OREANDA-NEWS. Fitch Ratings has assigned PAO SIBUR Holding's (SIBUR) recent issue of RUB10bn ten-year rouble bonds a local currency senior unsecured 'BB+' rating.

Fitch has simultaneously affirmed SIBUR's Long-term Issuer Default Rating (IDR) at 'BB+' with Negative Outlook, Short-term foreign currency IDR at 'B', and SIBUR Securities Limited's five-year USD1bn guaranteed Eurobonds due 2018 at 'BB+'.

SIBUR's USD1bn Eurobonds due 2018 and new RUB10bn rouble bonds rank pari passu with the group's senior unsecured debt and are only structurally subordinated to SIBUR's debt at its subsidiaries, largely represented by debt at Tobolsk Polymer and ZapSibNefteKhim (ZapSib-2). We expect SIBUR's structurally senior debt to increase with further utilisation of ZapSib-2 project debt funding, but to remain well below Fitch's 2x-2.5x threshold of prior ranking debt-to-EBITDA for notching unsecured debt rating until the bonds mature. Thus, we see no subordination pressure on the bonds' recoveries, as reflected in the bonds' ratings being equalised with SIBUR's IDR.

KEY RATING DRIVERS
Leveraging Risk Drives Outlook
The Negative Outlook reflects Fitch's expectations of materially higher leverage during 2017-2019, due to expenditure on the multi-billion ZapSib-2 project at a time of low and volatile petrochemical pricing. We expect funds from operations (FFO) adjusted net leverage to rise to 2.8x over 2017-2019 before returning to below our 2x rating guideline in 2020. This is despite SIBUR's operational performance benefiting from a weak rouble and a long-term drawdown/maturity period under its recent loan facilities obtained for the ZapSib-2 project. Fitch believes that, once completed in 2020, ZapSib-2 will materially enhance SIBUR's operational profile.

SIBUR's ratings are constrained by higher-than-average systemic risks associated with the Russian business and jurisdictional environment. Excluding these risks, Fitch assesses SIBUR's credit profile in the 'BBB' category, which reflects the group's leading market and cost position in the petrochemical sector, diversified portfolio and proven access to competitively priced feedstock.

Leveraging on Transformational ZapSib-2 Project
SIBUR's USD9.5bn ZapSib-2 project is expected to add 1.5 million tonnes (mt) of steam cracking capacity and 2mt of polymer capacity, and will be transformational for SIBUR's operational profile. In particular, SIBUR's basic polymer capacity will triple from its current 1mt level and the share of internally processed liquefied petroleum gas (50% of SIBUR's energy product sales) will almost double. This will further reduce SIBUR's sales exposure to volatile, oil-linked energy products towards 30% from 45%, and increase the exposure to more resilient, higher value added petrochemical products to 60% from 40%.

ZapSib-2 is SIBUR's largest investment, accounting for 80% of 2016-2020 total capex. SIBUR has already raised long-term debt financing, including USD2.3bn of export credit agencies' funding, a USD1.75bn loan from the National Wealth Funding, and a USD210m loan from Russian Direct Investment Fund and its partners, with most facilities maturing beyond 2020 when the project is expected to launch.

While SIBUR has demonstrated flexibility in the past by postponing some of ZapSib-2's capex, we believe there is limited scope for this once the financing is raised. We expect SIBUR's capex will peak in 2016-2018 at over 35% of sales. At a time of low oil prices partly offset by the weak rouble, this will put SIBUR's leverage under pressure over this period. This pressure, coupled with the risks around SIBUR's limited further flexibility to defer ZapSib-2 capex, is reflected in the Negative Outlook.

Pricing Pressure Varies Across Products
SIBUR's product portfolio consists of energy products (48% of 1H15 sales) and petrochemical products (48%). Energy products are diversified across liquefied petroleum gas, natural gas, naphtha and other products, but most of these products have significant pricing correlation with oil. Petrochemical products are mostly represented by polypropylene, polyethylene, synthetic rubbers and other plastics, which are more resilient to oil price shocks. While the recent oil shock has eroded SIBUR's energy products performance, it has had a less severe impact on petrochemical products' sales and aided its margins due to the decreasing cost of inputs.

