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March 17 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned Emeco Pty Ltd’s USD335m senior secured notes due 2019 a final rating of ‘BB-’ with a Recovery Rating of ‘RR3’.
The final rating is in line with the expected rating assigned on 27 February 2014 and follows a review of the final documentation, which materially conformed to the draft documentation previously received. Emeco Pty Ltd is a wholly-owned subsidiary of Emeco Holdings Limited (Emeco, B+/Stable).
The notes are secured by the assets of the Emeco Group, and guaranteed by Emeco and some of its subsidiaries. Proceeds from the notes will largely be used to refinance existing debt of about AUD350m. The ‘RR3’ recovery rating assigned to the notes reflects our expectation of at least a 51% value recovery for the note holders in the event of default, based on the agency’s assessment of the liquidation value of Emeco’s rental fleet and other assets under a stressed situation. As a result, under Fitch’s recovery rating methodology, the bond is rated a notch above Emeco’s Issuer Default Rating (IDR).
Emeco’s ratings reflect the high sensitivity of its earnings to commodity cycles, due to its position as a rented equipment supplier to mining companies. The ratings also take into account Emeco’s low operating leverage, Fitch’s expectation of an improvement in Emeco’s financial profile, and Emeco’s flexibility in managing capex, which allows it to preserve operating cash flows during industry downturns.
High Cyclicality: Emeco’s focus on mine production provides more stable revenues compared to exploration and new mine development, although the ability of mining counterparties to cancel contracts, typically between 30 to 180 days, brings with it volatility and asset underutilization. This explains Emeco’s 30% drop in EBITDA in the financial year ended June 2013 (FY13) and Fitch’s expectation of a further 50% drop in EBITDA in FY14.
Rental Fleet Utilization to Improve: Emeco’s overall utilization has trended downwards since early 2012, driven by weak volumes in its Australian coal business. Coal miners have been reducing overburden removal volumes in response to weak global coal prices. Fitch does not expect this trend to continue and expects the utilization rates of Emeco’s assets to improve - Emeco’s Australian business is already showing signs of picking up. It has secured new contracts which should help increase its utilisation rates in Australia to about 50% in June 2014, up from 40% in the six months to 31 December 2013.
Diversification: In FY13, 61% of revenue was generated in Australia, with coal (both thermal and metallurgical) making up 42% of revenue. Earnings derived from Australia are volatile due to the generally high cost of Australian thermal coal on a global scale. Coal production has remained buoyant, although coal producers’ response to weak commodity prices has been to optimize productivity and reduce costs by lowering strip ratios, by mining in areas that require less removal of overburden. However, Emeco’s geographical diversification has helped it redeploy its fleet of 700-odd vehicles among different industries and regions, which underpins its ability to optimize rental fleet utilization.
High Quality Fleet: Emeco’s strategy of disposing most of its equipment about halfway through expected lifespans ensures it maintains a relatively young fleet with low operating hours, which is attractive to mining companies. This, coupled with the generic nature of most of its assets, aids in the resale of these assets. Over the past seven years, the company has disposed of between AUD20m to AUD50m of assets at generally above-depreciated value. The recurring nature of these cash inflows helps to mitigate the volatility in operating cash flows.
Improving Financial Profile: Fitch expects Emeco to deleverage from FY14 onwards, due to both improving utilization and a substantially curtailed expansionary capex spend. However, Emeco’s leverage, as measured by net debt/EBITDA, is likely to deteriorate in FY14, compared to 2.4x in FY13, mainly due weak average utilization.
Positive rating action is not envisaged in the medium term. A meaningful reduction in Emeco’s portfolio risk profile, so that there is greater geographical and commodity diversification, would be necessary before any positive rating action were possible.
Negative: Future developments that may, individually or collectively lead to negative rating action include:
- A failure to reduce leverage as measured by net debt/EBITDA to below 3.0x by FY16.