OREANDA-NEWS. Fitch Ratings has affirmed Russia-based Agribusiness Holding Miratorg LLC's (Miratorg) Long-term foreign and local currency Issuer Default Ratings (IDR) at 'B+'. The Outlook is Stable.

Fitch has also assigned a 'B (EXP)' rating to the RUB5bn bonds (4B02-06-36276-R) that are to be issued by Miratorg Finance LLC in April 2016. The assignment of the final instrument rating is contingent on the receipt of final documents conforming materially to information already received. A full list of rating actions is available at the end of this commentary.

The affirmation reflects Miratorg's strong market position and our expectation that a projected hike in leverage in 2016 slightly above our downgrade trigger of 4.0x (including guaranteed but unconsolidated projects) will be temporary and the company will be able to reduce FFO adjusted leverage to around 3.5x in 2017-2018. We also expect management to remain committed to maintaining low to moderate leverage and that the company's access to bank financing to refinance short-term debt will remain adequate.

The ratings continue to factor in state support to the sector, especially in the form of interest rate subsidies. Although Fitch does not notch down Miratorg's ratings for company-specific corporate governance issues, the company's unique and complex group structure constrain the ratings at 'B+'.

The rating of the proposed RUB5bn bonds is one notch below Miratorg's Long-term local currency 'B+' IDR, reflecting a substantial portion of prior-ranking debt and below-average recovery prospects in case of default under Fitch's going-concern valuation scenario. The bonds will be issued by Miratorg Finance LLC and guaranteed by the parent entity, Miratorg excluding operating subsidiaries (parent). Miratorg Finance LLC is a bond issuing vehicle which, despite not being owned by the parent but by its shareholders, is consolidated in the group's audited accounts.

KEY RATING DRIVERS
Vertically Integrated Business Model
Miratorg's ratings are supported by the group's leading position in the pork market in Russia and vertical integration across the value chain - from crop growing and fodder production to livestock breeding, slaughtering and product delivery. This enables the company to maintain higher-than-peer EBITDA margins and to smooth out the business's inherent volatility. It also enables the company to defend its position as the leading pork producer in Russia.

Likely Pork Price Decline in 2016
Fitch assumes a mid-single digit decrease in average selling prices for pork in 2016 compared with 2015. We believe pork prices will be under pressure in 2016 if the supply and demand imbalance experienced since 4Q15 persists through the year. In view of subdued consumer sentiment in Russia, we do not expect demand to improve. Moreover, we expect pork supply to further increase in 2016 in Russia, driven by continued growth in output by large industrial producers, which in our view may only be partially offset by decreasing production from households and small inefficient players.

Lower EBITDA in 2016
We conservatively project that Miratorg's EBITDA will decrease in 2016, due to higher fodder costs and our assumptions of lower average pork selling prices. This negative impact would only partly be compensated by growth in pork output this year. In 2015 fodder costs benefitted from cheaper grain largely procured before the rouble depreciation of end-2014, which positively impacted Miratorg's EBITDA last year. We expect EBITDA to recover in 2017 before growing at high single digits in 2018-2020, driven by stabilisation in pork prices, the company's increasing self-sufficiency in grain, efficiency improvements in the pork division and higher sales of semi-finished goods.

Sub-Standard Corporate Governance
Although Fitch does not apply any company-specific notching to Miratorg's ratings for corporate governance, they are constrained at 'B+' by a complex group and governance structure. The group provides financial support to its related parties involved in growing and processing of poultry and cattle. In addition, Miratorg's audited consolidated accounts include entities that are not owned by the parent but rather by its ultimate shareholders. Consolidation is based on agreements for the preliminary sale and purchase of such entities signed between its shareholders and the parent. According to management, these agreements represent potential voting rights that could be exercised at any time. Among these entities the most material to the group are Miratorg Finance LLC, the bond issuing vehicle, and TK Miratorg LLC, the major trading company that distributes Miratorg's products as well as poultry and beef produced by its related parties.

Suretyships for Related-Party Obligations
Miratorg guarantees the debt of Bryansky Broiler LLC and Kalinigradskaya Myasnaya Kompaniya LLC, two related-party entities owned by Miratorg's shareholders and involved respectively in poultry production and cattle breeding. Guaranteed debt was around RUB21bn at end-2015 (in addition to total group debt of RUB80bn). Our ratings take into account debt and profits of these guaranteed projects in view of the likely consolidation into Miratorg in 2017 of the poultry business, which bears most of the debt (around RUB18bn).

Our assumptions are based on the group's track record of developing certain businesses through related-party entities and later bringing them onto the group's balance sheet. As these guaranteed projects are already operational, our rating case assumes that they will be able to repay or refinance their debt over the medium term and therefore no claims will be made under these guarantees.

Support to Related-Party Beef Project
The company's shareholders are also developing a beef business, partly with the financial help of Miratorg. Miratorg does not guarantee the debt of this project but has been making some cash contributions through related-party loans. We expect the beef business to remain outside of Miratorg's consolidation scope over 2016-2020. Although external long-term financing (without recourse to Miratorg) has been obtained to fund expansion capex, our rating case assumes additional cash support from Miratorg through related-party loans of around RUB5bn per year in 2016-2019.
In addition, our rating case factors in Miratorg's support to the project through favourable payment terms as Miratorg distributes beef produced by these related parties. Higher-than-expected outflows to related parties may put pressure on Miratorg's credit metrics and liquidity.

