OREANDA-NEWS. Fitch Ratings has affirmed the long-term local and foreign currency Issuer Default Ratings (IDRs) of Samarco Mineracao S.A. (Samarco) at 'BBB' and the National Scale Rating at 'AAA(bra)'. A full list of rating actions follows at the end of this release.

Samarco benefits from its ownership under two industry leaders, Vale S.A. (Vale; 'BBB+'/Outlook Stable) and BHP Billiton Limited/Plc (BHPB; 'A+'/Outlook Negative), with each company owning 50% of Samarco. Fitch believes Samarco's two strong shareholders, with combined operating EBITDA in 2014 of over USD44 billion, would support Samarco in the event of a sovereign-related liquidity crisis due to reputational risk.

KEY RATING DRIVERS

Lowest Cost Pellet Producer:

Samarco's credit profile benefits from its position as a low-cost producer of iron ore pellets and its geographical revenue diversification. The company continues to be competitive during difficult trading conditions because of its low-cost iron ore transportation through its slurry pipelines. The P4P project started its operations in March 2014, following a total capex of approximately BRL6.4 billion. The project has further improved Samarco's production cost position to remain profitable even during periods of low prices and lower pellet demand. Samarco ships 97% of its production to steelmakers in 20 countries. In 2014, the company had 39 overseas customers distributed across Africa/Middle East (23%), Asia (22%), Europe (21%), China (17%), and Americas (17%). Unusual for producers of seaborne iron ore products, Samarco's sales exposure to China is modest.

Samarco has a long track record of consistent high profitability. During 2014, the company's EBITDA margin was 50%, and has consistently remained above 50% over the last decade except during the global credit crisis of 2009, when it was 42% and 2007 when it was 45%. The more recent strong profitability was due to surging demand for pellets as steel mills sought more energy-efficient raw material inputs to offset higher energy costs, which began during the second half of 2009. Samarco regularly commits its entire production up to a year in advance through its long-term contracts with customers. During 2014, Samarco generated net revenue of BRL7.5 billion and EBITDA of BRL3.8 billion compared to BRL7.2 billion and BRL3.9 billion in 2013, respectively.

Solid Credit Profile:

Samarco has exhibited low leverage ratios during the past five years, but debt has increased every year since 2010 as a result of the P4P and P3P pelletizing plant projects, as expected. As of Dec. 31, 2014, the company had a net debt-to-EBITDA ratio of 2.5x. In 2013 and 2012, Samarco had net debt-to-EBITDA ratios of 2.2x and 1.5x, respectively. Samarco's net debt-to-EBITDA ratio is expected to be around 2.9x in 2015, 2.8x in 2016 and declining to below 2.0x in 2017 under Fitch's Base Case. Fitch previously expected to see a decrease in leverage from 2014 as a result of the higher pellet volumes following the launch of P4P project and resulting lower capex.

Fitch's revised view is based upon the lower average iron ore prices reflected in the agency's mid-cycle price assumptions, notwithstanding higher volumes and lower capex. A portion of the funding for the P4P project was achieved through cash freed-up by lower dividend payments to Vale and BHPB during the investment period and a USD1 billion senior unsecured notes issuance in October 2012 followed by an additional USD700 million in October 2013. These investments increased Samarco's production of iron ore pellets and fines reaching over 25 million dry metric tons (dmt) during 2014, an increase of 15.4% compared to 2013. Samarco's total debt at the end of 2014 was BRL11.7 billion, a year-over-year (y-o-y) increase of BRL2.6 billion.

Robust Cash Flow Generation:

Samarco's cash flow generation is robust due to its low cost structure, with the company's annual free cash flow (FCF) position dictated by the amount of dividends paid to its parent companies. Fitch would expect BHPB and Vale to continue to scale down dividends if operating conditions required additional liquidity, as seen both recently and historically. In 2014, the company's FCF was BRL425 million after capex and investments of BRL1.5 billion and dividends of BRL1.8 billion. Funds from operations (FFO) was BRL3.9 billion and after a small working capital outflow, reached BRL3.7 billion. This performance compares to FFO of BRL3.4 billion and CFFO of BRL3.3 billion in 2013. Fitch expects FFO of approximately BRL2.3 billion during 2015 under its base case, increasing in subsequent years reflecting a stronger pricing scenario.

