OREANDA-NEWS. Fitch Ratings has assigned Russian pig iron company OAO KOKS Group (KOKS) Long- and Short-term Issuer Default Ratings (IDR) of 'B' respectively. The Outlook is Stable.

Fitch has also assigned KOKS Finance Limited's loan participation notes a senior unsecured rating of 'B-' with a Recovery Rating of 'RR5'.

The rating reflects KOKS's small size, limited operational diversification and fairly high leverage. Positively they also reflect the company's strong market position in pig iron and coke, two key components of steel production. Partial vertical integration in raw materials to the pig iron production chain provides KOKS with reasonably high profit margins and insulation from sharp price swings in coal and iron ore.

KOKS is a vertically integrated metallurgical group with four business segments: coal, coke, iron ore/pig iron and powder metallurgy. Its main production facilities are situated in Kemerovo, Belgorod and Tula regions. KOKS generated RUB6.6bn of EBITDA (by Fitch's definition) in 2013 and Fitch expect this to rise to over RUB8bn in FY14.

KEY RATING DRIVERS
Small Size
KOKS is a fairly small sized pig iron producer compared with major Russian steel companies. Its production chain is limited to pig iron production whereas such majors as NLMK (BBB-/Negative) and Severstal (BB+/Stable) are producing high quality steel end products, such as hot deep galvanized steel (HDG), transformer steel, and long steel products, etc. KOKS is also limited in operational diversification with Tulachermet being the only pig iron production site within the group.

Strong Market Position in its Niche
KOKS is the world's largest exporter of merchant pig iron and top producer of merchant coke in Russia. In 2013 it controlled 16% of the world's pig iron exports and 43% of total Russian pig iron sales. KOKS accounted for 29% of total coke sales in Russia. The company is geographically diversified in its pig iron sales with a strong presence in markets such as the Americas, Europe, Turkey and The Middle East.

Partial Vertical Integration
KOKS aims to raise the level of vertical integration of its business by increasing production at its mining divisions (coal and iron ore). Currently, it is 42% self-sufficient in coking coal and 65% in iron ore. With the commissioning of Tikhova mine in in the period between 2016 and 2018 and further production ramp-up at recently commissioned Butovskaya mine, KOKS expects to achieve 100% self-sufficiency in coking coal by 2018 and 75% self-sufficiency in iron ore by 2022.

Strong Reserve Base
As of 30 September 2010, proved and probable reserves under JORC standards amounted to 115mt of coal and 285mt of iron ore with 33% of Fe content. At current production levels, this implies almost 70 years of remaining operating life for coal production and 60 years for iron ore production.

Exposure to Steel
Along with two partners, Slovenian Steel Group and OOO Steel, KOKS is planning to develop a RUB30bn steel project in Tula region. A 2mtpa steel plant is expected to be commissioned in 2017. As the plant will be fed with pig iron produced by Tulachermet, a KOKS subsidiary, the steel project should integrate seamlessly into KOKS's business model and raise value creation. The steel plant is expected to produce construction and high quality specialty steel. Seventy per cent of the project will be funded by project finance and the remaining 30% on a pro rata basis by the partners and KOKS (via equity).

Strong Powder Metallurgy Division
JSC POLEMA, a subsidiary of KOKS, is one of the largest producers in the world of electrolytic refined chromium and high purity chromium sputtering targets, rolled metal and molybdenum and tungsten products, and heavy-current contact materials. The plant has an annual capacity of 3ktpa and is capable of producing more than 200 grade marks of powders based on nickel, cobalt, molybdenum, chromium, titan, cuprum, zinc and powdered alloy steels.

Solid Financial Performance
Despite a weak price environment for metals in 2013, KOKS's financial performance was reasonably solid. The company reported an EBITDA (Fitch's definition) margin of 15.3%, 2.2pp higher than in 2012. This was due to effective cost control measures and favourable prices of major raw materials. Over 2014-2017, Fitch expect a further improvement of EBITDA margin to 18% due to increased vertical integration, RUB depreciation and more efficient pig iron production. Free cash flow over this period is, however, expected to be consistently negative, due to an increase in capital spending. As a result funds from operations (FFO) gross leverage should remain at around 4x in FY16, before falling in 2017.

Average Corporate Governance
Fitch assesses KOKS'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.

RATING SENSITIVINESS
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Further increase in vertical integration
- Positive FCF across the cycle
- FFO-adjusted gross leverage below 3x on a sustained basis
- FFO fixed charge cover above 6x on a sustained basis (2.98x expected by end-2014)
- Successful implementation of steel project, without delay or cost overruns
- Improved liquidity in the form of consistently higher cash balances or an improved maturity profile

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Capital spending overrun causing further leverage increase, i.e. FFO-adjusted gross leverage remaining above 4x after 2016
- Significant deterioration of business operations caused by adverse market conditions
- Loss of access to a material portion of the RUB18.6bn (USD530m) of available undrawn facilities.