Pork Production Doubling Not Assumed
Our rating does not factor in the potential doubling of pork production that Miratorg is envisaging in a project over the medium term. Timing, funding and other features of this project are not yet decided and the current weakness of the domestic pork market makes a near-term launch unlikely, in our view. Nevertheless, if the project is approved, this could result in a downgrade of Miratorg's ratings in view of the large amount of potential investments (estimated by the company at RUB115bn), which are likely to be debt-funded.

Higher Leverage
We project Miratorg's FFO adjusted gross leverage to peak at 4.2x in 2016 (including debt and profits of guaranteed projects which accounts for 0.5x leverage) due to our assumption of lower EBITDA and working capital outflows. The figure is then likely to fall to around 3.3x-3.9x in 2017-2018 due to improving free cash flow generation.

Although FFO adjusted gross leverage in 2016 will be above our downgrade trigger, we consider this hike in leverage as temporary. Expected deleveraging in 2017-2018 will be driven by EBITDA recovery and lower working capital outflows as in our rating case revenue growth moderates to 6%, from an assumed 16% in 2016. In addition, we assume capex of 7% of revenues in 2016, before falling to 5% in 2017-2018 as management does not anticipate further major investments in pork and poultry businesses.

State Support to the Sector
Being an agricultural producer, Miratorg enjoys a favourable tax regime and receives interest rate subsidies that covered around a third of its interest payments in 2015. This helps Miratorg's FFO margin and coverage metrics, leading to improved financial flexibility. Historically the difference between subsidy-adjusted and unadjusted FFO fixed charge coverage has been around 1.0x.

We expect state support to agricultural producers to be maintained, despite deteriorated public finances, as food self-sufficiency remains one of key objectives of the Russian government. A material reduction in state support could put pressure on Miratorg's cash flows and credit metrics.

Below-average Recoveries for Unsecured Bondholders
We have applied a one-notch discount to the senior unsecured rating of the proposed RUB5bn bonds compared with Miratorg's Long-term IDR of 'B+' as Fitch's going concern scenario valuation approach points to below-average recoveries in case of default. This is driven primarily by the substantial portion of prior-ranking debt, which consists of secured and unsecured debt at operating companies.

New unsecured bonds are expected to be issued by financial company Miratorg Finance LLC and will benefit from a suretyship from the parent. Although bondholders will also have an option to put the bonds to TK Miratorg LLC, this, in our view, is insufficient to eliminate subordination issues as TK Miratorg has marginal contribution to the group's EBITDA and assets.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for the issuer include:
-Strong double-digit revenue growth in 2016, driven by growing sales volumes of distributed beef and poultry and of own produced pork, and mid-single-digit growth thereafter
-EBITDA margin at 22%-25% over 2016-2019
-Capex at 7% of revenue in 2016 and then 5% over 2017-2019
-Working capital absorption of approximately RUB10bn in 2016 and declining thereafter
-Interest rate subsidies covering at least 30% of interest payments
-Additional loans to related parties of around RUB5bn per year over 2016-2019
-No dividends
-Adequate liquidity

RATING SENSITIVITIES
Negative: Future developments that could lead to a negative rating action include:
-Gross FFO adjusted gross leverage consistently above 4.0x (both including and excluding guaranteed projects)
-FFO fixed charge cover sustainably below 2.0x or FFO fixed charge cover adjusted for government interest rate subsidies below 2.5x
-Material deterioration in free cash flow (FCF) generation driven, for example, by lower EBITDA margin, and larger-than-expected loans to related parties
-Liquidity shortage caused by the limited availability of bank financing in relation to short-term maturities or refinancing at more onerous terms than expected

Positive: An upgrade is unlikely in the coming two years, unless there is an improvement in corporate governance, including better group structure transparency and diminishing cash support to related parties, and subject to:
-FFO adjusted gross leverage sustainably around 3.0x (both including and excluding poultry)
-FFO fixed charge cover sustainably above 3.0x or FFO fixed charge cover adjusted for government interest rate subsidies above 3.5x
-FCF margin close to mid-single digits, coupled with the management's commitment to a conservative capital structure
-Adequate liquidity

LIQUIDITY
Fitch considers Miratorg's liquidity position as weak as Fitch-adjusted unrestricted cash balances of RUB1.2bn (at end-2015), committed undrawn credit facilities of RUB12bn (as at 1 March 2016) were not sufficient to cover short-term debt of RUB38bn (as at 1 March 2016) and expected negative FCF in 2016. However, the major part of this debt was represented by maturing working capital facilities, which are usually of one-year tenor. We expect Miratorg to extend these facilities upon maturity due to its strong and long-standing relationships with its major lenders, state-owned Russian banks.

SUMMARY OF FINANCIAL STATEMENTS ADJUSTMENTS
- Operating leases: Fitch adjusted debt by adding 8x of yearly operating lease expense (2015: RUB444m).
- Cash: Fitch adjusted available cash at end-2015 by deducting RUB1.5bn for cash held for operating purposes.
- Consolidation scope: Fitch consolidates debt and profits of guaranteed projects (2015: debt of RUB21bn and EBITDA of around RUB2bn).

FULL LIST OF RATING ACTIONS

Agri Business Holding Miratorg LLC
Long-term foreign and local currency IDRs: affirmed at 'B+'; Outlook Stable
National Long-term rating: affirmed at 'A-(rus)'; Outlook Stable

Miratorg Finance LLC
Foreign currency senior unsecured rating: assigned 'B(EXP)'/RR5'
National Long-term senior unsecured rating: assigned 'BBB(rus)(EXP)'