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TEXT-S&P rates Mongolian Resources Corp. 'B-'; outlook stable
The rating on MRC reflects the company's production and sales ramp-up risks, its high customer and mineral concentration, and high debt. MRC's second-quartile cost position and positive demand prospects in the northwest Chinese iron ore market partly offset these limitations. The rating factors in the company's proposed issue of up to US$300 million in senior secured notes.
We assess MRC's business risk profile to be "vulnerable," as our criteria define the term, to reflect the high risk associated with a ramp-up in the company's production and sales volumes over the next 12-18 months. MRC's target of doubling annual production and sales to 3.7 million tons in 2013, from the 1.8 million tons it expects in 2012, is aggressive, in our opinion. We view the company's record of growing production and sales at such a pace and scale as mostly untested.
MRC's high customer concentration heightens its sales ramp-up risk, in our view. We believe the company may find it difficult to rapidly redirect its production to other customers or outside the region if demand temporarily slows down. In addition, MRC's clients have strong bargaining power and this could disrupt the company's cash flows if commercial disputes are prolonged. We expect customer concentration to remain high over the next two years, despite MRC's stated strategy to broaden its customer base. The company's two largest clients accounted for about 95% of its revenues for the six months ended June 30, 2012.
We view MRC's risk tolerance as high. As of June 30, 2012, more than 50% of the company's debt stems from a 2011 debt-funded buy-out of the shares held by Deutsche Bank AG (A+/Negative/A-1) in Euro 7 Investment, MRC's major shareholder, and in Altain Khuder LLC (not rated), MRC's main operating subsidiary. Some of these shares were subsequently granted to business partners of Mr. Bazar Radnaabazar, who owns Euro 7 Investment. MRC failed to pay its working capital loans from Golomt Bank of Mongolia (B+/Positive/B) when they fell due in March and May 2012, although it fully repaid these loans in September 2012. In our view, these events highlight the limitations of the company's internal controls and its lack of established financial discipline.
MRC's good second-quartile cost position and low mining costs partially mitigate its high mineral concentration to iron ore. We estimate that a 5% decline in iron ore concentrate prices would result in about 10% decline in EBITDA. Nevertheless, we expect the company's gross profit per ton before depreciation and amortization at about US$34-US$38 over the next three years. This should keep EBITDA positive even if iron ore prices fall 25% from current levels.
In our base-case scenario, we expect MRC's financial risk profile to remain "highly leveraged," as defined in our criteria, over the next 12 months. We forecast a debt-to-EBITDA ratio of 4.5x-5.0x in 2013, with a ratio of funds from operations (FFO) to debt at about 10% following the company's proposed notes issuance. We expect MRC's debt-to-EBITDA ratio to improve to less than 4.5x in 2014 to reflect the growth in sales. We assume MRC's iron ore concentrate sales to be about 2.5 million tons in 2013 and 2.9 million tons in 2014.
MRC intends to uses the proceeds of the proposed notes to repay existing indebtedness and for capital spending and general corporate purposes. Because the company plans to use the proceeds to repay all existing secured indebtedness, we expect its ratio of priority debt to total assets to be less than 15% over the next two years. MRC's major cash-generative subsidiaries Altain Khuder LLC and Million Vision Group Ltd. will guarantee the notes. We expect the notes to be secured over the capital stock of all of MRC's restricted subsidiaries, mining and exploration licenses, cash accounts and receivables, existing mining equipment, and existing processing plants, including processing plant no. 6--if and when it is completed. MRC will be able to incur additional indebtedness subject to a number of incurrence covenants.
MRC's liquidity is "less than adequate," as defined in our criteria. The company's liquidity is sensitive to iron ore prices, sales volumes, and fluctuations in working capital requirements. We expect MRC's liquidity sources to cover its liquidity needs by about 1.05x over the next 12 months.
Our liquidity assessment incorporates the following factors and assumptions:
-- Liquidity sources over the next 12 months include our expectation of about US$30 million-US$35 million in FFO, and about US$7.9 million in cash and cash equivalents as of June 30, 2012.
-- Liquidity sources also include proceeds of up to US$300 million from the proposed notes and about US$22 million in committed bank working capital facilities.
-- Liquidity needs over the next 12 months include our expectation of capital expenditure of about US$93 million until the end of 2012 and about US$207 million in 2013. While we expect MRC to proceed with its capital spending plan, we note that most of the company's capital spending in 2013 is uncommitted, providing some flexibility.
-- Liquidity needs also include debt of about US$32.8 million due in 2012 and about US$32.9 million due in 2013. The company expects to repay a US$30 million senior secured loan due in 2015 from the European Bank for Reconstruction and Development (EBRD: AAA/Stable/A-1+) and secured loans from local banks with the proceeds from the proposed notes.
-- We have not factored any dividend distribution.
The stable outlook reflects our expectation that MRC's financial risk profile will remain "highly leveraged" in the next 12 months, despite higher sales volumes. The stable outlook is also contingent on the company issuing the proposed notes.
We could raise the rating if MRC demonstrates an ability to expand its earnings base substantially by increasing sales volumes, such that it can sustain a debt-to-EBITDA ratio at less than 4.5x for more than 12 months. We believe this could happen if the company's sales volumes exceed 2.8 million tons in 2013 and 750,000 tons over the first quarter of 2014, with an average selling price of more than US$85, implying a gross profit per ton excluding depreciation and amortization in excess of US$40 over the period.
We could lower the rating if MRC's liquidity profile weakens materially due to: (1) a delay in the proposed notes; (2) an increase in working capital because of slower sales; or (3) a fall in the average selling price of its iron ore concentrate to below US$70 per ton for more than 12 months that pushes gross profit per ton before depreciation and amortization to less than US$30. We could also lower the rating if the company's capital spending is higher than our expectation.
Related Criteria And Research
-- An Iron Ore Price Persisting At $100 Per Ton Could Trip Up Single-Commodity Miners, Oct. 1, 2012
-- Key Credit Factors: Methodology And Assumptions On Risks In The Mining Industry, June 23, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
Mongolian Resources Corp.
Corporate Credit Rating B-/Stable/--
Senior Secured B-
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