OREANDA-NEWS. Fitch Ratings has downgraded Canada-based First Quantum Minerals Ltd's (FQM) Issuer Default Rating (IDR) and senior unsecured rating to 'B' from 'BB-'. The Recovery Rating for its senior unsecured issues is 'RR4'. Simultaneously all ratings have been placed on Rating Watch Negative (RWN) pending further news regarding the company's USD1bn asset sales programme and the outcome of current covenant negotiations with its banking group.

The downgrade reflects the material deterioration in FQM's credit metrics caused by a weaker and more volatile commodity price environment at a time when the company faces large cash outflows - and consequently negative free cash flow (FCF) - in respect of its Cobre Panama project. Fitch believes that the company's current overall credit profile better corresponds to a 'B' category rating.

KEY RATING DRIVERS
Weakened Credit Metrics
Fitch now expects FQM's gross leverage (total debt/funds from operations (FFO)) to peak at around 10.0x in 2016 before declining to around 7.0x by 2017 due to higher EBITDA derived from recently completed new projects (the Kansanshi smelter and Sentinel mine). The sharp increase in leverage compared with our previous expectations of around 6.0x for 2016 reflects a combination of factors, including an assumed rebasing of copper prices to around USD4,800 in 2016, and delays in the ramp-up of the Sentinel mine and Kansanshi smelter in Zambia.

Debt Reduction Needed
As of end-September 2015, the company's total drawn debt amounted to USD5.7bn, mainly composed of a USD3bn term loan and revolving credit facility (RCF; of which USD1.4bn was drawn) and USD3.4bn of senior unsecured notes. The covenant schedule applicable to the RCF facility requires a gradual step-down in the net debt/EBITDA ratio over the period to maturity in 2018. In May 2015 FQM obtained a covenant amendment to 7.5x until December 2015, then step down to 5.5x for 1H16 and 4.5x for 2H16 and 1H17.

Under the company's revised production numbers and assuming a USD4,800/t copper price, we expect FQM to comply with its covenant in 1H16, but to breach it in 2H16 if it fails to reduce debt and/or negotiate a further amendment to covenant levels in the next few months. FQM announced a debt reduction programme of USD1bn by 1Q16 through a combination of assets sales and other strategic initiatives.

Liquidity Dependent on Refinancing
In the medium-term, we project that FQM will face aggregate negative FCF of around USD4bn and debt service costs of USD1.1bn over 2016-2018. Potential sources of funds include (i) cash (USD276m as of September 2015), (ii) USD1.7bn of committed undrawn facilities (mature in 2019), (iii) USD662m drawdown under a USD1bn precious metals streaming agreement with Franco-Nevada Corp, (iv) approximately USD600m from Korea Panama Mining Corp for its share of development costs for Cobre Panama and (v) planned asset disposals of around USD1bn.

The availability of existing undrawn facilities remains subject to compliance or successful renegotiation of covenants. We additionally estimate that the completion of the company's current project pipeline will require it to procure USD2bn of additional funds by 2018.

Large Zambian Operational Exposure
Assets in Zambia contributed over 45% of group revenues and EBITDA in 2015 and the share is expected to increase in the short-term as the Kansanshi smelter and Sentinel mine reach full output. In our opinion, the business environment for miners operating in Zambia has become increasingly uncertain, particularly with respect to dealings with the government and the enactment of new legislation for the mining sector. The failed plan in 2015 to introduce a materially higher rate of mining royalties highlights this risk.

In 2015, Fitch revised the Outlook on Zambia's Long-term foreign IDR of 'B' to Stable from Positive. This reflected weak policy coherence and credibility from the government as well as expectations of moderating growth (expected to have slowed to 4.9% in 2015 from 6% in 2014) due to weaker copper prices and power supply deficit.

Large Project Pipeline
FQM has been involved in a large project pipeline including the construction of a new Kansanshi copper smelter and the Sentinel mine in Zambia, as well as the Cobre Panama copper mine in Panama. Management has taken steps to reduce 2016 capex to around USD1.2bn, largely through the deferral of USD600m of capex at Cobre Panama. However, we still expect capex to average USD1.7n in 2017 and 2018, resulting in negative FCF throughout the period. Absolute debt is likely to peak at over USD7.5bn in 2017 (excluding USD1bn debt reduction in 2016), materially above our previous expectations.

The new copper smelter was originally planned to start ramp-up in 2H14 but was delayed to the summer 2015 by logistical issues. The delay resulted in the stockpiling of copper concentrate at the Kansanshi smelter because of a lack of alternate smelting capacity. The Sentinel mine was also impacted by the slower smelter ramp-up, as well as by delays in the construction of power supply. Construction at Cobre Panama is now around 70%-complete. We do not expect future progress to be impacted by the capex reductions in 2016 (which result from the purchase timing for large capital items), but we will continue to monitor this aspect of the project.

KEY ASSUMPTIONS
- Fitch's copper price assumptions: USD4,800/t in 2016, USD5,200/t in 2017, USD6,000/t in the long-term
- Volumes as per management guidance
- Capex of approximately USD1.4bn in 2015 and USD1.2bn in 2016, increasing to USD1.6bn in 2017 and USD1.9bn in 2018
- Additional cash inflows from variously ENRC promissory note, Franco-Nevada streaming facility and KPMC equity contribution received as currently planned

RATING SENSITIVITIES
Positive: Future developments that may individually or collectively lead to positive rating action (removal of RWN) include:
-Successful completion of planned asset sales
-Successful renegotiation of existing covenant levels

Negative: Future developments that may individually or collectively lead to negative rating action include:
-Failure to agree new covenant levels with its banking group and/or to agree new financing arrangements
-FFO gross leverage not trending towards 5.0x by 2018
-Significant problems or delays at key development projects delaying the expected improvement in EBITDA generation and improvement in credit metrics
-Measures taken by the Zambian government materially adversely affecting cash flow generation or the operating environment.