Fitch Downgrades Cobre del Mayo's Ratings to 'CCC'
KEY RATING DRIVERS
Elevated Unit Costs:
CdM encountered a number of operational issues since the second half of 2014 that have lowered copper production and increased unit costs from Fitch's previous expectations. Production issues include greater levels of altered ore, slowing down production of copper cathodes resulting in higher production costs on a per unit basis. During the first quarter of 2015 (1Q15), the company's C1 cost of production increased to $2.40/lb of copper compared to $2.08/lb in 1Q14. During this period, copper prices declined significantly to between $2.40/lb-$2.30/lb currently from around $3.10/lb on average in 2014, exacerbating operational challenges. Fitch's mid-cycle price assumption for copper during 2015 and 2016 is $2.72/lb on average, rising to $2.95/lb in 2017 and beyond.
High Leverage Expected in 2015:
Fitch's base case for CdM indicates EBITDA generation in the region of $26 million in 2015 representing a significant decline when compared to over $80 million in previous expectations adjusting for revised prices for copper of $2.72/lb for the year. The company's EBITDA was $64 million in 2014 and $92 million in 2013. The year-on-year decline in EBITDA was attributable to copper cathode production decreasing to 75.5 tonnes per day (tpd) in 2014 compared to 83.3 tpd in 2013 while average realized copper prices to fell $3.21/lb from $3.31/lb. Production issues that materialized during the second half of 2014 (2H14) are in the process of being resolved by the company with improvement expected in 2H15. Costs are expected to reduce in-line with a return to CdM's installed copper cathode production capacity of around 87 tpd from 70.2 tpd achieved during 1Q15. As a result of these issues, CdM's total debt to EBITDA ratio is expected at above 9x in 2015, declining to below 5.0x in 2016 and around 3.0x in 2017 as production levels recover.
Shareholder Support Necessary in 2015:
CdM's parent companies, Frontera Copper Corporation, S.A.P.I. de C.V. (FCC), Frontera Cobre del Mayo Mexico S.A. de C.V. (FCDM) and Lawrie Associates LLP, have demonstrated commitment to CdM's capital structure while it continues to invest in maximizing production through equity contributions totalling over $37 million over the three year period spanning 2012 to 2014. Fitch's base case indicates further shareholder contributions may be required in 2015 to aid CdM in making its November coupon payment on the 10.75% senior unsecured notes due 2018, as it resolves its operating and production issues. The shareholders' renegotiated the announced acquisition of the common shares of Kupari Holdings (KH) following the decline in copper prices resulting in CdM now holding 40% of the total share capital of KH, with CdM accounting for its participation using the equity method. Subsequently, KH, Kupari Metals S.A. and Bi Metals Mexico S. de R.L. de C.V. each executed supplemental indentures whereby they became additional guarantors of CdM's senior unsecured notes.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for the issuer include:
--Copper price of $2.72/lb in 2015 and 2016, increasing to $2.95/lb in 2017.
--C1 cash cost of $2.26/lb in 2015 and between $1.80/lb to $2.00/lb during 2016 to 2018. Prior expectations for cash costs were around $1.60/lb from 2015-2018.
--Copper sold of approximately 28,600 tonnes in 2015, 32,500 tonnes in 2016 and 31,500 tonnes in 2017.
RATING SENSITIVITIES
Refinancing Strategy:
Fitch's base case indicates that CdM will likely experience a challenging operating scenario during 2015 and 2016 due to its third-quartile cost of production combined with a period of low copper prices. Fitch's previous expectations for CdM indicated a gradual transition to a second quartile producer of copper. Ongoing support from shareholders may be necessary to ensure future interest payments are made on time over the next 18 to 24 months, a scenario that may result in difficulty refinancing CdM's notes due 2018. Ratings could be downgraded further should operating unit costs remain elevated with liquidity insufficient and shareholder support not be forthcoming over this period.
A ratings upgrade is dependent upon the company significantly lowering its C1 production costs to below $2/lb on a sustained basis, demonstrating improved ongoing liquidity along with proactive initiatives to secure funds for refinancing CdM's 10.75% notes due 2018.
LIQUIDITY
Liquidity Concern:
CdM's cash and marketable securities were $18 million as of March 31, 3015 compared to interest expense of $25 million and expected capex of around $28 million due during the year. CdM may require additional liquidity support to bridge the gap between lower cash flow generation and its various financial obligations during the year. Fitch's base case indicates low cash flow from operations (CFFO) of around $16 million and FCF of negative $11 million in 2015. The company is on track to resolve its production issues and should receive additional cost relief from the continued depreciation in the Mexican Peso. Fitch expects CdM's EBITDA to recover to over $50 million, CFFO to over $30 million and FCF to $18 million in 2016 as production volumes increase to 89 tpd.
Higher Refinancing Risk:
CdM's 10.75% senior unsecured $217 million notes are due on Nov. 15, 2018 and comprise approximately 90% of total debt as of March 31, 2015 with the remaining debt mostly related to capital leases. The company repurchased $7.8 million of the notes during March 2015 decreasing the outstanding amount from the $225 million originally issued and proportionally lowering its interest payment going forward. Lower copper prices and anticipated higher interest rates may possibly complicate the refinancing process.
FULL LIST OF RATING ACTIONS
Fitch has downgraded the following ratings:
Cobre del Mayo S.A. de C.V.
--Long-term foreign currency IDR to 'CCC' from 'B';
--Long-term local currency IDR to 'CCC' from 'B';
--Senior unsecured 10.75% notes due 2018 to 'CCC/RR4' from 'B/RR4';
--National long-term rating to 'CCC(mex)' from 'BBB-(mex)'.
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