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July 10 (The following statement was released by the rating agency)
Fitch Ratings has revised Russia-based OJSC
Uralkali's (Uralkali) Outlook to Stable from Negative and affirmed its Long-term
Issuer Default Ratings (IDR) at 'BBB-'. The foreign currency senior unsecured
rating on Uralkali Finance Limited's loan participation notes (the Notes) has
also been affirmed at 'BBB-'.
The Stable Outlook reflects our expectation that amid challenging market
conditions, Uralkali's return to conservative financial policies will support an
improvement in its financial profile to levels commensurate with the ratings
within the next two years. Specifically, we forecast a reduction in fund from
operations (FFO) net leverage to 1.6x by end-2016, from 3.0x at end-2013 as
positive free cash flow (FCF) is applied to the deleveraging exercise.
The ratings continue to factor in Uralkali's leading cost position in the potash
sector and strong cash generative capacity through the cycle. Our base case
assumes a single digit increase in potash export prices in 2015 from the record
lows of 2014, and a modest increase in production levels, as demand recovers.
Return to Conservative Financial Policies
The Stable Outlook reflects our view that Uralkali's financial metrics will
improve from the current weak levels as a result of the group's renewed focus on
deleveraging. Management has made debt reduction a priority and publicly guided
to a net debt to EBITDA target below 2.0x. This provides clarity on the new
owners' stance on shareholders' returns and appetite for leverage and contrasts
significantly with last year's aggressive financial policies. Under our base
case, FFO net adjusted leverage reduces to 1.6x at end-2016 from 3.0x at
end-2013 as positive FCF is applied to debt reduction.
We had revised the Outlook on the rating to Negative in July 2013 when
debt-funded share-buy backs threatened the group's credit profile. This was
compounded later in the year by a downward revision in our base case operating
cash flow forecasts following the break-up of BPC, Uralkali's trading
joint-venture (JV) with Belarus-based JSC Belaruskali, and subsequent collapse
in potash prices.
Robust Cash Generation Capacity
Under our base case, Uralkali's vertical integration and competitive cost base
continue to translate into EBITDA margins around 50% through the cycle. The
group's leading market and cost positions place it well to withstand the current
weak pricing environment and its high profitability cushions it against the
inherent demand volatility of the potash market. Uralkali's operations comprise
of five ore mines and seven processing plants in Russia. In 2013, EBITDA was
USD1.6bn on sales of USD3.3bn (47% margin) amid challenging market conditions.
FCF was a positive USD598m (18% margin) after capex of USD427m and dividends of
Continued Pricing Pressure
BPC and North American JV Canpotex had controlled 70% of the world's potash
trade. The break-up of BPC resulted in intensifying competition on prices in
late 2013 as Uralkali fought to regain lost market share. This was a stark
departure from the supply-discipline that had characterised the market and
underpinned the resilience of potash prices through the cycle. Spot F.O.B.
prices dropped to USD287/t in May, a level below the trough of the 2009
downturn. This is despite an apparent recovery in demand in 1H14 and could
signal a fundamental rebasing of potash prices at a lower level.
Uralkali's seaborne contract to China, the floor for global prices, was set 24%
below 2013 levels in January at USD305/t. In April, its 2014/2015 contract with
India was at a seven-year low at USD322/t (USD375/t in 2013). The group reported
an increase in production to 6mt in 1H14 from 4.5mt in 1H13 but has reduced its
guidance for 2014 to 11mt, from 12mt previously (10mt in 2013). While this could
indicate that supply discipline is returning to the industry, we expect the
recovery to be slow. Our base case assumes a single digit increase in prices in
Cash reserves amounted to USD930m at end-2013, against short-term debt of
USD1.5bn. We assume that the group will continue to have access to the bank and
debt capital markets to refinance maturing debt. In June, Uralkali signed a
USD450m five-year unsecured club facility with five international banks at Libor
+ 1.75%. FCF is forecast at around USD300m annually over 2014-2015. This assumes
continuous investments towards capacity expansion with capex increasing to
USD750m in 2016 from around USD500m in 2015, and dividend distributions in line
with the group's policy (50% of net income).
Country and Industry Risks
Rating constraints include Uralkali's full exposure to the potash demand cycle.
In Fitch's view, this, combined with the high contribution of emerging markets
to revenues (65% in 2013 excluding Russia), implies higher near-term demand
volatility risk than for more diversified peers. These markets, while presenting
strong growth potential, tend to exhibit more erratic demand patterns than
mature agricultural regions. Operational risks are also higher in potash mining
as the water soluble salt deposits are susceptible to flooding. Finally, the
rating is constrained by the higher than average legal, business and regulatory
risks associated with Russia ('BBB'/Negative/'F3').
Negative: Future developments that could lead to negative rating action include:
- FFO net adjusted leverage sustained above 2.5x as a result of a financial
policy inconsistent with the announced focus on deleveraging or a rebasing of
prices well below the levels currently envisaged under the rating case.
- FCF margin sustained below 5%.
Positive: A positive rating action is not envisaged in the rating horizon.