OREANDA-NEWS. Fitch Ratings has downgraded Compania Minera Milpo S.A.A.'s (Milpo) long-term foreign and local currency Issuer Default Ratings (IDRs) to 'BBB-' from 'BBB' and its USD350 million senior unsecured notes to 'BBB-' from 'BBB'. The Rating Outlook has been revised to Negative from Stable.

KEY RATING DRIVERS

Ratings Linked to Votorantim:

The downgrade and Negative Outlook of Milpo's ratings follows the downgrade and Negative Outlook of its ultimate parent, Votorantim S.A. (VSA; IDR 'BBB-'/Negative Outlook). Votorantim increased its ownership in Milpo to 60.06% during July 2015 with Votorantim Metais S.A. (VM), VSA's metals and mining subsidiary, consolidating 100% of Milpo because of the majority ownership. Milpo is also listed as a 'Material Subsidiary' for the cross-default and acceleration provisions on a significant portion of VSA's local debt.

Fitch considers Milpo as a subsidiary of VM that is in turn controlled by VSA, to which its ratings are tied. Milpo's strategic, financial and operational decisions are ultimately approved and dictated by VSA. Operationally, Milpo supplies approximately 45% of total zinc concentrate volumes to VM's Cajamarquilla zinc refinery and contributes close to 25% of VM's EBITDA.

Low-Cost Polymetals Miner:

Cash flow generation at Milpo has historically been robust due to its low second quartile position on the global zinc cost curve with a consolidated weighted average cost of production for zinc of USD1135 per tonne. Zinc accounted for 45% of 2015 revenues, followed by copper 32%, silver 16%, lead 9% and gold 2%.

Revenues are mainly generated by the company's three mines located in Peru, with the largest mine, Cerro Lindo, accounting for 68% of revenues during 2015, followed by El Porvenir 19% and Atacocha 12%. Milpo's largest customer is VM, accounting for around 35% of annual revenues, followed by Glencore (31%), Trafigura (20%), Optamine (8%) and others (6%). The company enters into five-year supply contracts which historically have been renewed.

Operational Improvements:

Milpo's consolidated cash cost of production decreased considerably to USD33.30 per tonne of treated ore in 2015 from USD35.50 per tonne in 2014 as a result of the company's cost reduction initiatives. The lower cash cost helped to mitigate the effect of the challenging low pricing environment during the year. Milpo's revenues and EBITDA during 2015 declined to USD626 million and USD179 million, respectively, from USD758 million and USD266 million during 2014.

The operational integration between El Porvenir and Atacocha, together the Pasco mining complex, is in progress and will allow for lower production costs due to synergies in the production process. Higher cash costs of production were partially off-set by lower administrative expenses. As of 2015, the company's EBITDA margin decreased to 30% due to lower metal prices despite the cost reductions, compared to 35% in 2014 and 36% in 2013. Fitch expects Milpo to improve its EBITDA margins closer to historical levels of around 40% when new, more profitable projects come into production in 2017-2018.

Growth Funded Mainly Through Cash Flow Generation:

Milpo generated free cash flow (FCF) of USD22 million in 2015 following capex of USD107 million and dividends paid of USD27 million. This compared to FCF of USD163 million in 2014. Due to lower commodity prices, the company's growth strategy is focused on the most profitable Brownfield projects for its current operations (Cerro Lindo's increased capacity and integration of the Pasco mining complex) and the smaller scale execution of Greenfield projects in order to allow for payback in the shorter term. Capex will continue to be partially funded by internal cash flows, with the shortfalls funded by the company's substantial cash on the balance sheet.

Fitch's Base Case for Milpo uses our conservative mid-cycle price assumptions and indicates that EBITDA will decline to around USD140 million in 2016 due to zinc prices at USD1,625 per tonne and copper prices at USD4,800 per tonne. FCF is expected to be around USD5 million in 2016, approximately negative USD100 million in 2017 and negative USD75 million 2018 as Greenfield capex ramps up and dividend payments begin to increase. FCF is expected to revert to historical positive levels in 2018.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

--Zinc price of USD1,625/tonne in 2016, USD1,800/tonne in 2017 and USD1,900/tonne in 2018.
--Copper price of USD4,800/tonne in 2016, USD5,200/tonne in 2017 and USD6,000/tonne in 2018.
--Lead price of USD1,750/tonne in 2016 and long term.
--Concentrate sales volumes of around 230,000 tonnes in 2016 and 240,000 tonnes in 2017.
--Reserve life to be replenished annually.
--Net debt-to-EBITDA ratio below 2x through 2019.

RATING SENSITIVITIES

Milpo's ratings are linked to the ratings of VSA because of its ownership, strong operational and legal ties, and shared management, based on Fitch's Parent and Subsidiary linkage criteria. Should the current level of operational and legal ties change as a result of VSA divesting its ownership stake in Milpo, then a rating action based on Milpo's standalone credit profile could follow.

LIQUIDITY

Conservative Leverage Profile and Strong Liquidity:

Milpo's liquidity position is strong. The company exhibits a conservative capital structure with funds from operations (FFO) adjusted leverage of 3.7x and net debt-to-EBITDA at negative 0.5x in 2015. These ratios compare to FFO adjusted leverage of 1.7x and net debt-to-EBITDA of negative 0.3x in 2014. Milpo's net debt-to-EBITDA was negative in 2015 mainly as a result of the company's high cash balance of USD440 million. Projected leverage remains low for the rating category in the Base Case with expected FFO adjusted leverage of around 3x and negative net debt-to-EBITDA of about negative 0.7x in 2016.

The company held USD440 million of cash and marketable securities versus short-term debt of USD7.6 million in 2015, with a strong coverage ratio of 58x. A portion of the proceeds from the USD350 million senior unsecured notes issuance refinanced USD179 million of Milpo's bank debt in March 2013, extending its debt maturity schedule to 10 years, with the rest of the notes balance held as cash. The company relies primarily on strong internal cash flow generation to meet its operational requirements, but also benefits from good relationships with local and international financial institutions. In addition, Milpo benefits from access to commercial advances from its key clients.

FULL LIST OF RATING ACTIONS

Compania Minera Milpo S.A.A. (Milpo):
--Long-term foreign currency Issuer Default Rating (IDR) downgraded to 'BBB-' from 'BBB';
--Long-term local currency IDR downgraded to 'BBB-' from 'BBB';
--USD350 million 4.625% senior unsecured notes rating downgraded to 'BBB-' from 'BBB'.