OREANDA-NEWS. Fitch Ratings has affirmed Compania Minera Milpo S.A.A.'s (Milpo) long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BBB' and its senior unsecured notes up to USD350 million at 'BBB'. The Rating Outlook is Stable.

KEY RATING DRIVERS

Low-Cost Polymetals Miner:

Cash flow generation at Milpo has historically been robust due to its low second quartile position on the global zinc cost curve. The company is a low-cost polymetals miner in Peru majority-owned by Votorantim Participacoes S.A. of Brazil (VPAR; long-term foreign currency IDR 'BBB'/Outlook Negative) with zinc accounting for 45% of 2014 revenues, followed by copper 30%, silver 15%, lead 8% and gold 1%. Milpo's ratings are linked to VPAR following Fitch's Parent and Subsidiary Linkage.

Revenues are mainly generated by the company's three mines located in Peru, with the largest mine, Cerro Lindo, accounting for 66% of revenues during 2014 followed by El Porvenir 20% and Atacocha 13%. Milpo's two copper operations are on hold after the closing of Chapi (Moquegua-Peru) in 2013 and Ivan (Antofagasta-Chile) in 2012. Milpo's largest customer is Votorantim Metais, accounting for around 35% of annual revenues, followed by Glencore (31%), Trafigura (20%), Optamine (8%) and others (6%). The company enters into five-year supply contracts that have historically been renewed.

Rating Linkage Supported by Strong Legal and Operational Ties:

Milpo is listed as a 'Material Subsidiary' for the cross-default and acceleration provisions on approximately BRL11 billion of Votorantim debt. Accordingly, Fitch links Milpo's credit strength to that of its parent. Parental support from VPAR to Milpo is considered very strong, as financial weakness at Milpo could trigger cross-defaults for VPAR. Operationally, Milpo supplies approximately 45% of total zinc concentrate volumes to Votorantim Metais' Cajamarquilla zinc refinery and contributes close to 25% of Votorantim Metais' EBITDA. Votorantim Metais consolidates 100% of Milpo because of the majority ownership.

Milpo is a key component of VPAR's metals and mining strategy to significantly grow their metals and mining division, Votorantim Metais. Milpo's location in Peru and its position as a local mining company provides VPAR with favorable access to Peru's abundant geological resources and vibrant market. Milpo is a low-cost producer of zinc, ranking 10th in size on a standalone basis globally in 2013, with broad asset diversification in Peru and Chile. Combined, Milpo and Votorantim Metais ranked as the world's fifth largest producer of zinc in 2013 according to the International Lead and Zinc Study Group. Votorantim Metais has invested USD720 million in Milpo since 2005.

Operational Improvements:

Milpo's revenues in 2014 increased to USD758 million from USD720 million in 2013 due to higher production of zinc, copper and lead concentrates related to greater treated ore volumes. This bolstered EBITDA to USD266 million in 2014 from USD257 million in 2013. Milpo's consolidated cash cost of production increased modestly to USD35.5 per metric ton (mt) of treated ore in 2014 from USD35 per mt in 2013 due to elevated maintenance and development costs anticipating the increased production capacity of 18,000 tons per day (tpd) at Cerro Lindo. This was partially off-set by the decrease in the production cash costs at El Porvenir and Atacocha which reflected the positive impact of the cost reduction initiatives taken by the company.

The operational integration between El Porvenir and Atacocha, together the Pasco mining complex, is in progress and will allow production costs to reduce due to synergies in the production process. Higher cash costs of production were partially off-set by lower administrative expenses primarily due to the corporate office optimization program which included a shared services center implemented since August 2014. As of 2014, the company's EBITDA margin was 35% which compared to 36% in 2013 and 30% in 2012. Fitch expects Milpo to continue improving its EBITDA margins closer to historical levels of around 40% when new, more profitable projects come into production in 2017-2018.

Growth Funded Mainly Through Cash Flow Generation:

Milpo generated free cash flow (FCF) of USD178 million in 2014 following capex of USD119 million and dividends paid of USD16 million from the prior year's net profit. This compared to FCF of USD87 million in 2013 with capex of USD84 million. Due to lower commodity prices, the company's growth strategy is focused on the most profitable brownfield projects for its current operations (Cerro Lindo's increased capacity and the Pasco mining complex) and the execution of greenfield projects by phases in order to achieve an earlier start-up reducing the payback period. Capex will continue to be partially funded by internal cash flows, with the shortfalls funded by additional debt but maintaining a conservative leverage level.

Fitch's Base Case for Milpo uses the agency's conservative mid-cycle price assumptions and indicates that EBITDA will decline to around USD218 million in 2015 due to zinc prices at USD1,950 per mt. and copper prices at USD6,500 per mt. FCF is expected to be positive in 2015 turning negative in 2016 and 2017 as greenfield capex ramps-up and dividend payments begin to increase.

Conservative Leverage Profile and Strong Liquidity:

Milpo exhibits a conservative capital structure with funds from operations (FFO) adjusted leverage of 1.6x and net debt-to-EBITDA at negative 0.3x in 2014. These ratios compare to FFO adjusted leverage of 1.9x and net debt-to-EBITDA of 0.1x in 2013. Milpo's net debt-to-EBITDA ratio was negative in 2014 mainly as a result of higher EBITDA and cash post issuance of its USD350 million 4.625% senior unsecured notes due 2023, comprising 97.5% of total debt, with the remainder related to finance leases. Projected leverage remains low for the rating category in the Base Case with expected FFO adjusted leverage of around 2.0x and negative net debt-to-EBITDA in 2015 rising to just 0.2x in 2016. Milpo's liquidity position is strong.

The company held USD437 million of cash and marketable securities versus short-term debt of USD9.6 million in 2014, a coverage ratio of 45x. A portion of the proceeds from the USD350 million senior unsecured notes issuance refinanced USD179 million of Milpo's bank debt in March 2013, extending its debt maturity schedule to 10 years, with the rest of the notes balance held as cash. The company relies primarily on strong internal cash flow generation to meet its operational requirements, but also benefits from good relationships with local and international financial institutions. In addition, Milpo benefits from access to commercial advances from its key clients.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

--Zinc price of USD1,950 per metric ton in 2015 and 2016 and long term of USD2,050 per metric ton.
--Copper price of USD6,500 per metric ton in 2015 and 2016 and long term of USD6,000 per metric ton.
--Silver price of USD17 per oz in 2015 and long term of USD18 per oz.
--Lead price assumption of USD 2,000 per metric ton in 2015 and long term.
--Additional debt in 2017 to fund expansionary capex.
--Sales volumes lower than management guidance.
--Reserve life to be replenished annually.
--Net debt to EBITDA ratio below 2.0x to 2018.

RATING SENSITIVITIES

Milpo's ratings benefit from its majority ownership by VPAR because of its strong operational and legal ties, based on Fitch's Parent and Subsidiary linkage criteria. Should the current level of operational and legal ties change as a result of Votorantim divesting its ownership stake in Milpo, then a rating action based on Milpo's standalone credit profile could follow.

If Milpo encountered operational and financial difficulty, Fitch would expect Votorantim to take steps to demonstrate support of its subsidiary. Precedents for Votorantim assisting companies where it has a significant investment stake exist, such as with the recapitalization of Fibria (VPAR owns 29.34% of common stock) with BNDES during 2010. Should such support not be forthcoming, a rating downgrade could take place.

Milpo's ratings would also be downgraded following a rating downgrade of VPAR.