S&P: Alumina Ltd. Rating Lowered To 'BB' On Materially Weaker New Joint-Venture Partner; Outlook Stable
"We have lowered the rating on Alumina because we consider the company's new joint-venture partner Alcoa Upstream Corp.'s (Alcoa Corp., BB-/Stable/--) credit quality is materially weaker than the previous 'BBB-' rating on Alumina," said S&P Global Ratings credit analyst Sam Heffernan.
Alcoa Corp. will be the operator and majority owner of the assets and, in our view, still represents key counterparty risk for Alumina. In addition, the lower-rated joint-venture partner has, in our opinion, increased the probability for debt funding to transition from the joint-venture partner to Alcoa World Alumina and Chemicals (AWAC). As such, Alumina's leverage, including a pro rata consolidation of AWAC, could be higher than its current level.
Although initially we believe the amount of debt raised will likely be modest, over time we believe the partnership has a greater incentive to borrow at the currently unleveraged AWAC operating asset level, due to the likely lower cost of funding. We note that the joint venture's financial policy allows leverage at the operating asset of up to 30% of total capital.
Nevertheless, a provision under the joint-venture agreement could mitigate the risk of any potential disruption of distributions from AWAC in the event of insolvency of the joint-venture partner. The provision requires a super-majority vote for any AWAC asset to file for insolvency.
We evaluate Alumina's credit quality based on our view of AWAC's business risk profile and on a 40% pro rata consolidation for Alumina's financial position. We also incorporate in our rating analysis the counterparty risk of Alcoa Corp. as the operator and majority owner. In addition, we consider the partnership has an increased incentive to issue debt at the operating level.
Alumina's business risk profile reflects our view that AWAC's solid business position as the world's largest alumina and bauxite producer provides AWAC with the size and scope to adjust its operations to respond to market conditions. Alumina is a minority (40%) stakeholder in AWAC. Although AWAC has a track record of maintaining a high dividend payout, low alumina and aluminum prices could strain AWAC's ability to distribute a dividend to Alumina that would support Alumina's financial metrics being consistent with our expectations for the 'BB' rating.
Mr. Heffernan added: "The stable outlook reflects our view that Alumina could withstand at the current rating level any negative impact of increasing debt at the AWAC asset level. The stable outlook also reflects the outlook on Alcoa Corp., the operating partner and majority owner of the AWAC assets."
Any deterioration in the outlook or rating on Alcoa Corp. would likely result in a similar action on Alumina Ltd.
We could lower the rating on Alumina if AWAC raises material amounts of debt, approaching the financial policy level of 30% of total capital. Although less likely over the next 12 months, lower ratings could occur if we forecast Alumina's financial profile would weaken significantly because of persistently depressed alumina prices. A debt-to-EBITDA ratio remaining above 3x or free operating cash flow (FOCF) to debt at less than 15% would indicate downward rating pressure.
In addition, any deterioration in Alumina's joint-venture partner Alcoa Corp. could also place downward rating pressure because of counterparty risk.
Upward rating momentum is limited over the foreseeable future because of Alcoa Corp.'s materially weaker credit quality. In addition, we consider the presence of a less creditworthy counterparty raises the incentive to increase debt funding at the operating asset level. This would materially weaken the distributions available to Alumina due to the structural subordination of cash flows from AWAC.
Nevertheless, upward rating momentum could occur if Alcoa Corp.'s credit quality improved, or the joint-venture partnership demonstrated a more-conservative financial policy at the AWAC operating level. Furthermore, a higher rating could occur if Alumina were to maintain the buffer in its key credit metrics, such that its adjusted debt-to-EBITDA ratio is less than 2x and FOCF to debt greater than 25%.