Metalloinvest Finance D.A.C. — Moody’s assigns Baa3 rating to Metalloinvest’s bonds; stable outlook

Rating Action: Moody’s assigns Baa3 rating to Metalloinvest’s bonds; stable outlookGlobal Credit Research – 14 Feb 2022London, 14 February 2022 — Moody’s Investors Service (« Moody’s ») has today assigned a Baa3 rating to the $650 million backed senior unsecured notes issued by Metalloinvest Finance D.A.C., a wholly-owned indirect subsidiary of JSC Holding Company METALLOINVEST (METALLOINVEST or the company). The backed senior unsecured notes are guaranteed by the company’s key subsidiaries. The outlook on Metalloinvest Finance D.A.C.’s rating is stable. »The assignment of rating to the bonds with the stable outlook reflects METALLOINVEST’s substantial deleveraging in 2021, corporate governance improvements with our expectation that there are no shareholder loans provided as of 31 December 2021 and that the balance of such loans, if any, will not be material in the future. Expected disposal of Ural Steel plant will substantially improve the company’s carbon footprint while growing share of value-added products (HBI, DRI, pellets, high quality steel) will allow the company to weather volatility in iron ore and steel prices with modest debt » says Denis Perevezentsev, a Vice President-Senior Credit Officer at Moody’s.RATINGS RATIONALEThe assignment of Baa3 rating with the stable outlook to the backed senior unsecured notes reflects a track record of deleveraging, high profitability, which the company has managed to sustain through the cycle owing to its vertically integrated business model and fairly high commodity prices, adhering to its financial and dividend policy with modest levels of debt, as well as corporate governance improvements, including elimination of loans issued to shareholders as of 31 December 2021 as well as amendments in the corporate structure, which have supported these improvements in transparency. While the company has long enjoyed a strong market position in iron ore in Russia due to the quality of its two major mines, this has been strengthened by the success of its mining segment; and while the company’s financial policy was previously characterised by large dividends and loans to its shareholders, strong profitability over the last few years has improved financial flexibility enabling accelerated debt reduction, underpinned by a more conservative financial policy, now targeting net leverage below 1.5x through the cycle with capital spending to be funded entirely out of operating cashflows. Although the potential disposal of Ural Steel plant for $500 million to Zagorsk Pipe Plant in February 2022 is not likely to trigger material debt reduction as the company has a comfortable debt level, it will reduce the company’s Scope 1 greenhouse gas emissions by almost twice to about 6.8 million tonnes per year, reducing capital spending and allowing the management to focus on strategic goals of improving efficiency of production and further growing the share of value added products, such as hot briquetted iron (HBI) and pellets. The closing of the transaction is expected by the company during 1H 2022.The company’s unique vertically integrated business model and its status as the largest merchant hot briquetted iron (HBI) producer in the world with one of the lowest cash costs in the sector and stellar reserve base, which SRK estimated at 15.4 billion tonnes, with an operating life of 150 years, will support strong financial results while the company’s high share of value added products fit very well with the global decarbonisation trends. Moody’s expects the company to continue delivering strong operating and financial performance, which will allow it to maintain modest levels of leverage under various iron ore and steel price scenarios. The company’s financial policy requires its free cash flows after shareholder distributions to remain positive. The nature of the company’s open pit mines with high quality ore grades supported by weak rouble exchange rate and the company’s focus on operational efficiencies will support the company’s performance through the cycle despite volatility in iron ore and steel prices. METALLOINVEST’s leverage, as measured by Moody’s adjusted debt/EBITDA declined to 0.8x as of 30 June 2021 from 1.5x as of year-end 2020. The deleveraging was achieved by a combination of Moody’s adjusted EBITDA expansion to $4.4 billion in the last twelve months ending 30 June 2021 (2020: $2.6 billion) supported by debt reduction with Moody’s adjusted debt declining to $3.4 billion as of 30 June 2021 from $3.8 billion as of year-end 2020. During 2021 the company reduced debt by about $0.7 billion to about $3 billion as of 31 December 2021, which will result in the Moody’s adjusted leverage of about 0.5x-0.8x as of 31 December 2021.Moody’s expects iron ore prices (62% Fe China) to move gradually toward their $70-$80/ton average levels of 2016-19 beyond 2022. Tight iron ore supplies will keep prices above their historical norms through 2022, but prices have retreated from their peaks reached in 2021 as supplies have increased and demand growth has decelerated. Restrictions on steel production in China limit future demand growth for iron ore. Iron ore prices peaked at above $230 per tonne in May 2021 and then contracted. Average iron ore prices of over $160/ton in 2021 were stronger than any time since 2008, but weakened to levels closer to $92/ton in November 2021 on Chinese government efforts to curb commodity prices