OREANDA-NEWS. Fitch Ratings has affirmed UK-incorporated Ukrainian iron ore pellets producer Ferrexpo Plc's (Ferrexpo) Long-term Issuer Default Rating (IDR) at 'CCC' and Short-term IDR at 'C'. The senior unsecured rating of Ferrexpo Finance plc's 2016 guaranteed notes issue has also been affirmed at 'CCC' with a Recovery Rating (RR) of 'RR4'. In addition, Fitch has affirmed the 'CCC(EXP)' expected senior unsecured rating on the issue of new notes under the Exchange Offer in respect of the 2016 notes.

Since the assignment of the 'CCC(EXP)' rating to the new notes on 19 January 2015, the terms of the Exchange Offer have been modified to extend the early bird period to 20 February 2015 and increase the cash pre-prepayment amount to 25% of the nominal amount of the bonds (previously 20%) with the remaining 75% exchanged with the new notes. For further information on the on-going exchange offer, see 'Fitch Rates Ferrexpo's Upcoming Bonds 'CCC(EXP)' dated 19 January 2015 at www.fitchratings.com).

Ferrexpo's ratings are constrained by Ukraine's Country Ceiling (CCC) due to the company's large operational exposure to the country. The company's lack of geographic and commodity diversification further constrains the rating. Ferrexpo's credit strengths include its competitive cost position in the iron ore pellets market, significant reserve base, proximity to consumer markets, and expected moderate leverage over the medium term.

KEY RATING DRIVERS
Ratings Constrained by Country Ceiling
Ferrexpo's ratings are constrained by the Ukrainian Country Ceiling due to its operating base within the country. Ukraine has recently experienced high domestic inflation, hryvnia depreciation (by more than 50% in 2014 versus the US dollar), rising energy costs, disrupted electricity supply and a delay in VAT repayment by the state. With respect to the ongoing military conflict within the country, Ferrexpo's operations and transport infrastructure so far have not been directly impacted by the conflict in the Donbas region, as all assets are located in the Poltava region, around 425km north of Donetsk.

Low Iron Ore Price Environment
In December 2014, 62% Fe iron ore prices averaged USD69 per tonne, down 50% yoy, reflecting oversupply in the market and expectations of slower demand from the Chinese steel industry. Fitch expects iron ore prices to stabilise at around USD80 per tonne in the long term, below the 2014 average price of USD97 per tonne, which will negatively impact the company's earnings and credit metrics. As a pellets producer, Ferrexpo will continue to benefit from a quality premium over the 62% Fe iron ore, which has widened over the past six months. Ferrexpo has recently completed its USD2bn modernisation and expansion programme and is planning to produce 12m tonnes of 65% Fe pellets per year by 2016.

Competitive Cost Producer
Ferrexpo's cost position has moved to the lower second quartile of the global cost curve. In 2014, cash costs improved significantly compared with the previous two years, due to rising volumes from the ramp-up of the Yeristovo mine and the currency depreciation (50% of operating costs are linked to the hryvnia). Costs had decreased 22% yoy as of 9M14 and reached USD47 per ton, down from USD61 in 9M13 and USD60 in FY12. Energy costs represent approximately 50% of total costs and should contribute to further cost savings, due to recent falls in global oil prices.

Decreasing but Still Robust Profitability
Fitch expects the company's financial profile to have remained solid in 2014, with a 33% EBITDA margin (up 1.2 percentage points yoy). This is despite a significant reduction in revenues (down 15% yoy), which was offset by currency depreciation. The ongoing fall in iron ore prices will erode future EBITDA margins, which we forecast to decline to 27% in 2016. Funds from operations (FFO)-adjusted gross leverage will increase to 3.8x in 2014 and peak at 5.8x in 2015 (under Fitch's new iron ore price deck) but should stabilise at around 2.0x thereafter, due to reduced capex and positive free cash flow (FCF) generation. FFO-adjusted gross leverage was 2.7x in 2013.

Rebalanced Maturity Profile
At end-9M14 the company's debt profile was mainly composed of USD500m 2016 notes offered for exchange, a USD420m pre-export finance facility maturing in 2016 and a new USD350m pre-export finance loan maturing in 2018. Due to increased iron ore price volatility in 2H14, the company is planning to proactively manage its debt repayment schedule, by extending the notes' maturity and progressively reducing absolute debt levels.

In Fitch's view, the company's liquidity position is adequate for the next two years, based on our expectation of FCF turning positive in 2015 and a solid cash balance. However, liquidity may be put under pressure in 2016 should the bond exchange fail to materialise and should iron ore prices remain materially under USD80 per tonne.

KEY ASSUMPTIONS
- Fitch iron ore price deck: USD65/t in 2015, USD75/t in 2016, USD80/t in the long term.
- Forecast price premium for pellets based on 9M14 realised premium.
- Production volumes in line with management's expectations: 12mt p.a. iron ore pellets by 2016.
- Bond exchange offer is assumed to be accepted at the minimum level (i.e. USD300m).
USD/UAD 17 in 2015.

RATING SENSITIVITIES
Changes to Ukraine's Country Ceiling, which may accompany a change to its sovereign rating, would likely result in a corresponding action on Ferrexpo's ratings.

The main factors that could, individually or collectively, result in a downgrade of the sovereign rating are:
-Intensification of political and/or economic stress, potentially leading to a default on government debt.

The main factors that could, individually or collectively, could result in an upgrade of the sovereign rating are:
-Improvement in political stability.
-Progress in implementing economic policy agenda agreed with the IMF.
-Improvement in external liquidity.