Country Ceiling or parent/subsidiary aspects impact the current ratings," it reads.

Key assumptions

Fitch's key assumptions within our rating case for the issuer

- Fitch iron ore price deck: $55/tonne in 2018 and 2019; and $50/tonne onward

- UAH 29/$1 in 2018, UAH 31 in 2019 and UAH 30 thereafter

- 5% growth in steel production volumes in 2018, driven by an increase in semi-finished exports, flat steel volumes in 2019 and 2% annual growth thereafter

- Decline in iron ore production in 2018, followed by 3% increase in 2019 and flat thereafter. We expect Metinvest to change its iron ore product mix to higher-margin pellets (30% volume increase expected in 2018) against iron ore concentrate

- Capex of around $750 million in 2018, $840 million in 2019 and $600 million onward

- More moderate working capital movements: working capital outflows to continue in 2018 and to amount to around $250 million before stabilizing from 2019 and onward; the latter is reflective of Fitch's volume and price assumptions detailed above

-The shareholder loan to start paying interest and being amortised, subject to restrictions from the covenants. The shareholder loan will remain subordinated to the PXF facility and notes.

Rating sensitivities

Developments that may, individually or collectively, lead to positive rating action

-Improved liquidity position with reduced reliance on trade finance and factoring coupled with supportive financial policies, including on shareholder distributions and growth aspirations

-Better control over working capital flows and avoidance of exposure concentrations to single parties, including related parties

-Capital expenditure sustainably above maintenance levels to support long-term cash flow generation of the business

-Hard-currency debt service ratio above 1.5x over the rating horizon, as calculated in accordance with Fitch's methodology "Rating Non-Financial Corporates above the Country Ceiling"

-Upgrade of Ukraine's Country Ceiling

Developments that may, individually or collectively, lead to negative rating action

-Sizeable related party transactions putting pressure on working capital and overall liquidity position

-Development of the conflict in the eastern part of Ukraine affecting the group's operations and profitability

-FFO gross leverage sustained above 3.5x

-Hard-currency debt service ratio below 1x over the rating horizon

-Downgrade of Ukraine's Country Ceiling

"Metinvest reported cash and cash equivalents of $259 million at end-2017, of which $59 million cash in transit was not available as of December 31, 2017 but became available afterwards. Apart from the resulting $200 million readily available cash, the group had availability of around $120 million under trade finance facilities and makes regular use of factoring. Otherwise Metinvest funds its business through internal cash flows. In the past Metinvest has had to cut capital expenditure in some years to manage its liquidity position. The outlook for the steel sector remains positive and we expect operating cash flows to be strong over the medium term," the report reads.

"The refinancing raised an additional $90 million of liquidity for operational requirements (net amount after payment of all fees and tender premiums to bondholders and PXF lenders, accrued interest on discharged obligations as well as transaction costs). The group is now fully funded until the end of 2020," according to the document.