Moody's downgrades Kazakh ENRC rating to B2; outlook negative

Azerbaijan, Baku, Sep.3 / Trend E. Kosolapova/

Moody's Investors Service downgraded the corporate family rating (CFR) of Kazakhstan's Eurasian Natural Resources Corporation plc (ENRC) to B2 from B1 and the company's probability of default rating (PDR) to B2-PD from B1-PD, the agency reported.

Concurrently, Moody's downgraded the provisional rating on ENRC's $3 billion euro medium-term note (EMTN) programme to (P)B2 (LGD3, 48 percent). The rating outlook is negative.

Given the recent and forthcoming developments in the ownership structure of ENRC in connection with the takeover offer supported by the founding shareholders of the company and the Kazakh Government via a buyout vehicle ('Bidco'), and the fact that the Kazakh Government has already increased, via Bidco, its indirect shareholding in the Company above 20 percent, Moody's now considers ENRC as a Government-Related Issuer ('GRI'). As such, ENRC's CFR reflects also the application of Moody's rating methodology for GRIs.

The downgrade of ENRC's ratings to B2 mainly reflects its weak stand --alone Baseline Credit Assessment (BCA) at b2, which factors in the further deterioration in ENRC's key credit metrics as of June 2013, and Moody's expectation of a further material increase in the company's level of debt and weakening of its interest coverage ratio, as soon as the largely debt funded takeover offer on the company is concluded. Moody's assumes that the offer is highly likely to be successfully finalised by year-end, subject to the customary antitrust clearances being obtained, and expects that up to $1.7 billion of debt that Bidco is using to fund the takeover, will likely be pushed down at the ENRC Plc level in due course, post deal completion.

Pro-forma for the takeover offer being completed, Moody's expects ENRC's leverage ratio (gross debt/EBITDA on a Moody's-adjusted basis) to peak at around 6x as of June 2013, based on the last 12 months adjusted EBITDA, from an already high level of 4.7x as of June 2013 pre-takeover impact, and the pro-forma June 2013 EBIT/Interest cover ratio to weaken to 1.2x, from 1.6x pre-transaction, due to the more expensive debt being incurred to fund the acquisition and to refinance most of ENRC bank facilities at the time of offer completion.

By year-end 2013, the agency expects the leverage ratio and the interest cover ratio, pro-forma for the takeover offer completion, to remain weak, at around 4.5x and 2.0x, respectively. This would however require a better financial performance in the second half of this year, driven by the improved contribution of the new Frontier copper mine in the Democratic Republic of Congo, which is completing its ramp-up phase and reaching full production in Q3 this year. Such an improvement at the EBITDA level would partially offset the higher debt resulting from the takeover offer, which Moody's considers as a financial liability of ENRC. This is because, even if the acquisition debt is not pushed down at the ENRC level after transaction closing and remains at the Bidco level, the Company will nevertheless become a guarantor within 6 months from closing and its cash flows will need to service the scheduled interests and repayment installments on the acquisition debt facilities, when due.

The b2 BCA also reflects the weak liquidity of the company. This takes into account the substantial amount of capex scheduled over the coming several quarters to complete expansionary projects; the lack of meaningful availability under the committed bank facilities, once the existing debt is refinanced at the time of transaction closing, because the closing will trigger change of control clauses in most loan agreements; and the company's more vulnerable refinancing profile resulting after transaction completion. The latter reflects the increased reliance on the two key existing relationship Russian lenders of ENRC, Bank VTB, JSC ('VTB', Baa2 stable) and Sberbank (Baa1 stable), as they are providing the entire financing to fund the takeover offer and the associated refinancing for the existing facilities, and have also already agreed to waive the mandatory prepayment clauses of the facilities they are already lending to ENRC, which otherwise would have been triggered by the change of control provision.

Moody's considers these developments as credit negative, as they leave the company with reduced room for manoeuvre in terms of reversing its weakening financial profile, and with a very limited cushion in a possible scenario of protracted weaknesses in the prices of the company's commodities. This, in turn, would affect its cash flow generation and prompt negative free cash flows, in absence of a decisive reduction in capex.
As a mitigating factor, the b2 BCA takes into consideration ENRC's good access to high-grade and long-reserve-life mining assets in Kazakhstan (more than 35 years of reserves at current production levels), which provide the group with good access to the Chinese and Eurasian markets; its favourable cost structure as a result of its high-quality mining assets; and its high operational and commodity diversity, with several operating mines and processing facilities in Kazakhstan and, to a lower extent, in Russia and the DRC, and important market shares in the EMEA region for ferrochrome, iron ore and aluminium.

Though a credit positive, the B2 CFR does not reflect any uplift on the BCA for the increased ownership in ENRC from the Kazakh government. This is due to Moody's current assessment of low government support in a situation of financial distress.
The negative rating outlook reflects Moody's expectation that ENRC's financial profile will remain weakly positioned for its current rating at least over the next 12 to18 months, and exposed to downside risks associated with the completion of the takeover offer.

Eurasian Natural Resources Corporation (ENRC) is one of the leading diversified natural resources groups with integrated mining, processing, energy, logistical and marketing operations. ENRC production assets are mainly located in Kazakhstan. Moreover, the company operates in China, Russia, Brazil and Africa (the Democratic Republic of Congo, Zambia, Mozambique and South Africa). ENRC is the world's largest producer of ferrochrome on the chrome content basis and one of the world's significant iron ore and alumina producers

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