OREANDA-NEWS. Fitch Ratings has assigned JSC Ruspolymet a Long-term Issuer Default Rating (IDR) of 'B-'. Fitch has also assigned a 'BB+(rus)' National Long-term rating and an expected senior unsecured rating of 'B-(EXP)'/RR4 to the company's upcoming RUB3bn rouble bond issue. The Outlook for the Long-term ratings is Positive.

The ratings reflect Ruspolymet's small scale, low operational and end-market diversification versus other Fitch-rated steel companies. The ratings also reflect the company's position as Russia's leading producer of specialty steel ring blanks used in the aviation, machinery, nuclear and oil industries. The company controls 30%-70% of Russian alloyed steel rings market. Being a supplier to leading Russian manufacturers of engines for military and civil aircraft, Ruspolymet meets the high quality requirements for steel products used in aviation as evidenced by the quality certificates obtained by the company.

Profitability has recently improved as the company replaced purchases of steel from third party suppliers with its own production. Higher margins and moderate capital spending are expected to help funds from operations (FFO) adjusted gross leverage (leverage) reduce to 3.4x by end-2015 from 4.8x at end-2014. We expect the placement of RUB3bn bonds and utilisation of the new RUB3bn VTB loan to substitute the company's short-term bank loans, considerably improving the company's liquidity position. The Positive Outlook reflects our expectation that the company will successfully expand sales in markets other than aerospace and improve its liquidity position.

KEY RATING DRIVERS
Small but Established Niche Producer
Ruspolymet is a Russia-based integrated steel rings producer. It is small on a global scale with around 40 thousand tonnes (kt) of annual steel products capacity against the 1.6 billion tonnes of global steel output. However, it is an established player in Russian steel rings, which are a value-added sub-segment of the steel market representing less than 3% of global steel production.

The group's single site operations in European Russia produce specialty steel products and account for over 80% of the group's turnover and EBITDA. Other group activities include low-margin carbon steel scrap collection, manufacturing industrial knives and other industrial steel products.

Weak but Improving Liquidity
Fitch views the liquidity position of Ruspolymet as weak as its short-term debt has remained above RUB3bn (60%-70% of total debt) throughout most of 2H15. The expected refinancing of some short-term debt with new three-year credit facilities and the new RUB3bn eight-year VTB facility will improve liquidity in 2016.

A successful placement of the RUB3bn rouble bonds, allowing the company to refinance more expensive short-term debt, should result in a further improvement of liquidity. If the bonds are not placed, and given the company's low cash cushion, undrawn credit lines and neutral FCF, this would leave liquidity limited until 2017 when Ruspolymet would have utilised most of the VTB loan to replace more expensive short-term loans.

Segment Concentration
Ruspolymet's high dependence of the company on a particular industry segment is a constraint on the operational profile. Revenue from the aviation segment accounted for 63% of total sales in 2014 and grew to almost 70% in 1H15. This part of the business has remained relatively strong, and its share has grown marginally since 2011 as a result of increased military spending by the Russian State in recent years.

The deteriorating Russian economy has had limited immediate impact on Ruspolymet's aviation segment as military spending has remained stable. However, sustained budgetary pressure could translate into military spending cuts and weaker performance in the aviation sector. We expect Ruspolymet to diversify its sales towards forgings and ingots, which will have broader applications by 2017, helped with a new Danieli forging mill to be commissioned in early 2016.

Strong Market Position
The CIS aviation specialty steel market totals RUB40bn. The market is competitive but is controlled by nine main producers most of which have high concentration in a particular type of alloyed steel. Ruspolymet's market share is 70% in heat-proof nickel alloyed steel rings and 10% in titanium and aluminium alloyed steel rings. Ruspolymet is the only Russian company present in aviation steel products with all main alloy components: aluminium, nickel, titanium and chromium. It sells ring blanks and disks to all major engine producers in Russia and Ukraine. It also supplies ring blanks to global jet engine producers as Honeywell and Pratt & Whitney Canada, although those sales accounted for only 2.5% of 2014 total sales.

Capex to Peak in 2016
Since 2009 Ruspolymet has been executing an extensive modernisation programme to upgrade production facilities with new equipment supplied by leading international producers. In particular, the company launched a new 19kt capacity ring rolling mill in 2010, a Danieli 35kt capacity electric arc furnace in 2011, a Danieli 15kt capacity forging machine in 2012, and a number of refining melting furnaces in 2015. These new facilities allow the company to be self-sufficient in steel production and increase capacity in forged rolled steel, which will contribute to sales starting from 2016.

The company's capex will peak in 2016 at RUB1.5bn, driven by the ongoing modernisation programme as well as recently approved new RUB3bn debt funding for the project to produce rolls for steel rolling mills that are widely used by Russian steel majors and mini-mills. The company has secured RUB3bn funding from VTB bank fully guaranteed by the Russian State, and plans to utilise it during 2016-2018.

Profitability Improvement
Ruspolymet's average EBITDA margin during 2011-2014 amounted to 11%, which is adequate for a small-scale steel producer with no vertical integration. 1H15 IFRS and 9M15 Russian accounting standards results showed a material improvement in the EBITDA margin to 24%, as a result of production ramp-up of own steel-making in replacement of purchases from third-party steel producers.

We expect Ruspolymet to be able to sustain EBITDAR margins at a higher 18%-20% level over the next three years given its ability to pass on its nickel-related and FX-related costs for its specialty steel product cost to its customers. This is based on the assumption that volume risk will be limited over the next three years.

Leverage to Moderate after 2016
Fitch expects the company's leverage to decline to 3.4x in 2015-2016 from 4.8x in 2014. We expect further deleveraging towards 3x in 2017, due to growing scale, improving margins and moderating capex to below RUB1bn. We assume no dividends during the 2016-2018 forecast period, which coupled with post-2016 capex reduction, will translate into positive free cash flow (FCF) and reduced total debt.

KEY ASSUMPTIONS
Our key assumptions for the issuer rating case are as follows:
- 9% sales drop in 2015 due to aviation rings sales reduction, followed by 11% sales recovery in 2016 as rolled steel sales double;
- EBITDA margin rebased at 18%-20% level starting from 2015 due to new equipment being commissioned in 2015 and 1Q16;
- Capex to moderate to RUB0.5bn in 2017 as the high investment cycle completes, no dividends over the next two to three years;
- Leverage to reduce to 3.1x in 2016 (2015E: 3.5x) on sales and EBITDAR growth, and to below 3x in 2017 on positive FCF.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Revenue diversification and increasing revenue share of new markets in line with management's expectations;
- Deleveraging with leverage moving to below 3x;
- Improving liquidity position with liquidity ratio sustained above 1.0x (2014: below 0.1x)

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Further liquidity pressure with liquidity ratio sustained below 1.0x or leverage materially exceeding 4x;
- EBIT margin falling below 3%.