Samarco's revenues reached a high of BRL7.6 billion in 2014 from BRL7.2 billion in 2013. This increase was mainly attributable to higher sales volume following the completion of the P4P plant and the depreciation of the Brazilian Real versus the U.S. Dollar. The average exchange rate during 2014 was 2.477 BRL/USD compared to 2.16 BRL/USD in 2013. While iron pellet and fines sales volumes increased during 2014 to 25.2 million dmt from 21.7 million dmt the prior year, average pellet prices dropped to USD123 from USD154 per dmt during 2013.

KEY ASSUMPTIONS

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

--Total iron ore pellet, pellet feed and pellet screening sales volumes of around 30.5 million dmt in 2015 and 30.9 million dmt in 2016.
--Iron ore pellet premium of between USD38-USD39 per dmt.
--Average Index price for 62% iron ore of USD50/dmt in 2015 and 2016, USD60 in 2017 and USD70 long term (Fitch mid-cycle iron ore price assumptions).

RATING SENSITIVITIES

Samarco is subject to a large number of pending judicial and administrative proceedings in various courts and with government agencies. They have arisen as a result of the company's normal course of operations and include tax, civil, labor and environmental issues. Management has made a provision for these contingencies in an amount considered sufficient to cover cases considered as probable losses. They amounted to BRL192 million in 2014 and are not considered material in the context of the rating.

Samarco also has other contingent liabilities that amount to BRL5.7 billion related to tax, civil, labor, environmental and social contributions on net income (CSLL) for which no provisions have been made. This is due to the company's legal assessment that losing is not probable, but that it is possible. The company only makes provisions for probable loss.

Should Samarco lose some or all of these cases, the expected outcome would be a payment scheme similar to REFIS that would take place over a long time period, hence mitigating any rating impact. Possible penalties arising from an unsuccessful outcome could be paid should Vale and BHPB choose not to take dividends for one to two years. Fitch considers these contingent liabilities as an event risk.

Samarco's ratings could also be negatively affected in the event of its parent companies' ratings being downgraded.

LIQUIDITY AND DEBT STRUCTURE

Samarco is well placed to benefit from the expected continued devaluation of the BRL with almost 99% of its 2014 revenues generated in USD, while its costs were around 68% in BRL (32% in USD). The company's debt profile closely reflects this currency split, with USD denominated debt comprising 98% of total debt and BRL local debt comprising 2%.

Compared to other investment-grade Brazilian corporates, Samarco held relatively modest cash and marketable securities on its balance sheet prior to 2014. This position is dictated by Samarco's dividend payout ratio target, under normal operating conditions, of 100% of FCF to Vale and BHPB. Cash and marketable securities as of Dec. 31, 2014 was robust at BRL2.1 billion as part of the company's strategy to maintain net debt to EBITDA ratio below 2.5x through-the-cycle. Short-term debt was BRL1.4 billion.

The company uses a combination of pre-export receivables financing alongside uncommitted bank lines as an additional source of liquidity when required. Liquidity is also strong when measured by cash plus CFFO/short-term debt which indicates a ratio of 2.7x coverage as of Dec. 31, 2014. Fitch would expect Vale and BHPB to reduce dividends paid by Samarco should the company require further liquidity, as was seen during 2012.

FULL LIST OF RATING ACTIONS

Samarco Mineracao S.A. (Samarco)
--Local currency long-term IDR affirmed at 'BBB';
--Foreign currency long-term IDR affirmed at 'BBB';
--National long-term rating affirmed at 'AAA(bra)';
--Senior unsecured debt rating affirmed at 'BBB';

The Rating Outlook is Stable.