OREANDA-NEWS. Fitch Ratings has revised the Outlook on PJSC Uralkali's Long-Term Issuer Default Rating (IDR) to Negative from Stable and affirmed the IDR at 'BB-'. Fitch has also affirmed the foreign currency senior unsecured rating on Uralkali Finance DAC's notes at 'BB-'.

The Negative Outlook reflects Uralkali's higher than expected leverage. This will exceed our previous negative rating guideline of 4x over 2016-2017 on share buyback-driven accumulated debt and weak potash pricing environment. In particular, we expect Uralkali's funds from operations (FFO) net adjusted leverage to peak at 4.4x in 2016 before gradual reduction thereafter. This is based on our expectations of USD0.5bn share buyback in 2016, zero shareholder distributions in 2017, and flat potash pricing in 2H16-2017. Share buybacks or other distributions above those assumed which jeopardise Uralkali's ability to deleverage towards 4x by 2018 could trigger a downgrade.

The Negative Outlook also reflects Uralkali's reduced headroom under the financial indebtedness covenants including net debt-to-EBITDA. We note Uralkali's significant discretion and flexibility in capex and shareholder distributions, which mitigate but do not completely remove this risk. We believe that Uralkali should be able to renegotiate these covenants if it anticipates a period of non-compliance, although this cannot be guaranteed.

The 'BB-' rating reflects Uralkali's strong operational profile, weak financial profile, and a two-notch discount for corporate governance that we typically apply to Russia-based corporates with concentrated ownership. The strong operational profile is underpinned by Uralkali's significant scale as a leading global potash producer and its sustained global cost leadership that translates into EBITDA profitability at above 50% through the cycle.

KEY RATING DRIVERS

Buybacks End in 2016

We expect Uralkali to finalise buybacks from the free float in 2016, as evidenced by year-to-date 2016 actual level of around USD0.5bn (2015: USD3.4bn) and underpinned by Uralkali's shrinking free float which fell below 6% in September 2016. Further shareholder distribution risks might arise from Uralkali's balance sheet-funded share buyback from the new shareholder Mr. Lobyak, or re-establishing a regular aggressive dividend policy.

Markets and Buybacks to Drive Performance

Our rating case assumes Uralkali will cease share buybacks in 2016 as the free float shrinks. In 2016-2017, we conservatively expect potash pricing flat at 2H16 lows of around USD230/t, capex-to-sales at around 12%-13% at a given price scenario, and zero dividends. Coupled with moderate rouble inflation, this translates to gradually shrinking margins and moderately positive post-buyback free cash flow, and FFO net leverage exceeding 4.0x.

An earlier or faster than expected market recovery could favourably impact Uralkali's 2016-2017 leverage. However, this might be offset by higher than expected shareholder distributions or long-term expansion investments.

Covenant Headroom Limited

Uralkali's discretion in its expansion capex and shareholder distributions is not sufficient to completely eliminate the risk of covenant breaches arising from significant pricing pressure, rouble revaluation or operational disruptions. This risk is reflected in the Negative Outlook. Uralkali's leverage proximity to the 4.0x net debt-to-EBITDA level (which stands close to 4.5x in terms FFO net adjusted leverage) over the next three years remains a risk.

Pricing Conservatively Flat

Fertiliser pricing pressure continued into 2016 from 2015. The potash players' recent progress in signing the supply contracts with China and India following the 1H16 destocking incorporated the double-digit pricing pressure observed on potash spot markets but set a price floor and added confidence to potash markets in 2H16 and 2017. We conservatively revised our potash pricing expectations down to the levels of around USD230/t during 2H16-2018 as currently suspended and newly arriving capacities limit potential price growth.

Country and Industry Risks

Rating constraints include Uralkali's full exposure to the potash demand cycle. In Fitch's view, combined with the high contribution of developing regions to revenues (above 60% in 2014 and 2015, excluding Russia), this implies higher earnings volatility than for more diversified peers. These markets present strong growth potential, but they also tend to exhibit more erratic demand patterns than mature agricultural regions.

Operational risks are also higher in potash mining than other fertilisers as water-soluble salt deposits are susceptible to flooding. Finally, the ratings are constrained by the higher-than-average legal, business and regulatory risks associated with Russia (BBB-/Negative/F3).

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Uralkali include

- Potash pricing further down by 20%-25% in 2016 with no recovery over the next two years

- Potash sales volumes to bottom at under 11mt in 2016 before single-digit growth

- RUB/USD to continue gradual strengthening towards 57 in 2019

- Capex-to-sales at around 12%-13% over the next two years

- Share buybacks around USD0.5bn in 2016 and zero thereafter

- Dividend payout ratio of 50% from 2018 onwards

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- Further market pressure or an aggressive financial policy resulting in sustained leverage pressure with FFO adjusted net leverage expected to be significantly above 4x.

- Continued limited headroom under the financial covenants.

- Aggressive shareholder actions (e. g. further share buybacks) detrimental to the Uralkali's credit profile and indicating a weaker corporate governance discount.

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

- Revision of the Outlook to Stable

Neutral-to-positive post-share buyback free cash flow resulting in FFO adjusted net leverage declining towards 4x or below in FY18, and ensuring sustainably comfortable headroom under the financial covenants.

- Upgrade

Stable and transparent shareholder structure translating into re-established predictable financial policies, coupled with market improvement, resulting in FFO adjusted net leverage sustainably below 2.5x.

LIQUIDITY

Liquidity Improved on Covenant Amendment

Uralkali's liquidity improved in 1H16 with USD1.2bn short-term debt sitting against USD1.5bn reported cash and equivalents. This improvement follows the reclassification of USD1.5bn back to long-term debt from short-term debt at end-2015 as Uralkali amended the net debt-to-net worth covenant calculation thereby eliminating FX-driven covenant breach risk.