OREANDA-NEWS. Fitch Ratings has downgraded Ferrexpo plc's (Ferrexpo) Long-term and Short-term Issuer Default Ratings (IDR) to 'RD' (Restricted Default) from 'C'. The downgrade to 'RD' follows Ferrexpo's successful completion of its exchange offer and consent solicitation in respect of its 2016 bonds. Subsequently Fitch has assigned the company a Long-term IDR of 'CCC' and Short-term IDR of 'C'. The Outlook on the Long-term IDR is Stable.

Under Fitch's criteria, the exchange offer was defined as a distressed debt exchange and Ferrexpo's IDR was downgraded to 'RD'. Under the offer, the residual USD286m 2016 notes were exchanged for USD100m cash and USD186m new 10.375% 2019 guaranteed amortising bonds. Following receipt of final documentation Fitch has assigned the new bonds a final 'CCC' senior unsecured rating with a Recovery Rating of 'RR4'. The existing 2019 senior unsecured notes have been upgraded to 'CCC' from 'C'.

The bonds will rank pari passu with existing senior unsecured debt and will benefit from guarantees from several group companies (which together represented 96% of the group's assets and 89% of total group EBITDA in 1Q15). The notes will also include a limitation on liens, restrictions on dividends (the greater of a 10% dividend yield ratio or USD60m per annum) and limitations on additional indebtedness.

The 'CCC' IDR reflects Ferrexpo's lengthened debt maturity profile and improved liquidity over 2015-2016 as a consequence of the exchange offer. However, the company's ultimate liquidity position over this period remains uncertain and subject to a variety of factors including iron ore prices, pellet premiums and the rate of domestic inflation in Ukraine. We expect USD400m to be repaid in 2015 and USD195m in 2016, leaving the company's cash balance at nearly USD200m at end-2016 under Fitch's USD50/t iron ore price deck. Under certain scenarios, there is uncertainty about the company's capacity to meet its scheduled PXF payments post 2016 if new agreements regarding the PXF amortisation profile are not concluded.

KEY RATING DRIVERS
Ukrainian Risk Exposure
Ferrexpo has a large exposure to Ukraine, which is its operating base. Ukraine has recently experienced a significant hryvnia depreciation (by more than 50% in 2014 versus the US dollar, and more than 100% YTD in 2015), followed by high domestic inflation, a brief electricity supply disruption and a delay in VAT repayment by the state. Ferrexpo's operations and transport infrastructure have not yet been directly impacted by the conflict in the Donbas region, as all assets are located in the Poltava region, around 425km north-west of Donetsk.

Liquidity Limited by Debt Maturities
At end-1Q 2015 Ferrexpo reported pro-forma cash balances of USD535m compared with USD475m debt maturities through December 2016 (USD100m cash consideration for the bond exchange, USD180m bank amortisation payments in 2015 and USD195m in 2016). In addition, the business requires a further USD100m-USD150m of cash for working capital purposes. Although we expect Ferrexpo remain free cash flow positive at current market iron ore prices, and in addition to the exchange offer, we believe that some form of further bank debt (PXF) rescheduling would remove a lot of uncertainty around the company's ability to maintain adequate liquidity over the next one to two years.

Ferrexpo's sound operating performance and profitability support a rescheduling with the main risk factors for investors being the future evolution of iron ore prices and the company's Ukrainian risk exposure.

Low Iron Ore Price Environment
Year-to-date 62% iron ore prices have averaged USD61 per tonne, down approximately 50% yoy, reflecting oversupply in the market and a significant slow-down in demand from the Chinese steel industry. Fitch's modelling assumption is for iron ore prices to average USD50 per tonne over 2015 and 2016, below the 2014 average price of USD97 per tonne, which will negatively impact the company's earnings and credit metrics. As a pellets producer, Ferrexpo will continue to benefit from a quality premium over the benchmark 62% iron ore price, which has widened over the past six months. Ferrexpo recently completed its USD2bn modernisation and expansion programme and remains on track to produce 12 million tonnes of 65% Fe pellets per year by 2016.

Decreasing but Robust Profitability
Fitch expects the company's financial profile to remain solid in 2015, with a nearly 30% EBITDA margin. This is despite an expected significant reduction in revenues (down 40% yoy), offset by currency depreciation. However, the ongoing low iron ore prices and cost inflation will erode EBITDA margins, which we forecast to fluctuate between 20%-25% in the medium term. Funds from operations (FFO)-adjusted gross leverage increased to 3.6x in 2014 and will peak at 4.6x in 2016 (under Fitch's new iron ore price deck) but should stabilise at around 3.0x thereafter, due to the expected modest improvement in iron ore prices in the longer term.

Competitive Cost Producer
Ferrexpo's cost position has moved down to the top of the first quartile of the global cost curve. In 2014 and 1Q15, cash costs improved significantly compared with the previous two years, due to rising volumes from the ramp-up of the Yeristovo mine and currency depreciation (50% of operating costs are linked to the hryvnia). Costs had decreased 35% yoy as of 1Q15 and reached USD33 per tonne, down from USD51 in 1Q14. Energy costs represent approximately 50% of total costs and should contribute to further cost savings, due to recent falls in global oil prices.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Ferrexpo include:
- Fitch iron ore price deck: USD50/t in 2015 and 2016, USD60/t in 2017, USD70/t in the long term
- Forecast price premium for pellets based on 1Q 15 realised premium
- Production volumes in line with management's expectations: 12mt p.a. iron ore pellets by 2016
- USD/UAD 24 in 2015

RATING SENSITIVITIES
Changes to Ukraine's Country Ceiling, which may accompany action on its sovereign rating, are a precondition for any positive rating action on Ferrexpo.

Negative: Future developments that could lead to negative rating action include:
- Lowering of Ukraine's Country Ceiling.
- Weakening of Ferrexpo's liquidity position due to lower ongoing cash flows caused by lower than expected iron ore prices.

Positive: Future developments that could lead to positive rating action include:
- Increase in Ukraine's Country Ceiling.
- Improvement in the company's future liquidity profile including an amendment of the future PXF amortisation profile.