OREANDA-NEWS. Fitch Ratings has placed Russia-based Evraz Group SA's (Evraz Group) and holding company Evraz plc's (Evraz) Long-term Issuer Default Ratings (IDR) of 'BB-' on Rating Watch Negative (RWN). A full list of ratings is at the end of this commentary.

The RWN follows the release of the group's 2015 annual results, which were below our base case expectations. This reflected generally weak demand trends for steel in the Russian market and in particular with respect to construction steel - a key market for Evraz. We believe there is now a higher risk that Evraz Group's credit metrics will not return within expected parameters for the current rating, including funds from operations (FFO) gross leverage sustainably below 3.5x, over the next two to three years.

We expect to resolve the RWN over the next three to six months. Over this period we expect to meet with company management to better understand expectations for future operating performance as well as potential options to reduce absolute debt levels. We will also monitor the development of near-term market conditions and prices.

KEY RATING DRIVERS
Weak Financial Performance, High Leverage
Weak end-market conditions had a significant impact on Evraz's financial performance in 2015. Revenues were down 33% compared with 2014 due to the combination of materially lower product prices and lower production volumes. However, a favourable foreign exchange impact on rouble-denominated costs, together with the cost efficiency measures implemented by management, have largely contained the drop in EBITDA margins, going down to 16% from 17.6%.

Results were materially below our expectations from the base rating case in September 2015, both in terms of debt reduction and profitability. We expected then that EBITDA would amount to USD1.8bn for 2015 and FFO gross leverage would be approximately 4.0x in 2016 and not exceed 3.5x over the rating horizon. Instead, the company achieved USD1.4bn of EBITDA, largely due to a further drop in domestically sold long products prices. FFO gross leverage was 5.4x, and Fitch now forecasts it to exceed 5.0x in 2016 and remain over 3.5x until end-2019.

No Recovery Expected in Key End-Markets in 2016
Evraz's key domestic end-markets are construction, which made up 37% of 2015 sales volumes, and railway products (8%), while about 45% of Russian production was exported in the form of semi-finished products. Russian GDP declined by 3.8% in 2015, driving consumption and prices significantly down. Construction and railways prices dropped by 32% and 29%, respectively, and are not expected to recover in 2016, in line with Russian GDP. Our main assumption behind this assessment is our view on oil prices in 2016. We believe that there is a strong correlation between the prices of oil and gas and the Russian economy, and therefore, in turn, with the steel market in general, and the construction and railway markets in particular. We do not believe that oil prices will recover enough this year to reverse the trend. Exports of semi-finished product have followed the same trend in 2015, with prices down by 33%, and are expected to remain equally strained in 2016.

Raspadskaya Ratings Linked to Evraz
Stronger ties between Evraz plc and Raspadskaya developed after Evraz increased its ownership to 82% in January 2013. The companies have since merged several support departments, such as treasury, logistics and other operations to increase synergies. Evraz also refinanced all of Raspadskaya's bank debt in 3Q13. Evraz remains a top-three offtaker for Raspadskaya, which plays a crucial part in Evraz's integration into coal. Despite these factors, a one-notch differential remains appropriate and reflects the absence of formal downstream corporate guarantees for Raspadskaya's debt from Evraz.

High Raw Material Self-Sufficiency
Evraz Group benefits from high self-sufficiency in iron ore and coking coal, including supplies of coal from its subsidiary Raspadskaya. Consequently, it is better placed across the steel market cycle to control the cost base of its upstream operations than less integrated Russian and international steel peers. The cash cost of slab production at Evraz's Russian steel mills is estimated to have fallen by around 50% in absolute terms to USD193/t since 2013, reflecting a combination of operating cost efficiencies and the fall in value of the rouble, which have enabled the company to maintain high plant capacity utilisation.

Corporate Governance
We regard Evraz's corporate governance as reasonable compared with its Russian peer group, but we continue to notch down the rating in respect of corporate governance by two notches relative to international peers. This factors in our view of the higher than average systemic risks associated with the Russian business and jurisdictional environment.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Evraz plc/Evraz Group/Raspadskaya include:
-USD/RUB exchange rate: 75 in 2016, 68 in 2017 and 62 in 2018
-Fall in steel sales volumes in 2016 of 5.3%, progressive recovery thereafter (+1% in 2017 and 4% in 2018 and 2019)
-Fall in coal sales volume in 2016 of 2%, flat in 2017 and steady growth thereafter (+2% in 2018-2019)
-Decrease in prices of steel products and coal in 2016 (-14% for steel and -2% for coal), progressive increase thereafter
-USD450m capex spend in each of 2016 and 2017, USD500m thereafter
-No dividend payments or share buybacks over the period to 2018

RATING SENSITIVITIES
Evraz plc/Evraz Group SA
Negative: Future developments that could lead to negative rating action include:
- FFO-adjusted gross leverage above 4.0x by end-2016 or sustained above 3.5x
- FFO-adjusted net leverage sustained above 3.0x
- Persistently negative free cash flow (FCF)
- Failure to extend debt maturities falling due in 2017 and 2018

Positive: Future developments that could lead to an affirmation include:
-Further absolute debt reduction with FFO gross leverage moving sustainably below 3.0x
-FFO-adjusted net leverage sustained below 2.5x
-Sustained positive FCF

OAO Raspadskaya
Positive: Future developments that could lead to positive rating action include:
-Stronger operational and legal ties with Evraz, including a corporate guarantee of Raspadskaya's debt, which could lead to the equalisation of the companies' ratings.
-Positive rating action on Evraz plc, which could lead to a corresponding rating action on Raspadskaya.

Negative: Future developments that could lead to negative rating action include:
-Evidence of weakening operational and legal ties between Evraz and Raspadskaya
-Negative rating action on Evraz plc, which could lead to a corresponding rating action on Raspadskaya.

LIQUIDITY
The refinancing of approximately USD970m of the company's 2015-2018 debt maturities with proceeds from USD750 Eurobond issue in December 2015 and RUB15bn in March 2016 rebalanced the company's overall maturity profile. Fitch believes that the company is in a position to service all of its mandatory repayments until 2017 out of FCF, cash and an available undrawn revolving credit facility.

At end-2015, Evraz had USD1,375m unrestricted cash, USD317m in undrawn committed bank facilities and strong FCF generation of USD760m. Fitch expects the company to generate around USD350m-USD450m FCF between 2016 and 2017.

FULL LIST OF RATING ACTIONS

Evraz Group SA
- Long-term foreign currency IDR of 'BB-' placed on RWN
- Short-term foreign currency IDR of 'B' affirmed
- Senior unsecured rating of 'BB-' placed on RWN

Evraz plc
- Long-term foreign currency IDR of 'BB-' placed on RWN
- Short-term foreign currency IDR of 'B' affirmed

OAO Raspadskaya
- Long-term foreign currency IDR of 'B+' placed on RWN
- Short-term foreign currency IDR of 'B' affirmed
- Long-term local currency IDR of 'B+' placed on RWN
- Senior unsecured rating of 'B+'/RR4 placed on RWN
- National Long-term rating of 'A(rus)' placed on RWN