OREANDA-NEWS. Fitch Ratings has downgraded Russia-based OJSC Uralkali's (Uralkali) Long-term Issuer Default Ratings (IDR) to 'BB+' from 'BBB-'. The Outlook is Negative. The foreign currency senior unsecured rating on Uralkali Finance Limited's notes has been downgraded to 'BB+' from 'BBB-'.

The downgrade reflects Uralkali's weakened financial and operational profile as well as corporate governance that can no longer be considered materially above average against Russian peers. It follows a USD1.1bn share buyback and commencement of a discretionary dividend policy from 2015 at a time of low production following the Solikamsk mine accident, leading to accelerated capex spend, and continued weak potash pricing. As a result, Fitch forecasts funds from operations (FFO) adjusted net leverage will go over the negative rating sensitivity of 2.5x to 3.0x at FY15, and may stay above 2.5x after 2015 subject to the shareholder distributions made after the announced buyback. This is despite Uralkali's continued leading cost position in the potash market and strong cash generative capacity through the cycle.

The Negative Outlook reflects the uncertainty around the future pace of deleveraging stemming from uncertainty on future shareholder returns, following Uralkali's departure from its previously communicated deleveraging target.

KEY RATING DRIVERS
Share Buybacks increase Leverage
In 2013 Fitch revised the Outlook to Negative when debt-funded share-buy backs threatened the group's credit profile and were followed by a subsequent collapse in potash prices due to the break-up of BPC, Uralkali's trading joint-venture with Belarus-based JSC Belaruskali. Fitch then revised the Outlook to Stable in 2014 following management making debt reduction a priority and publicly guiding to a net debt to EBITDA target below 2.0x.

The company has departed from this target by carrying out a further USD1.1bn share buyback in 2015 and adopting a less predictable discretionary dividend policy. This is at a time of low production following the Solikamsk mine accident leading to accelerated capex spend and continued weaker than expected potash price recovery, meaning FFO adjusted net leverage will reach around 3x at FY15.

Corporate Governance Discount Increases
Fitch has re-evaluated the one-notch corporate governance discount applied by it on Uralkali's IDR following the share buyback and commencement of a discretionary dividend policy. The notching reflected the above average corporate governance that Uralkali's diversified shareholding structure, listing on LSE and MICEX and robustness of financial strategy provided. Fitch notes that several majority shareholders may have allied interests despite the presence of independent directors, and that a less concentrated shareholder structure does not necessarily imply balance of interests across all stakeholders.

Fitch therefore now applies a two-notch corporate governance discount to Uralkali, on a par with its Russian peers with a concentrated ownership structure.

Lower Production, Higher Capex
The flood accident at Uralkali's Solikamsk-2 potash mine resulted in around 1.7mt of lost capacity meaning 2015 production is expected at 10.4mt, down from 12.1mt in 2014. Production is not expected to reach 2014 levels until 2020 when new potash fields come on line. Uralkali has therefore accelerated capex plans to help bring production on line in order to help partially restore production volumes over the next few years. This will help it recover market share and earnings, although Fitch does not forecast Uralkali will meet 2014 sales levels until 2017.

Uralkali's decrease in earnings from lower production is offset by rouble depreciation, which is helping lower Uralkali's production costs compared with its US dollar-linked revenues.

Continued Pricing Pressure
The break-up of the BPC potash cartel resulted in intensifying competition on prices since late 2013 as Uralkali fought to regain lost market shares. This was a stark departure from the supply-discipline that had characterised the market and underpinned the resilience of potash prices through the cycle. Spot Free on Board prices remain at depressed levels of over USD300/t in 2015 reflecting the fundamental rebasing of potash prices at a lower level. Uralkali's seaborne contract to China, the floor for global prices, was set at a slight increase to 2014 levels at USD315/t from USD305/t. Fitch forecasts a prudent 2% increase in potash prices per year to 2018. However, we believe that low potash prices will continue, considering significant excessive capacity in the market as well as potential capacity coming on in Canada and a low grain environment in the short term.

Leverage Drives Negative Outlook
Under our base case, Uralkali's vertical integration and competitive cost base continue to translate into EBITDA margins of around 50% through the cycle. Under Fitch's forecast, FFO net leverage increases to 3x at FY15 following the share buyback. However, it is then forecast to remain over guideline levels of 2.5x until 2018 due to pressure from higher capex, lower prices and lower production. Combined with Uralkali's departure from a previously communicated deleveraging target and the recent adoption of a less predictable discretionary dividend policy, this drives the Negative Outlook.

Country and Industry Risks
Rating constraints include Uralkali's full exposure to the potash demand cycle. In Fitch's view, combined with the high contribution of emerging markets to revenues (64% in 2014 excluding Russia), this implies higher earnings volatility than for more diversified peers. Although these markets present strong growth potential, they also tend to exhibit more erratic demand patterns than mature agricultural regions. Operational risks are also higher in potash mining as the water soluble salt deposits are susceptible to flooding. Finally, the rating is constrained by the higher than average legal, business and regulatory risks associated with Russia (BBB-/Negative/F3).

RATING SENSITIVITIES
Negative: Future developments that could lead to negative rating action include:
--A further lower rebasing of potash prices, material disruptions and decrease in production or a continued aggressive financial policy resulting in FFO net leverage sustained materially above 2.5x (FYE15: 3x)

Positive: Future developments that could lead to positive rating action include:
--A stable and transparent financial policy resulting in FFO net leverage sustainably moving to below 2.5x over the next two years could lead to the stabilisation of the Outlook.
--A stable and transparent financial policy, coupled with an improvement in potash pricing and higher production resulting in FFO net leverage sustainably below 1.5x could lead to an upgrade.

LIQUIDITY AND DEBT STRUCTURE
Uralkali's liquidity is robust with USD2.5bn of available cash at YE14 and positive free cash flow generation forecast over 2015, against USD0.7bn short-term financial obligations and a cash outflow of USD1.1bn for the share buyback. The buyback in May 2015 has had a limited impact on liquidity as Uralkali had ample available cash to cover the buyback. Uralkali also continues to access capital markets as demonstrated by the recent four-year pre-export financing loan of USD655m.