OREANDA-NEWS. December 16, 2015. Fitch Ratings has downgraded Anglo American Plc's (AA) Issuer Default Rating (IDR) to 'BBB-' from 'BBB' and placed the ratings on Rating Watch Negative (RWN). A full list of rating actions is below.

The downgrade follows the group's announcement of a radical operational restructuring, a lower outlook for production, principally at its iron ore assets, and a weaker outlook for commodity prices. The combination of these factors weakens expected credit metrics in the near term, and introduces uncertainty regarding their return to a level commensurate with an investment grade rating. The RWN reflects our expectation that we will receive more clarity on the group's plans in its February 2016 results presentation.

The challenges AA is facing are worse than we had previously forecast. Continued deterioration in commodity markets has led to a greater number of its assets losing cash and leading to a more severe cash burn for 2015 and 2016. The production outlook is worse due to licensing constraints at Minas Rio and a decrease in production outlook for Kumba, platinum and copper (due to disposals and closures). These factors result in medium-term elevated leverage that is no longer in line with a 'BBB' rating, even taking into account the announced dividend cut and expected disposal proceeds.

The company's announcement that it plans to divest, close or mothball more than half its mines suggests that although AA will be leaner and with higher average asset quality, it may also have reduced diversification and scale. Such a radical reorganisation also brings execution risks, which could weigh on the rating.

AA has sound liquidity, which gives it time to turn itself around, and has demonstrated a commitment to managing debt protection measures through the recently announced dividend cut.

KEY RATING DRIVERS
New Strategy
Under a new transformation strategy revealed by management on 8 December 2015, it is expected that the size and the composition of AA's assets will change in time as the company will concentrate on Priority 1 assets that generate operating free cash flow, while cash negative assets will be closed, sold or placed on care and maintenance. AA expects to reach USD1.1bn of cost reduction in 2016 and USD1.0bn in 2017 as a result of asset optimisation and cost and productivity improvements. Fitch believes there are material implementation risks to AA's strategy as the current market environment remains challenging. There are also a number of operational issues (such as Minas Rio), which pose downside risks.

Diamond Market Weak
Weak demand for diamonds in China and declines in India and Japan have caused wholesale prices to fall by 15% YTD while the inventory of midstream producers has risen, causing liquidity problems and even bankruptcies among them. AA's quarterly diamond sales deteriorated materially to only 3mct in 3Q15 from 8.6mct in 1Q15. Weakness in demand in 2016 coupled with further price decline poses downside risk to the company's financial performance as the diamonds business accounts for over 20% of consolidated EBITDA.

Cash Flow Preservation
The company's management announced a dividend suspension for 2H15 and 2016. The company also intends to cut its capital spending programme to USD2.5bn, representing a reduction of around 55% vs 2014 levels. AA has also raised its disposal target to USD4bn, with USD2bn asset disposals already agreed to date. Fitch views positively the company's decision to adjust its dividend policy to preserve cash but considers further disposals will be challenged by the buyer's market.

High Leverage
Fitch expects AA's leverage to remain elevated for the next 12 months despite the cash preservation measures. In our forecasts, funds from operations (FFO) gross leverage will grow to around 5.5x by end-2015, after which we expect the company to delever and credit metrics to reach a level more commensurate for an investment grade rating in 2018. We expect free cash flow (FCF) to remain mostly negative throughout the forecasting period (2015-2017), only becoming positive in 2018.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Gradual production ramp up at Minas Rio to 26.5mtpy of iron ore by 2018.
- USD4bn cash inflow on disposals during 2015-2017.
- Price assumptions for selected commodities: iron ore (USD50/t in 2016, USD55/t in 2017-2018), platinum (USD1,000/oz flat in 2016-2018), palladium (USD800 flat in 2016-2018), copper (USD5,500/t in 2016, USD6,000/t in 2017-2018), nickel (USD13,500/t in 2016, USD15,000/t in 2017-2018).

RATING SENSITIVITIES
Positive: Further clarity on the group's restructuring strategy and some evidence of successful implementation along with expectations that the group will achieve, by 2018, FFO gross leverage around 3.0x, EBITDA margins above 25%, and positive FCF is likely to result in removal of the RWN and a Stable Outlook.

Negative: Future developments that could lead to negative rating action include:
A material worsening of business profile as a result of the reorganisation or FFO gross leverage being sustained above 3.5x by end-2018 while EBITDA margin remains below 20% with no evidence that FCF will reverse to positive.

LIQUIDITY
AA's liquidity remains strong, with around USD7bn of cash and USD8bn of undrawn committed facilities as of end-1H15 while short-term borrowings were USD0.8bn. Cumulative repayments for 2016-2018 are USD8.4bn.

FULL LIST OF RATING ACTIONS
Anglo American Plc:
Long-term IDR: downgraded to 'BBB-' from 'BBB'; placed on RWN
Short-term IDR: downgraded to 'F3' from 'F2'; placed on RWN

Anglo American Capital Plc:
Senior unsecured debt guaranteed by Anglo American Plc: downgraded to 'BBB-' from 'BBB'; placed on RWN

In accordance with Fitch's policies the issuer appealed and provided additional information to Fitch that resulted in a rating action which is different than the original rating committee outcome.