October 19, 2017 / 12:34 PM / 3 years ago

Fitch Upgrades Russia's Rusal to 'BB-'; Outlook Stable

(The following statement was released by the rating agency) MOSCOW/LONDON, October 19 (Fitch) Fitch Ratings has upgraded Russia-based aluminium company United Company RUSAL Plc's (Rusal) Long-Term Issuer Default Rating (IDR) to 'BB-' from 'B+'. The Outlook on the Long-Term IDR is Stable. Rusal Capital D.A.C.'s senior unsecured rating has also been upgraded to 'BB-'/'RR4' from 'B+'/'RR4'. The Short-Term IDR has been affirmed at 'B'. Fitch has also upgraded the Long-Term IDR on Rusal's 100%-owned subsidiary, Russia-based OJSC Rusal Bratsk, to 'BB-' from 'B+' with a Stable Outlook. Bratsk's senior unsecured rating has been upgraded to 'BB-'/'RR4' from 'B+'/'RR4' in line with Rusal's senior unsecured rating. The upgrade in part reflects recent positive structural changes in the aluminium industry including our assumption that net Chinese smelter additions will be lower than previously expected in 2018 and beyond. We anticipate this will have a positive impact on market prices and therefore Rusal's free cash flow generation, resulting in the company's FFO adjusted leverage decreasing to 3.3x in 2017, and remaining below 3.5x afterwards. KEY RATING DRIVERS Positive Aluminium Market Dynamics: Fitch has recently updated its commodity price assumptions and we now assume aluminium prices at USD1,900/t over the next four years compared with USD1,700/t previously. The change in assumed prices primarily reflects a downward revision of our assumptions for net Chinese smelter capacity growth due to supply-side reform closures. We now expect Chinese output to grow by only about 4% year on year in 2018 due to a combination of state-directed and winter closures. Aluminium prices are also being supported by a cost push from increasing alumina prices. Smelter capacity in China, and specifically the balance of smelter additions and curtailments, remains key to the aluminium market outlook and is a main factor in the weak market prices and higher exports from China in recent years. Net smelter capacity additions in China and the rest of the world is a variable to watch in the next three years, although we expect demand for aluminium to remain sound in the medium term. Competitive Cost Position: In 2016 Rusal's smelters were strongly positioned in the first quartile of the global aluminium cost curve. In the past couple of years the group has benefitted from highly favourable FX dynamics following the rouble devaluation, which positively affected the company's cash costs (around 50% +/-5% of Rusal's cash costs are rouble denominated). The company also still benefits from the results of its own cost-saving measures (including idling of 647,000t of its least efficient assets in 2013-2014). Rusal's cash costs therefore decreased to USD1,334/t in FY16 (-8% yoy). However, higher energy costs due to a new electricity agreement, increase in raw material costs and FX effects pushed Rusal's average costs to USD1,497/t in 2Q17 (up 12% on FYE16), still within the first quartile of the cost curve. However, most of Rusal's smelters, including Bratsk, are located in Siberia and source 90% of their electricity needs from the region's hydro power generation assets, benefitting from lower electricity prices. We forecast gradual rouble strengthening to 56RUB/USD by 2020 to have the biggest negative impact on the company's cost structure in the next three to four years, leading to gradual EBITDA margin erosion from 20% in 2017 to 15% by 2020. Ongoing Deleveraging: Rusal has been highly leveraged since the purchase of its 25% stake in Norilsk Nickel (NN; BBB-/Stable) in 2008. However, the group has benefitted from strong support from its bank group and has consistently deleveraged, although at a slower pace than Fitch initially expected, to an estimated USD8.8 billion at end-2017 (Fitch-adjusted) from USD9.1 billion in 2016. In Fitch's view further debt reduction remains a key priority for Rusal but the pace will depend on aluminium prices and the level of dividends paid by NN. At end-December 2016, funds from operations gross leverage temporarily increased to above 5x from 3.6x at end-2015. We now expect this ratio to decrease to 3.3x by end-2017 and to remain below 3.5x in 2018-2020. This is mainly due to improved prices, as reflected in the expected 30% rise in Fitch adjusted