OREANDA-NEWS. Fitch Ratings has assigned Georgia-based Rustavi Azot (Rustavi) an expected Long-term Issuer Default Rating (IDR) of 'B(EXP)' with Stable Outlook.

In addition, Fitch has assigned Agrochim S.A.'s (holding company of Rustavi), prospective eurobond issue of up to USD180m, guaranteed by Rustavi, and with a five-year maturity a 'B(EXP)' senior unsecured rating with Recovery Rating 'RR4'. The expected IDR assumes the successful notes issuance and the notes' final rating is contingent on the receipt of final documentation conforming to information already received.

Although Rustavi benefits from export sales diversity and a sound cost position, the ratings are capped in the 'B' category by its small size, its ownership concentration risk, and its primary focus on a single product. The financial profile is also commensurate with a 'B' category for a fertiliser company, with funds from operations (FFO) adjusted net leverage of 3.6x-4.3x and a FFO fixed charge cover of 2x-2.6x over the next two to three years.

The prospective senior unsecured bonds do not benefit from any rating uplift for recoveries due to a country cap of 'RR4'. Fitch views the guarantor and issuer under the substitution clause as interchangeable, without the need for consent from note holders, and notes that covenants will apply in equal terms.

KEY RATING DRIVERS

Small Scale Fertiliser Producer
Rustavi is a Georgian-based ammonium nitrate (AN) producer with 1% global market share and a 500 thousand tonnes (kt) of annual capacity. It operates a single site plant, with AN being its main product with a 92% share of 2014 revenues. The single site and limited scale of operations cap the rating at the 'B' category.

The company has strong geographical revenue diversification with Turkey as the largest market (31% of 2014 sales) followed by the US (18%) and Georgia (15%). All export sales are denominated in US dollars.

Competitive Gas Costs
Gas is the key cost input, comprising two-thirds of the company's production costs. Rustavi secured gas supplies by entering into an eight-year gas contract until 2019 with Azerbaijani gas producer SOCAR (BBB-/Stable) at a competitive fixed USD-nominated price. We deem the supply concentration risk as neutral to the current ratings, and FX risk as manageable given that 85% of revenues and 65% of costs of goods sold are USD-nominated.

Purchase Agreement Secures Offtake
Around 70% of Rustavi's sales are to a single distributer, exposing the company to offtake risk. This is particularly important given Rustavi's small size and limited reach in the market. However, this has recently been mitigated by Rustavi securing the offtake of AN with the distributer through a fixed five-year purchase agreement that is linked to the market price of AN plus a margin.

Former Related Party Exposure
Rustavi has had large related-party exposures through a purchase agreement with its previous minority shareholder, which accounted for 71% of sales in 2014. The related-party exposure has been eliminated with the purchase by Roman Pipia via the Loyal Capital Group of the minority shares so that Loyal Capital Group now owns 100% of Rustavi.

Short-term Price Volatility
AN is a nitrogen fertiliser that has a fairly stable market volume size but is subject to volatile pricing, driven by volatility in agricultural yields and farmers' purchasing power across different regions. The global fertiliser sector's long-term outlook is strong, supported by declining arable land, growing population and meat consumption, and biofuel production.

Eurobond Issuance
Agrochim S.A., the holding company of Rustavi with no other assets, plans to place up to USD180m five-year eurobonds guaranteed by Rustavi to refinance all of the group's and the sole shareholder's debt. Although unlikely, should lower-than-expected eurobond issue placement result in residual secured debt, this could lead to a lower final eurobond rating on weaker recovery prospects.

Bond terms and conditions are standard including event of default, cross acceleration and change of control. Bond documentation also contains a limitation on indebtedness once gross consolidated debt/EBITDA exceeds 3.5x from 2015 (3x starting from 2017), including a carve-out of up to USD30m of ammonia plant modernisation off gross debt. Dividend restrictions are also in place under this covenant and the restricted payment covenant. This means only a cumulative dividend of up to 25% of the previous year's net income can be paid if the ammonia plant project has not been commissioned, and up to 50% upon the ammonia plant project being commissioned.

The substitution clause allows an exchange of the guarantor with the issuer without consent from note holders, with all covenants applying in equal terms. We expect the substitution clause to be triggered.

Modernisation Supports Leverage until 2017
We expect Rustavi's FFO net adjusted leverage to peak at 4.3x at end-2015, based on prudent assumptions on AN prices and sales volumes, as well as the refinancing of group debt at the operating company (Rustavi) level.

We forecast leverage to fall to 3.6x-3.9x in 2016-2017 on low single-digit AN price recovery. We expect the company to carry out modernisation projects to its dormant ammonia plant in 2016-2017, which should result in negative single-digit free cash flow (FCF). The company's new 220kt ammonia capacity in 2018 will boost ammonia sales, increase scale and EBITDA generation and may reduce leverage to below 3x FFO gross consolidated debt/EBITDA when dividends are permitted to be paid again.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- High single-digit price decline in AN in 2015 with weak recovery afterwards
- Flat output volumes until 2018 when new ammonia output starts
- Temporary capex increase on ammonia capacity modernisation results in single-digit negative FCF margin in 2016-2017
- A cumulative dividend in 2018, following commissioning of the ammonia plant, reflecting 25% of net income from 2015-2017 and 50% of net income in 2018
- Leverage moderates from its 2015 peak towards 3.6x-3.8x until 2018.

RATING SENSITIVITIES

Future developments that could lead to positive rating action include:
-Scale and EBITDA improvement following the addition of the modernised ammonia capacity, leading to FFO net adjusted leverage falling below 2x
-Improved liquidity profile with FFO fixed charge cover above 3x
-A more diversified shareholder structure

Future developments that could lead to negative rating action include:
-FFO net leverage above 4x beyond 2016
-EBITDA margin below 20% (2014: 28%)
- Tightened liquidity and/or FFO fixed charge cover ratio falling below 2x
- AN at below-market pricing to the detriment of earnings

LIQUIDITY AND DEBT STRUCTURE

The bullet repayment of the proposed bond in 2020 will ensure that liquidity post 2015 is robust; we forecast positive FCF in 2015 of around GEL40m. We forecast cash accumulation on the balance sheet due to the restricted payment covenant until 2018 when dividend payments resume upon the completion of the ammonia project and the commencement of ammonia sales.

If the refinancing is unsuccessful, we expect the ammonia project to be put on hold. Otherwise Rustavi could become FCF-negative, which will result in pressure on the company's liquidity position. However, this could be mitigated by Rustavi's access to an uncommitted line from Bank of Georgia of USD100m.