OREANDA-NEWS. Fitch Ratings has assigned OJSC Polyus Gold (OJSCPG) a Long-term Issuer Default Rating (IDR) of 'BBB-'. Fitch has also affirmed UK-based Polyus Gold International Limited's (PGIL) Long-term IDR at 'BBB-'. The Outlooks on both entities are Negative as they are constrained by Russia's sovereign Outlook. A full list of rating actions is at the end of this commentary.

OJSCPG is a 95% subsidiary of Jersey-based PGIL, and is a Russia-based holding company which directly or indirectly controls all of the group's gold mining companies in Russia. Fitch has applied its Parent and Subsidiary Linkage methodology to assign an IDR to OJSCPG. Under this methodology, we have aligned OJSCPG's Long-term IDR with that of PGIL as they essentially have similar credit profiles.

KEY RATING DRIVERS
Possibility of Share Capital Consolidation
Wandle Holdings Limited controls 40.2% of PGIL's share capital. On 2 September 2015, Wandle announced a possible offer to acquire all of the issued and to be issued share capital of PGIL it does not already hold for USD2.97/share in cash. The possible consolidation of PGIL's share capital by the only shareholder with the view to make the company private could lead to a deterioration in corporate governance, which would lead Fitch to consider negative rating action. At present, PGIL has not received an official offer from Wandle. Fitch will closely monitor the development of the offer process.

Competitive Cost Position
Polyus Gold reported total cash costs (TCC) of USD585/oz in 2014, 17% down yoy mostly due to the significant devaluation of the rouble against the US dollar and implementation of a full-scale cost optimisation programme. In 1H15, TCC further declined to USD436/oz or 34% yoy decline. Fitch's base case does not incorporate further material decline in TCC in 2H15 unless there is additional rouble devaluation driven by weak oil prices. All of Polyus Gold's operations are open pit, which is a significant operational advantage compared with underground mining. Combined with the fairly high quality of gold reserves, this makes Polyus Gold one of the world's most efficient gold producers and firmly places it in the first quartile of the global TCC curve.

Downward Revision of Reserves
In February 2015, the company announced a material (49%) reduction versus previous estimates of proved & probable reserves at the Natalka deposit. The reduction was driven by the revised geological results of the ore body layout and new parameters applied to make the development of the deposit economically viable. The Natalka reserves decline along with a minor mining-related reserve depletion in 2014 resulted in a 20% reduction of Polyus Gold's total reserves to 67.7moz. This reserve estimate still makes Polyus Gold the third-largest among global gold producers. With annual production of 1.7moz in 2014, this implies a lifespan of its operations of around 40 years, well above the gold industry's average levels. The world-class quality of Polyus Gold's reserves is supported by a fairly high average gold grade of 2.21g/t compared with the industry average of 1.1g/t.

Natalka Postponed
Due to the significant revision of the resource block model and the on-going operational review, Polyus Gold has postponed the commissioning of the Natalka mine. The company is continuing the technical evaluation of the project with the view to optimise its configuration and minimise capital and operating costs.

Optimisation of Operating Projects
With Natalka under review, Polyus Gold intends to concentrate on streamlining and capacity improvement at key operational projects in order to attain annual production growth in the medium term. A capacity increase at the Krasnoyarsk business unit, which includes the Olimpiada, Blagodatnoye and Titimukhta mines, along with the utilisation of accumulated stockpiles should yield incremental production of 300koz-350koz by 2018. Increases in capacity throughput at Verninskoye and Kuranakh should bring an additional 100-160koz and 45-50koz, respectively. Fitch views this strategic approach as balanced and optimal in the current market environment.

Higher Dividends
Fitch expects a higher dividend stream, in line with the recently adopted dividend policy of paying 30% of adjusted net income vs 20% previously. The company's board of directors approved the payment of a special dividend of USD500m based on 2014 results. Under its base case, Fitch does not expect special dividend payments in its forecasts over 2015-2018.

Corporate Governance
At present, and pending any changes in shareholder structure, Fitch assesses PGIL's corporate governance as strong compared with other Russian corporates. We believe that relationship agreements, signed between the company and its shareholders, contribute to the independence of the company's board and reduce the potential for shareholder actions to negatively impact the company's financial profile and/or the position of creditors. This is reflected in the ratings being notched down by one notch from their standalone level, compared with the more usual two notches for Russian companies.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Average gold price of USD1,200/oz during the forecasting period.
- No production from Natalka project as the company continues the technical evaluation of the project with a view to optimise its configuration and minimise capital and operating costs.
- Profitability improvement in 2015-2016 driven by weakness of rouble and cost-cutting measures, as well as by higher production volumes.

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating action include:
- Considerable additional operational scale and diversification, while maintaining conservative credit metrics.
- Positive rating action on the Russian sovereign.
- Positive FCF on a sustained basis.
Funds from operations (FFO) adjusted gross leverage below 1.5x.

Negative: Future developments that could lead to negative rating action include:
- Negative rating action on the Russian sovereign.
- EBITDA margin below 30% on a sustained basis,
- Failure to deleverage in line with Fitch's expectations resulting in FFO leverage sustainably above 2.5x.

LIQUIDITY AND DEBT STRUCTURE
Polyus Gold's liquidity position is strong with USD1.5bn of cash and USD0.7bn of undrawn committed bank facilities as of 10 August 2015, compared with only USD48m of short-term borrowings.

Despite a challenging market environment, Polyus Gold's profitability remained robust in 2014, with a 45% EBITDA margin versus 39% in 2013. The company's margin further improved in 1H15 to 58% driven by rouble devaluation. Despite a significant decrease in capital spending in 2014 due to the Natalka construction revision, the payment of USD0.5bn in special dividends, resulted in negative free cash flow (FCF) of USD0.3bn and an increase in FFO adjusted gross leverage to 2.73x (1.85x in 2013). Fitch expects the company to be FCF positive during 2015-2018 in the absence of further special dividend payments.

FULL LIST OF RATING ACTIONS

Polyus Gold International
Foreign currency Long-term IDR: affirmed at 'BBB-'; Outlook Negative
Foreign currency Short-term IDR: affirmed at 'F3';
Foreign currency senior unsecured rating: affirmed at 'BBB-'

OJSC Polyus Gold
Foreign currency Long-term IDR: assigned at 'BBB-'; Outlook Negative
Local currency senior unsecured rating: affirmed at 'BBB-'