OREANDA-NEWS. Fitch Ratings has upgraded Russian steel company OAO Severstal's (Severstal) Long-term Issuer Default Rating (IDR) to 'BB+' from 'BB'. The Outlook is Stable.

The upgrade reflects improvement of the company's profitability following gains in production efficiencies and successful deleveraging.

KEY RATING DRIVERS
Improvement in Profitability
Severstal has been successful in improving its production efficiency, which boosted profitability in the final quarters of 2013 despite a weak market environment. EBITDA margin increased to 18% in 4Q13 and 17% in 3Q13, from 14% in 2Q13 and 13% in 1Q13. Fitch believes the company has room for further efficiency improvement and expects EBIDTA margin to improve to 16%-17% in 2014-2016, from 15.3% in 2013.

Most of the efficiency improvements came from the mining business. In particular, at Vorkutaugol (Severstal's coal mining asset) the company commissioned gas-reciprocating power plants running on methane (a coal by- product), which substantially improved the heat and energy efficiency of coal beneficiation plants.

Further Deleveraging
Severstal reduced its total debt by approximately USD1bn in 2013 and is committed to further deleveraging. The company remained free cash flow-positive in 2013 (USD157m), which Fitch expects to continue with a more conservative capital spending programme. This should result in further deleveraging. Funds from operations (FFO) adjusted gross leverage declined to 2.49x in 2013 from 2.87x at end-2012 and is expected to fall to 2.2x by end-2014.

Restructuring Benefits
Severstal has retained its only two profitable overseas plants in the US (Dearborn and Columbus), following divestment of its loss-making facilities (three in the US and one in Italy). Both plants have recently been modernised to satisfy the needs of its vast customer base ranging from automotive, pipe and tube producers, to construction, and to appliance and furniture producers. In 2013 Severstal's North America division generated USD50m of EBIT versus a small loss in 2010.

Solid Business Profile
Severstal is one of Russia's most vertically integrated companies with a balanced product mix and strong geographical diversification. The company benefits from almost full self-sufficiency in iron ore and is more than self-sufficient in coking coal. Its mining assets are located close to its main steel production sites and are among the lowest cash cost producers globally. Severstal is one of the leading Russian steel producers by its share of high value added products in total sales (48%). This, along with vertical integration, allows Severstal to enjoy above-average profitability (USD136 of EBITDA/tonne in 2013 versus USD116/tonne for the industry).

Average Corporate Governance
Fitch assesses Severstal's corporate governance as average compared with other Russian corporates; the country's overall poor standards of governance and lack of legal safeguards are constraints on the ratings. As a result Fitch has notched down the company's ratings by two levels.

LIQUIDITY AND DEBT STRUCTURE
Severstal's liquidity position is strong with USD1bn of cash in hand and USD1.5bn of undrawn committed bank facilities compared with only USD0.6bn of short-term borrowings at end-2013.

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating actions include:
- Improvement in the Russian business environment
- Positive FCF on a sustained basis
- FFO-adjusted gross leverage below 1.5x
- Corporate governance improvement

Negative: Future developments that could lead to negative rating action include:
- EBITDAR margin below 16% on a sustained basis
- Failure to deleverage in line with Fitch's expectations resulting in FFO leverage above 2.5x.