Training on Forecasting, April 7–8

ACRA assigns A-(RU) to PJSC "KOKS", outlook Stable

The credit rating assigned to PJSC “KOKS”, that includes the company of the same name and a group of subsidiaries (hereinafter, the Group), is based on fairly high business profile assessment driven by the vertically integrated metallurgical production model that is being built, flexibility in geographical diversification of the target markets and low industry risk profile. On the other hand, the rating assessment is constrained by the size of the Company’s business as compared to other Russian steel companies, high leverage as well as modest debt servicing and free cash flow indicators due to substantial capital expenditures and the need to provide credit resources to Tulachermet-Steel LLC (controlled by the shareholder and is not part of the Company). The rating also reflects the fact that merchant pig iron, the Company’s primary product, has low added value.

The Group is one of the lead merchant pig iron suppliers with an 18% share of the global market and the Russian largest producer of merchant metallurgical coke with a 35% market share in 2018. The Group has a broad customer base for its merchant pig iron products, with the largest groups being trading companies (76%) and end consumers (24%). E.B. Zubitsky is the ultimate beneficial owner of the Group.

Key rating assessment factors

High assessment of the Group’s operating risk profile. The vertical integration model that is being built represents a positive factor and contributes to 100% coverage of coke needs as well as 67% coverage of needs in iron ore raw materials and 57% coverage of the coking coal needs. Further development of the vertical integration should help cover the iron ore and coking coal needs at 100% by 2022 and 2026 respectively. Broad customer base in Russia and overseas as well as favorable geographic location of the pig iron production facilities add flexibility to the sales process that is subject to the market environment. At the same time, the fact that the merchant pig iron is a product with low added value used as raw material in steelmaking is holding back the Group’s business profile assessment. PJSC Tulachermet, a subsidiary of the Group, accounts for 100% of the produced pig iron, which is its key product. This way, ACRA notes a limiting effect of the factor “concentration on a single plant” for the Group’s business profile assessment.

Assessment of the corporate governance factors, in ACRA’s opinion, is at the average level for the Russian corporate segment. The Group has been consistently implementing its strategy to build a vertically integrated holding company and grow the resource base for its mining operations, where the commissioning of new facilities follows the planned timelines without significant delays. The risk management system corresponds to the average level in the corporate sector, as only some of the risk management elements are present. The Group also strives to ensure a reasonable balance between revenues and obligations in foreign currencies (natural hedge). It is also noteworthy that low efficiency and lack of independence in the board of directors’ activities, which exposes the Group to the key-man risk, were taken into account in the Group’s governance structure assessment. Also considered in the assessment of the Group’s structure were its complexity and transactions with related parties, which, however, are economically justified. In terms of financial transparency, ACRA notes good quality of the audited financial reporting, with its key aspects disclosed in the accompanying notes. The Group also regularly discloses its operating performance on the corporate website.

The Group’s financial risk profile limits the SCA. ACRA assesses the scale of the Group’s business (FFO before net interest payments and taxes) as average compared to similar steel companies in the Russian Federation and significantly lower than industry leaders like PJSC NLMK, PAO Severstal, and PJSC Magnitogorsk Iron and Steel Works. This limits the Group’s financial risk profile assessment. However, the Group’s strong business profile, and in particular its high degree of vertical integration, ensure an above-average business profitability. In general, the assessment of the Group’s financial risk profile is based on low assessments of leverage, coverage, and cash flow. ACRA expects the Group’s total debt to FFO before net interest payments ratio to increase to 5.6x for 2019 compared to 4.7x a year earlier. This is due to a decrease in FFO amid lower sales prices for pig iron, as well as a drop in coal production in early 2019 after an incident at the Tihov coal mine. ACRA expects a gradual reduction in leverage to 3.5x by 2021. This will be due firstly to an increase in sales profitability in the pig iron segment, as deliveries will be made primarily to Tulachermet Steel LLC for further production of steel products. Secondly, the intensive capital expenditure phase for both the Group and Tulachermet Steel LLC has been completed, which implies a gradual improvement in free cash flow (FCF) that can be used to reduce leverage. ACRA notes that the Group’s controlling shareholder has designated leverage reduction as the main priority for the Group’s management. However, ACRA does not expect a significant reduction until 2021. The reduction in leverage is expected to contribute to improved coverage and cash flow indicators, which in turn may lead to an increase in the Group’s credit rating.

According to ACRA estimates, the Group has sufficient liquidity in view of the comfortable debt repayment schedule. In addition to the available cash totaling RUB 9.9 bln as of 2019, the Group had over RUB 39 bln worth of undisbursed credit facilities. Short-term debt maturing in 2020 totals RUB 12 bln, with RUB 8.8 bln are repayable tranches in the long-term revolving facilities.

Key assumptions

  • Decline in pig iron prices by 3%-5% in 2020-2021 followed by a moderate recovery by up to 2% in 2022-2023;
  • Capital expenditures at around RUB 8 bln per year in 2020-2023;
  • No dividend payments throughout the entire forecast period to 2023;
  • No corporate loans to Tulachermet-Steel LLC in 2020-2023.

Potential outlook or rating change factors

The Stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18-month horizon.

A positive rating action may be prompted by:

  • A decline of leverage (total debt to FFO before net interest payments ratio) below 3.5x accompanied by FFO to net interest payments to interest payments ratio exceeding 2.5x;
  • A positive FCF.

A negative rating action may be prompted by:

  • A decline of FFO margin before interest payments and taxes below 15%;
  • Maintaining Group’s leverage level (total debt to FFO before net interest payments ratio) above 5x;
  • Maintaining FFO before fixed charges to fixed charges ratio below 2.5x;
  • Significant deterioration in access to external liquidity sources while FCF remains negative.

Rating components

SCA: a-.

Issue ratings

No outstanding issues have been rated.

Regulatory disclosure

The credit rating has been assigned under the national scale for the Russian Federation based on the Methodology for Credit Ratings Assignment to Non-Financial Corporations under the National Scale for the Russian Federation and the Key Concepts Used by the Analytical Credit Rating Agency within the Scope of Its Rating Activities.

The credit rating has been assigned to PJSC "KOKS" for the first time. The credit rating and its outlook are expected to be revised within one year following the publication date of this press release.

The credit rating is assigned based on the data provided by PJSC "KOKS", information from publicly available sources, as well as ACRA’s own databases. The credit rating is solicited, and PJSC "KOKS" participated in its assignment.

No material discrepancies between the provided data and the data officially disclosed by PJSC "KOKS" in its financial statements have been discovered.

ACRA provided no additional services to PJSC "KOKS". No conflicts of interest were discovered in the course of credit rating assignment.

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