and inflation. For environmental reasons, China is also easing its production of steel from 2H 2021, the main end market for iron ore, and margin compression of steel producers are leading to higher use of lower-quality iron ore for now. Iron ore prices have also eased in the end of 2021 with some recovery in supply in Australia and Brazil. Moody’s uses a medium-term price sensitivity range of $80/tonne-$125/tonne for iron ore with the estimated 2022 price of $100/tonne, which is the agency’s baseline approximation for evaluating credit risk to companies within the sector, although iron ore prices have recently recovered to $150/tonne on temporary supply restrictions and strong demand, and are well above that range.METALLOINVEST’s unique vertically integrated business model with access to abundant reserves, developed infrastructure, fairly low energy costs and pelletising and HBI units, as well as its steel segment, incapsulates resilience of its financial results through the cycle. METALLOINVEST’s exposure to the volatility in iron ore prices is mitigated by its focus on high-grade iron ore, pellets and HBI, which are HVA iron ore products and accounted for 72% of iron ore product shipments in 2021 (2020: 72%). The prices of these products are less volatile, and they offer a premium compared with conventional iron ore concentrate. This justifies the company’s focus on high value added products and explains the resilience of the company’s metrics through the cycle and its strong positioning vis- -vis peers which don’t have substantial premium pellets or HBI/DRI capacities. METALLOINVEST is the leading producer of merchant HBI and the second largest producer of pellets globally. The company benefits from the high quality of its iron ore concentrate, with an iron content of up to 70% and low levels of impurities. Moody’s expects the fairly high premium for high-grade pellets and HBI to continue over the next twelve months even if benchmark iron ore prices decline, supported by the growing global demand for more efficient and less-pollutive steel feedstock. METALLOINVEST is a low-cost producer of HVA iron ore products, solidly positioned in the first quartile of the global cost curve because of its vertical integration into high-grade iron ore mining and low energy costs. The company’s low cost position is further supported by the weak rouble as more than 80% of its operating costs are denominated in roubles, while around 60% of its revenue is earned in hard currency.Moody’s estimates the company’s capital spending in 2022-23, on average, of up to $0.9 billion per year under the iron ore price assumption (62% Fe, CFR China) of about $125 per tonne (2020: $502 million, as adjusted by Moody’s), or up to $0.6 billion under the iron ore price assumption of $85 per tonne, with the increase in spending mainly related to the projects at the company’s mining segment, which will increase the share of high value added products, increase the iron content in ore, will improve characteristics and output of pellets. Such projects include, inter alia, construction of HBI-4 unit and conveyor complex at Lebedinsky GOK (LGOK), new HBI unit in Kursk region (JV of MGOK and USM), flotation facility and crushing and conveyor complex at Mikhailovsky GOK (MGOK) as well as a few projects at the company’s steel segment aimed at reduction of steel costs. The launch of HBI units at LGOK (fully owned by the company) and MGOK (45% owned by the company and to be developed on a joint venture basis with the company’s related party) will further the company’s leadership positions in the HBI market, increasing the company’s total HBI capacity to around 7.9 million tonnes per year by 2024 (on a pro-rata basis) from the current capacity of about 5 million tonnes per year and will further improve consolidated EBITDA margin of the company.Despite this pick-up in capital spending Moody’s estimates the company to maintain gross leverage, as measured by Moody’s adjusted debt/EBITDA of below 2.0x in 2022-23 under iron ore price scenario of $85/tonne-$125/tonne. Lower iron ore prices will result in lower EBITDA, which would be somewhat offset by lower capital spending and dividend distributions, supportive for the credit metrics. The company monitors the level of its capital spending relative to the market environment and can effectively cap its capital spending if market environment deteriorates. Historically, annual capital spending has been around 20% of the company’s EBITDA over the last three years and Moody’s estimates that capital spending will equal, on average, about 20%-25% of the company’s EBITDA going forward.METALLOINVEST has strong liquidity and benefits from its balanced debt maturity profile. As of 31 December 2021, METALLOINVEST’s liquidity comprised nearly $0.4 billion in cash and equivalents, and around $0.5 billion in available long-term committed credit facilities, some of which are committed. Moody’s expects the company to generate operating cash flow of about $3.5 billion in 2022 under the iron ore price assumption of $125/tonne ($2.6 billion under iron ore price assumption of $85/tonne). This liquidity will comfortably cover METALLOINVEST’s capital spending of up to $0.9 billion in 2022 and shareholder distributions. Owing to proactive debt management, the company reduced its debt coming due in 2022-24 and as of 31 December 2021 the company has almost no debt maturing in 2022 while debt maturing in 2023 is about $0.6 billion, in 2024 – $0.2 billion. Moody’s views the related refinancing risks as low because of the company’s sustainable operating cash flow, and access to both domestic and international debt financing.ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) CONSIDERATIONSMETALLOINVEST is exposed to environmental, social and governance (ESG) risks typical for a company in the mining sector. The environmental risks include, but are not limited to, air, soil and water pollution as a result of the processes used in the mining, processing and smelting of metals. Moody’s generally views these risks, including water shortages and human-made hazards, as very high for mining companies. Such hazards may include wall collapses at the company’s open-pit mines, flooding, underground fires and explosions, and cave-ins or ground falls at underground mines. All of the company’s mines are open-pit mines. Another type of hazard common to the mining industry is the collapse or leakage of tailings dams. METALLOINVEST regularly inspects its tailings storage facilities.Governance risks are an important consideration for all debt issuers and are relevant to bondholders and bank lenders because governance weaknesses can lead to a deterioration in a company’s credit quality, whereas governance strengths can benefit its credit profile. METALLOINVEST is a privately held company with a concentrated ownership structure, which creates a risk of rapid policy changes, elevated shareholder distributions, transactions with related parties and other non-creditor friendly transactions. From that standpoint Moody’s believes that the risks are mitigated by the fact that METALLOINVEST has public debt instruments and demonstrates a high level of public information disclosure and a track record of deleveraging. The risk that METALLOINVEST might favour shareholders’ interests over debt providers’ amid substantial dividend distributions is mitigated to some extent by the alignment of its distribution policy with its net leverage and free cash flow. Over the last two years the company managed to reduce the balance of loans provided to related parties (with our expectation that there are no such loans as of 31 December 2021), which it had used in lieu of or in addition to dividend distributions, and it also demonstrated a track record of adhering to its financial and dividend policy, which it adopted in 2019. Corporate governance is exercised through the oversight of independent members, who constitute five out of twelve seats on the board of directors, and through the relevant board committees.RATIONALE FOR STABLE OUTLOOKThe stable outlook on the notes rating reflects Moody’s expectation that, over the next 12-18 months, METALLOINVEST will sustain its modest leverage level, maintain strong liquidity and pursue a balanced financial policy.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSMoody’s could upgrade the notes rating if the company were to (1) generate positive FCF on a sustainable basis; (2) continue demonstrating a track record of balanced financial policy and prudent corporate governance, showing restraint and transparency with respect to shareholder distributions and maintaining its (CFO – dividends)/debt above 40%; and (3) maintain strong liquidity.Moody’s could downgrade the notes rating if (1) the company’s Moody’s-adjusted total debt/EBITDA were to rise above 2.75x on a sustained basis; (2) shareholder distributions or capital spending were to significantly exceed Moody’s current expectations; (3) the company’s capital spending exceeds the level of operating cash flows or the company does not calibrate the level of shareholder distributions in case market environment deteriorates which would result in the negative free cash flows after shareholder distributions on a sustained basis; or (4) operating performance and liquidity were to deteriorate substantially. A downgrade of Government of Russia’s (Baa3 stable) sovereign rating could also lead to a downgrade.PRINCIPAL METHODOLOGYThe principal methodology used in this rating was Mining published in October 2021 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1292752. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.METALLOINVEST is Russia’s largest producer of high-quality iron ore, pellets and HBI/direct reduced iron. The company has one of the world’s largest iron ore reserves, which it estimates at 15.4 billion tonnes, with an operating life of 150 years. In 2021, METALLOINVEST produced 40.8 million tonnes (mt) of iron ore, 28.5 mt of pellets, 7.7 mt of HBI/direct reduced iron, 2.4 mt of pig iron and 4.9 mt of crude steel. In the last twelve months ending 30 June 2021, the company generated revenue of $8.4 billion (2020: $6.4 billion) and Moody’s-adjusted EBITDA of $4.4 billion (2020: $2.6 billion). METALLOINVEST is wholly owned by the Russia-domiciled USM Metalloinvest LLC (a part of the Holding Company USM LLC), Alisher Usmanov (49%) is the major beneficiary of the Holding Company USM LLC.REGULATORY DISCLOSURESFor further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody’s rating practices. 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Please refer to Moody’s Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1288235.At least one ESG consideration was material to the credit rating action(s) announced and described above.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody’s affiliates outside the EU and is endorsed by Moody’s Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. 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