OREANDA-NEWS. Fitch Ratings has revised the Outlook on Polyus Gold International's (PGIL) Long-Term Issuer Default Rating (IDR) to Positive from Negative and affirmed it at 'BB-'. Fitch has affirmed the Short-Term IDR at 'B'. The senior unsecured rating of the existing senior unsecured guaranteed notes has also been affirmed at 'BB-'.

Simultaneously, Fitch has assigned an expected senior unsecured rating of 'BB-(EXP)' to PGIL's planned notes issue. The assignment of a final rating to the notes is conditional on the receipt of final documentation in line with the draft already received.

The revision of the Outlook to Positive reflects Fitch's view that Polyus Gold will maintain a conservative financial profile with no additional share buyback or one-off dividend payments over the next two to three years, supported by the adoption of a new dividend policy which links the dividend payout percentage to group leverage. The company's significant cash balances and the management's commitment to reduce leverage by end-2016 also underpin the Positive Outlook.

In the medium term we expect production growth at existing operations and the planned Natalka project being brought on stream. We forecast the company's funds from operations (FFO) adjusted gross leverage to reduce below 3.0x by 2018 compared with an expected 4.3x as at FYE2016.

The notes will be guaranteed by JSC Gold Mining Company Polyus, a key operating subsidiary and a holding company for all company's key subsidiaries accounting for 100% of 2016 EBITDA and 100% of fixed assets at end-2016. The proceeds from the offering are expected to be used to repay existing debt maturing in 2017-2018. The notes will rank pari passu with PGIL's existing and future unsecured and unsubordinated obligations. The guarantee will rank pari passu with all existing and future unsecured and unsubordinated obligations of the guarantor.

KEY RATING DRIVERS

Corporate Governance Changes

The previously strong corporate governance structures at PGIL were dismantled following the change in shareholding structure in late 2015. The company has since implemented a new framework at the PJSC Polyus level, including independent director representation. At present, we regard corporate governance within the group as being slightly below average compared with its peer group of major Russian corporates and notch its rating down by two notches compared with international peers. This factors in our view of the higher than average systemic risks associated with the Russian business and jurisdictional environment as well as our assessment of the company's specific corporate governance practices.

Leverage Reduction by 2018

The USD3.4bn share buyback completed in 1H16 was funded using USD2.5bn of new debt and USD0.9bn of balance sheet cash. This resulted in a material increase in leverage, driving FFO adjusted gross leverage to 4.3x in 2016 under our base case compared with 2.7x in FY15. Fitch expects net debt/EBITDA to exceed 2.5x in 2016 and 3.0x in 2017, compared with historical levels below 1.0x. We also expect absolute debt levels to remain elevated until 2018 when expected production increases from the company's new Natalka mine, as well as increased volumes from some existing mines, will start to have a positive impact on metrics. For 2018, our base case expectation is for FFO gross leverage at around 3.0x and FFO net leverage to be less than 2.0x.

Competitive Cost Position

Operationally PGIL remains a strong group with good quality gold reserves and large efficient open pit assets, which place it in the first quartile of the global cost curve (total cash costs (TCC)). In 1H16, TCC declined to USD377/oz - a 14% decline year-on year. This was driven by local currency (RUB) devaluation as well as operational improvements, which resulted in higher processing volumes and better recovery rates.

Strong Production Prospects

The group reported production growth of 7% in 1H16 to 839k/oz of metal versus 784k/oz in 1H15. This is in line with the positive trend over the past two years. Most of the increase came from the Blagodatnoe and Verninskoe mines, which delivered higher processing volumes and better recoveries. Fitch expects production to reach 1,900k/oz in 2016 versus 1,775k/oz in FY15.

In terms of growth, the group intends to concentrate on streamlining and improving capacity on its key producing mines. In addition, Fitch expects the group's key development mine - the Natalka mine - to start producing in late 2017 with a full ramp up in 2018, resulting in an approximate 15%-20% year-on year increase in the group gold production.

KEY ASSUMPTIONS

- No cash upstreaming over the rating horizon by way of share buybacks and no dividend payments in 2016

- Dividends in line with new dividend policy of 30% of EBITDA if net debt/EBITDA is less than 2.5x

- Average gold price of USD1,246/oz in 2016, USD1,141/oz in 2017, USD1,120/oz in 2018 and USD1,100/oz afterwards (realised prices adjusted to reflect gold price hedging entered into by the company)

- USD/RUB exchange rate of 67.7 in 2016, 65 in 2017, 60 in 2018 and 57 thereafter

- Natalka project to commence production in 2H17 and ramp up over 2018-2019

- Operating efficiencies at the existing mines as per management's expectations

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

- Expectation of FFO gross leverage below 3.0x by end-2018

- Sustained positive FCF generation

Negative: Future developments that could lead to negative rating action include:

- Higher than expected dividend payments or other shareholder distributions over 2016-2019 leading to weaker liquidity and sustaining high leverage metrics

- FFO gross leverage expected to be sustained above 4.0x by end-2018.

- Sustained negative FCF generation

LIQUIDITY

Polyus Gold's liquidity position is strong, with USD1.7bn of cash and USD0.7bn of undrawn committed bank facilities as of 1H16, compared with only USD129m of short-term borrowings.