Standard & Poor affirms 'CCC/C'' on Ukrainian iron ore producer Ferrexpo PLC

Standard & Poor affirms 'CCC/C'' on Ukrainian iron ore producer Ferrexpo PLCStandard & Poor's Global Ratings has affirmed its 'CCC/C'' corporate rating on Ukrainian iron ore producer Ferrexpo PLC, reads a posting on the Standard & Poor's rating agency's website.

"The outlook is negative. We also affirmed the 'CCC' long-term issue rating on Ferrexpo's senior unsecured notes due in 2019," the agency reported.

"The affirmation reflects the company's reliance on the favourable prevailing iron ore prices and pellet premiums to meet its debt maturities in the coming quarters. In our view, a drop in iron ore prices to $45 per tonne from the current price of about $55/tonne, together with some softness in pellet premiums for two consecutive quarters, would result in Ferrexpo generating insufficient EBITDA to cover its interest expenses and quarterly debt maturities of about $50 million. The company would, therefore, need to tap into its limited cash on the balance sheet. Under this scenario, the company could default or need to enter into a distressed exchange offer in the coming 12 months," according to the document.

"The rally in iron ore prices since the beginning of the year, with prices averaging $53/tonne and a healthy premium on pellets ($25-30/tonne), coupled with Ferrexpo being a low-cost producer, has been highly beneficial for the company. In the first half of the year, the company generated free operating cash flow (FOCF) of about $120 million, enough to fully cover its $120 million debt maturities in the same period. With favourable conditions in the third quarter, we expect the company to generate about $40-50 million of FOCF before facing maturities of $50 million. If prices remain at their current level, the company would be able to build up some cash cushion by year end," S&P experts stated.

"We expect iron ore prices to soften in 2017 to about $45/tonne as the impact of stimulus measures in China fades, reflecting industry supply and demand dynamics. We also understand that all iron ore producers continue to reduce costs, a process that could support a further shift in the global cash-cost curve and potentially lead to lower prices," they said.

"Under our base-case scenario, we project that Ferrexpo's S&P Global Ratings-adjusted EBITDA will be $340-360 million in 2016, falling to about $170-190 million in 2017. The company is likely to outperform our expectations over the short term if prices, especially iron ore, remain at the current level. The following assumptions underpin our estimates: iron ore production of 11.2 million tonnes in 2016, increasing to about 12.0 million tonnes in 2017," the rating reads.

"An iron ore price of $50/tonne for the rest of 2016 and $45/tonne in 2017. The current spot price is about $55/tonne. Pellet premiums of about $25/tonne in 2017, coming down from a recent level of $30/tonne. While softer iron ore prices could support higher premium prices, those could be under pressure if the Brazilian pellet producer Samarco resumes its operations in 2017. Direct cash cost of about $29/tonne in 2017, reflecting cost inflation and some depreciation in the Ukrainian hryvnia against the U.S. dollar. The cash cost reflects no change from the current mining plan. According to the company, under those price levels, they would likely to take some cost-cutting measures (such as deferring stripping costs). Capital expenditure (capex) of $50-60 million. No dividends," the report states.

"These assumptions translate into FOCF of $80-90 million in the coming 12 months. We estimate that as of September 30, 2016, the company only has about $60-70 million in cash (of which the majority is held outside Ukraine) and maturities of about $200 million in the coming 12 months. In our view, unless Ferrexpo secures new funds that help it to match its cash flows with a more comfortable maturity schedule, the company could run out of funds by mid-2017," S&P said.

"That said, if existing iron ore prices and pellet premiums persist, or if the hryvnia experiences sharp depreciation, the company should be able to fully cover its upcoming maturities from operating cash flows," it said.

"We continue to assess Ferrexpo's business risk profile as vulnerable, driven primarily by its exposure to Ukrainian country risk. Our assessment also reflects the cyclicality and capital intensity of the mining industry; Ferrexpo's focus on a single commodity, iron ore pellets; and the concentration of assets in one country. On the other hand, we take into account Ferrexpo's competitive cost position in supplying iron ore pellets to Central and Eastern European steel markets, the long life of the mines, and the relative stability of iron ore pellets compared with iron ore," the experts said.

"The negative outlook on Ferrexpo reflects the risk of a default or a debt restructuring over the coming 12 months if iron ore prices fall from the current spot price of about $55/tonne to our base-case assumption, without corresponding actions on costs or lower local currency, and pellet premiums soften, unless Ferrexpo manages to refinance its current debt," the report reads.

"We could lower the rating if iron ore prices fell below $45/tonne for more than a quarter, without mitigating factors on the cost side, and debt maturities remained elevated at a level of about $50 million a quarter, resulting in a quick depletion of the company's cash position and indicating a near-term liquidity crisis," according to the statement.

"Under a slightly less likely scenario, if the company reached an agreement with its lending bank regarding the coming debt maturities that met our criteria for a distressed exchange (for example, a maturity extension without appropriate compensation), we could lower the ratings to 'SD' (selective default). After the completion of such an exchange, we would raise the rating on Ferrexpo, taking into account its improved liquidity and more comfortable debt maturity," it said.

"We could take a positive rating action if the company improves its liquidity position, such that its future cash flows better match its debt maturity profile," it summarised.
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