Medium-term Margins and Leverage Pressure
We expect SIBUR's revenues to show consistent single-digit increases over the next five years, driven by rubbers and polymers volume growth, and oil price recovery and despite the strengthening rouble. The strengthening rouble and local inflation will also contribute to a reduction in SIBUR's margin to 33%-35% from 2017 from a 37%-39% peak in 2015-2016, which is more consistent with historical performance.

Aggressive capex exceeding 30% of sales for 2016, 2017 and 2018, coupled with a 25% dividend payout ratio, will outpace operational cash flows and translate into a negative high single-digit free cash flow (FCF) margin and leverage of 2.5x in 2016 and 2.8x in 2017-2018 (2015E: 2.5x).

Over the long term, we expect SIBUR to reduce capex from 2019 as most of the ZapSib-2 project capex is realised, resulting in gradual deleveraging towards below 2x post 2019. This is based on our assumption that SIBUR will not undertake new large projects before the ZapSib-2 ramps up. We assume the potential project of Amur gas chemical complex will be financed with non-recourse project finance.

Sinopec's Stake Neutral to Ratings
In December 2015 China Petroleum & Chemical Corporation (Sinopec; A+/Stable) acquired 10% of SIBUR's equity and subsequently nominated one of 10 Directors on SIBUR's Board of Directors. SIBUR's investment and dividend strategy remains intact after the change of shareholder structure. Fitch views this strategic partnership positively, as China is a growing market for SIBUR's products and future collaborative petrochemical projects.

FX has Multiple Implications
SIBUR reports in roubles. Its costs are dominated in roubles while its revenues are mostly driven by the US dollar. Similar to other petrocurrencies, the rouble becomes weaker during low oil pricing and vice versa. As a result, the price contraction in oil and oil derivatives by two thirds in 4Q15-1Q16 compared with 2014 was, to a large extent, compensated by more than a halving of the value of the rouble against the US dollar. This translated into reduced sales and margins for SIBUR's oil-linked energy products.

However, the relative price resilience of polymers and rubbers compared with oil, coupled with a weaker rouble, translated into higher sales and margins for SIBUR's petrochemical products. The overall effect of a weak rouble and low oil prices is broadly neutral for rouble-reported sales but positive for margins, as the rouble mitigates the impact of the weak oil price environment.

The weak rouble also has had an impact on SIBUR's capex and dividends. All other things being equal, a weak rouble increases the foreign currency element of capex and leads to a higher dividend payout through higher net profits. SIBUR's debt is also mostly in foreign currencies and is thus inflated by a weak rouble. Therefore, the overall weak rouble impact is positive on operational cash flow and moderately positive on leverage despite driving up capex, dividends and debt, all else being equal.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for SIBUR include:
- Oil price at USD35/bbl in 2016, gradually growing towards USD65/bbl by 2019.
- USD/RUB gradually strengthening towards 57 in 2019 from its peak at 75 in 2016.
- Energy product prices to follow oil price movements with petrochemical product prices dropping 15%-20% in 2016, before recovering in single-digit growth after 2016.
- Capex/sales peaking at above 35% during 2016-2018, and dividend payout of 25% of net income, driving a strongly negative FCF margin until 2019.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Progress towards the completion of ZapSib-2 project combined with expectations of FFO adjusted net leverage trending towards 2x, which would lead to the Outlook being revised to Stable
- Sustained positive FCF leading to FFO net adjusted leverage at or below 1.5x through the cycle, which would lead to an upgrade

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Material deterioration in the company's cost position or in access to low-cost associated petroleum gas.
- Aggressive investments leading to inability to keep FFO adjusted net leverage well below 3x in 2017-2019 and below 2x by 2020.

LIQUIDITY
Historically, SIBUR has had significant short-term debt constituting 25%-35% of total debt, which is well above its cash cushion. However, SIBUR's continued access to undrawn committed credit lines mitigates the liquidity gap. At end-3Q15 SIBUR had RUB84bn of short-term debt maturities, which were covered by RUB15bn of cash and RUB151bn long-term committed credit lines. SIBUR's exposure to uncommitted credit lines (end-3Q15: RUB106bn), coupled with its proven long-term relationships with state-owned banks, bolsters its liquidity balance.