OREANDA-NEWS. Fitch Ratings has assigned Ferrexpo Finance Plc's (Ferrexpo) proposed issue of 10.375% guaranteed amortising bonds due in 2019 an expected senior unsecured rating of 'CCC'(EXP)' with a Recovery Rating 'RR4'. The first principal repayment is due in April 2018.

The new bonds will be issued under an exchange offer in respect of Ferrexpo's existing USD500m 7.875% notes due in 2016. The exchange offer is subject to a minimum acceptance level of 60% or USD300m. Existing bonds tendered before the early exchange deadline will receive a cash pre-payment equal to 20% of the nominal amount of the bonds with the remaining 80% exchanged for new notes. Bonds tendered post the early exchange deadline will not receive the cash payment element and will convert in their entirety into new notes.

The bond rating is in line with Ferrexpo's Long-term Issuer Default Rating (IDR) of 'CCC', which remains constrained by the Ukrainian sovereign rating (CCC). The proposed bonds will rank pari passu with existing senior unsecured debt and will benefit from guarantees from several group companies (together these companies represented 87% of the group's assets and 95% of adjusted EBITDA in 9M14). The notes will also include a limitation on liens, restrictions on dividends (the greater of a 10% dividend yield ratio or USD60m per annum) and limitations on additional indebtedness (additional debt/EBITDA threshold set at 2.5x).

The bonds' final rating is contingent on the receipt of final documentation conforming to information already received and further details regarding the amount of the notes.

KEY RATING DRIVERS

Ratings Constrained by Sovereign
Ferrexpo's ratings remain constrained by the Ukrainian sovereign rating due to its operating base within the country. In recent periods, Ukraine has experienced high domestic inflation, hryvnia depreciation (by more than 50% in 2014 vs. USD), rising energy costs, disrupted electricity supply and a delay in VAT repayment by the State. With respect to the ongoing military conflict within the country, Ferrexpo's operations and transport infrastructure have not, at this stage, been directly impacted by the conflict in the Donbas region, as all assets are located in the Poltava region, some 425km north of Donetsk.

Low Iron Ore Price Environment
For December 2014, 62% Fe iron ore prices averaged USD69 per tonne, down 50% yoy, reflecting oversupply in the market and expectations of slower demand from the Chinese steel industry. Fitch expects iron ore prices to stabilise at around USD80 per tonne in the long-term, below the 2014 average price of USD97 per tonne, which will negatively impact the company's earnings and credit metrics. As a pellets producer, Ferrexpo will continue to benefit from a quality premium over the 62% Fe iron ore, which has widened over the past six months. Ferrexpo has recently completed its USD2bn modernisation and expansion programme and is planning to produce 12m tonnes of 65% Fe pellets per year by 2016.

Competitive Cost Producer
Ferrexpo's cost position has moved to the lower second quartile of the global cost curve. In 2014, cash costs improved significantly compared with the previous two years, due to rising volumes from the ramp-up of the Yeristovo mine and the currency depreciation (50% operating costs are linked to hryvnia). Costs decreased 22% yoy as of 9M14 and reached USD47 per ton, down from USD61 in 9M13 and USD60 in FY12. Energy costs represent approximately 50% of total costs and should contribute to further cost savings, due to recent falls in global oil prices.

Decreasing but Still Robust Profitability
Fitch expects the company's financial profile to have remained solid in 2014, with a 33% EBITDA margin (up 1.2 percentage points yoy). This is despite a significant reduction in revenues (down 15% yoy), which was offset by the currency depreciation. The ongoing fall in iron ore prices will likely erode EBITDA margin, which we forecast to decline to 27% in 2016. Funds from operations (FFO)-adjusted gross leverage will increase to 3.6x-3.8x in 2014-2015 (due to the reduction in EBITDA) but should stabilise at around 2.6x-3x thereafter, due to reduced capex and positive free cash flow (FCF) generation. FFO-adjusted gross leverage was 2.7x in 2013.

Rebalanced Maturity Profile
At end-9M14 the company's debt profile was mainly composed of USD500m 2016 notes offered for exchange, a USD420m pre-export finance facility maturing in 2016 and a new USD350m pre-export finance loan maturing in 2018. Due to increased iron ore price volatility in 2H14, the company is planning to proactively manage its debt schedule repayment, by extending notes maturity and eventually reducing its debt exposure.

In Fitch's view, the company's liquidity position is adequate for the next two years, based on our expectation of FCF turning positive in 2015 and a solid cash balance. Liquidity may, however, be put under pressure in 2016 should the bond exchange fail to materialise and should iron ore prices remain under USD80 per tonne.

Proximity to Consumer Markets
Military unrest in the eastern part of the country has not proven detrimental to Ferrexpo's export routes. The company still benefits from a favourable location at its Poltava and Yeristova mines, with strong access to the Black Sea ports and into central Europe via rail and waterway links. The company is also well-located to access Middle Eastern and Asian markets, which are the current growing export markets.

RATING SENSITIVITIES

Rating changes to Ukraine's ratings will result in a corresponding action in Ferrexpo's ratings.