OREANDA-NEWS. S&P Global Ratings affirmed its 'BB-' long-term corporate credit and 'ruAA-' Russia national scale ratings on Russia-based integrated steel producer Evraz Group S. A. We have also affirmed our 'BB-' long-term corporate credit rating on Evraz's financial subsidiary EvrazHolding Finance LLC and our 'B+' senior unsecured debt ratings on the notes issued by Evraz and EvrazHolding Finance LLC. The outlook remains negative.

The affirmation reflects our view that Evraz will have stronger operating and financial performance in the second half of 2016 than in the first half and will report metrics that are adequate for the rating for the full-year 2016, notably funds from operations (FFO) to debt sustainably above 12%. The affirmation also reflects our expectation that, in 2017, Evraz's metrics will show further improvement on the back of some market and demand recovery, positive free operating cash flow (FOCF) generation, and deleveraging, with the group's FFO to debt approaching 20%.

Evraz's performance in the 12 months ended June 30, 2016, suffered from weak industry conditions, highlighted by sluggish demand and falling prices for steel products. Notably, adjusted EBITDA for that period declined to as low as $1,146 million (with margins of about 15.5%), while FFO was just $563 million (including our adjustments). EBITDA from the steel segment contracted to $382 million (excluding our adjustments) in the first half of 2016 (compared with $740 million for the same period of 2015) as a result of significant average price declines for construction steel (down 18%) and semi-finished steel products (down 29%), exacerbated by demand dwindling in these segments--by 6% and 8%, respectively.

Devaluation of the Russian ruble helped Evraz to mitigate these negatives to some extent, bringing the average cash cost of producing slab steel at Evraz's Russian plants to $162 per ton in the first half of 2016 (versus $196 per ton in the first half of 2015). As a result, EBITDA margins fell only slightly, to 16.4% (1H2016) from 17.5% (1H2015). At the same time, weak performance and EBITDA contraction brought metrics slightly below our expectations: FFO to debt was 9.8% and debt to EBITDA was 5.0x (including our adjustments) in the 12 months ended June 30, 2016.

However, we have observed moderate steel price recovery since April 2016, which supported Evraz in the second quarter of 2016. We also assume that some revival on the domestic construction market this summer, aligned with positive price dynamics, will result in the group's continued stronger performance in the third quarter and to a lesser extent in the fourth quarter of 2016 (which usually suffers from a seasonality factor). The rail manufacturing segment, where Evraz is the No. 1 global producer, will also provide some support to Evraz's performance, given its solid market position, the more stable nature of this segment, and the increasing needs of Russian Railways.

We also view positively the proactive refinancing approach Evraz has demonstrated, which allowed it to reduce substantially its debt maturities coming due in the rest of 2016 and 2017. Evraz has also ensured covenant holidays with its main creditors until the end of next year, with the first testing to be made for full-year 2017 results. As part of the agreement with creditors, Evraz will have to refrain from paying dividends during this period, diverting all free cash flows to deleveraging.

We continue to assess Evraz's business risk as fair, based on the combination of the moderately high risk we see in the volatile and cyclical steel industry and our view of high country risk in Russia, where Evraz's key operations are concentrated.

The negative outlook reflects our view that weak and volatile steel prices will result in pressured credit metrics in 2016, notably FFO to debt of below 20%, which reduces headroom for the current rating.

We would consider a downgrade if Evraz fails to reduce debt and its FFO to debt therefore fails to improve to about 20% in 2017 from about 12%-15% in 2016. Such an improvement is dependent upon Evraz maintaining its strong free cash flow generation profile, with expected minimum annual FOCF of $300 million in 2016 and improving thereafter. We might also lower our rating on Evraz if the company does not refinance its 2017-2018 debt maturities well in advance (typically 12 months), leading to weaker liquidity. That said, we expect that Evraz will continue managing its refinancing risks in a proactive manner.

We may revise the outlook to stable if Evraz reports materially stronger EBITDA and free cash flow than we currently anticipate, which improves FFO to debt to about 20%.