EBITDA by end-2017. Absent an absolute debt reduction, Rusal will remain exposed to external factors, such as market price volatility, rouble strengthening and energy costs inflation, which add instability in the leverage metrics (as in 2016). Fitch expects positive free cash flow will be partly directed to deleveraging, resulting in total debt of less than USD8 billion at end-2018, USD7 billion at end-2019 and around USD6.5 billion in 2020. Stake in Norilsk Nickel: Rusal effectively owns 27.82% of the world's second largest nickel producer, NN. The market value of the stake was USD7.7 billion at 13 October 2017 thanks to stabilisation in nickel prices, representing nearly 87% of Rusal's total indebtedness, and therefore providing significant collateral coverage. NN has historically paid out significant dividends to its shareholder. From 2017 a new dividend policy applies, with a variable payout ratio of 30%-60% of EBITDA, depending on market conditions. However, the total dividend declared by NN in 2017 is around USD3.0 billion (Rusal received USD325 million in 1H17) and the total minimum payment will be USD1 billion from 2018 (USD278 million Rusal pre-tax share). Fitch expects dividends attributable to Rusal to exceed USD650 million/year on average in 2017-2020, contributing materially to Rusal's debt service. DERIVATION SUMMARY Comparable Fitch-rated peers to Rusal include Alcoa Corporation (BB+/Stable), Aluminum Corporation of China (Chalco; BBB+/Stable) and China Hongqiao Group (B+/Rating Watch Negative). Rusal's standalone rating of 'BB+' ('BB-' after notching down for the operating environment) reflects a comparable operating profile in most respects (eg market position, vertical integration, cost competitiveness), but typically higher leverage metrics. Chalco is rated three notches below China's rating based on Fitch's top-down approach in line with its parent and subsidiary linkage rating criteria. Fitch downgraded Hongiao Group, the biggest aluminium producer in the world, in April 2017 due to the continued delay in publishing annual results, which suggests weak internal controls and exposes the company to covenant breaches and liquidity events. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Fitch aluminium LME base prices: USD1,906/t in 2017 and USD1,900 in 2018-2020; - aluminium premiums earned by Rusal to average USD160/t in 2017, USD170/t in 2018 and USD180/t thereafter (across all products produced by the group); - RUB/USD exchange rates: 59 in 2017, 58 in 2018, and 56 in 2019 - 3% increase in production volumes in 2017 and 6% increase in 2018, flat thereafter; - EBITDA margin to average 19% in 2017-2018 and 16% in 2019-2020; - USD400 million dividend payment in 2017 and to average USD350 million thereafter; - sustained dividend from NN under new dividend policy. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Further absolute debt reduction with FFO adjusted gross leverage moving sustainably below 3.0x - FFO-adjusted net leverage below 2.5x Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - FFO gross leverage sustained above 3.5x with limited prospects for deleveraging - EBITDA margin below 12.5% on a sustained basis LIQUIDITY Adequate Liquidity: At end-June 2017 Rusal had nearly USD9 billion of Fitch-adjusted debt, including USD0.6 billion maturities to be repaid before December 2018 (after refinancing of a USD1.1 billion maturity with proceeds from its January and May Eurobonds) compared with USD0.6 billion of non-restricted cash. Near-term liquidity is also supported by free cash flow generation, which Fitch forecasts to be over USD1 billion over the next 18 months, including dividends from NN. Rusal also proactively manages its debt maturity profile after 2018, refinancing USD1.4 billion and USD2.9 billion of 2019 and 2020 maturities, and reducing them to USD0.7 billion and USD0.7 billion, respectively. Contact: Principal Analyst Maria Yakushina Associate Director + 44 20 3530 1315 Supervisory Analyst Peter Archbold, CFA Senior Director +44 20 3530 1172 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Maxim Edelson Senior Director +7 495 956 9986 Summary of Financial Statement Adjustments We added back USD68 million withdrawn under the factoring facility in 2016 to the total adjusted debt amount. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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