OREANDA-NEWS. July 13, 2015 Fitch Ratings has published its final rating for KOKS Finance Limited's new loan participation notes at 'B'/'RR4'. KOKS Finance Limited is a subsidiary of Russian pig iron company OAO KOKS Group (KOKS, B/Stable).

As part of an exchange offer for outstanding USD350m LPNs maturing in 2016, USD136m new LPNs maturing in December 2018 were issued. New LPNs have a maturity of 3.5 years and a coupon rate of 10.75%. The new notes have the same guarantee and security structure as the existing ones. Around USD200m of original LPNs maturing in 2016 are left outstanding.

The LPNs are rated at the same level as KOKS's Issuer Default Rating of 'B' as they represent direct, senior and unsecured obligations of the company.

The 'B' rating reflects KOKS's small size, limited operational diversification and fairly high leverage. At the same time the company has a strong market position in pig iron and coke and targets 100% self-sufficiency in iron ore and coking coal by 2018 to become a fully vertically integrated metallurgical group. KOKS generated RUB12.1bn of EBITDA (by Fitch's definition) in 2014, mostly driven by rouble devaluation. We expect EBITDA to rise to RUB15bn in 2015, again on the weaker rouble.

KEY RATING DRIVERS

Small Size
Unlike major Russian steel companies KOKS is a fairly small producer whose production chain is limited to pig iron. KOKS is also limited in operational diversification with Tulachermet being the only pig iron production site within the group.

Strong Market Position in Pig Iron
KOKS is the world's largest exporter of merchant pig iron and top producer of merchant coke in Russia. In 2014 it controlled 16% of the world's pig iron exports and 39% of total Russian pig iron sales. KOKS accounted for 27% 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
Currently KOKS is 66% self-sufficient in iron ore and 37% in coking coal. With the commissioning of the Tikhova mine in 2018 and further production ramp-up at recently commissioned the Butovskaya mine, KOKS expects to achieve 100% self-sufficiency in coking coal by 2018. With the Tikhova mine operational the company will be a producer of high quality ZH-grade coking coal. The commissioning of the iron ore deposit at Kombinat KMA Ruda in 2019 will bring KOKS's self-sufficiency in iron ore to 100%.

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 50 years for iron ore production.

Exposure to Steel
Along with its two partners, Dilon Cooperatief U.A. and OOO Steel, KOKS is planning to develop a RUB30bn steel project in the Tula region. A 2mtpa steel plant is expected to be commissioned in 2H16. 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% by the partners and KOKS via equity.

Solid Financial Performance
KOKS's financial performance was solid in 2014. The company reported an EBITDA (Fitch's definition) margin of 25.7%, 10.4pp higher than in 2013. The improvement in profit margin was primarily driven by rouble devaluation and effective cost control measures such as idling inefficient and high-cost coal deposits and ramping up production at low-cost ones.

We expect a further improvement of EBITDA margin in 2015 to 28%, due to increased self- sufficiency, rouble depreciation and more efficient pig iron production. Thereafter EBITDA margin is expected to decline due to cost inflation, which we expect to lag the rouble's fall. Free cash flow (FCF) over 2016-2018 is expected to be neutral due to an increase in capital spending. As a result funds from operations (FFO) gross leverage is expected to decline to 2.8x in 2015, from 3.6x in 2014, but remain slightly above 3.0x during 2016-2018.

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.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for KOKS include:
- Average export price decline on pig iron of 15% YoY in 2015, 1% YoY in 2016 and flat afterwards
- Profitability improvement in 2015 driven by the weakness of rouble with some reversal in 2016-2018 due to inflationary pressure

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Further increase in self-sufficiency
- 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 (4.85x at 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 available undrawn facilities

LIQUIDITY AND DEBT STRUCTURE

KOKS's liquidity continues to rely on undrawn committed long-term facilities (end-2014: RUB10.9bn), which comfortably cover the gap between RUB0.9bn cash and RUB8.1bn short-term debt. We believe these facilities represent banks' commitments to lend and are reliable for on-going debt rollover and refinancing. However, such lines provided by Russian banks may include options for banks to withdraw their commitments should the company's performance deteriorate.