Fitch Ratings has affirmed the 'BBB' Foreign and Local Currency Issuer Default Ratings (IDRs) of Samarco Mineracao S.A. (Samarco), as well as its National Rating of 'AA+(bra)'. The Rating Outlook is Stable.
Strong Ownership Supports Ratings:
Samarco's investment grade ratings are supported by its joint ownership profile by two industry leaders, Vale S.A. (Vale; Long-term Fitch IDR of 'BBB+') and BHP Billiton Plc (BHP Billiton; Long-term IDR 'A+'), with each company owning 50% of Samarco. Vale is the largest global player in seaborne iron ore, and BHP Billiton is the largest mining company in the world. Fitch believes Samarco's two strong shareholders, with combined operating EBITDA in 2011 of over USD66 billion, would support Samarco in the event of a sovereign-related liquidity crisis due to reputational risk.
Highly Profitable Operations:
Samarco is a very profitable mining company. For the latest-twelve-months (LTM) June 2012, Samarco generated net revenue of BRL7 billion, up significantly from BRL6.2 billion at the end of 2010. LTM EBITDA increased to BRL4.1 billion from BRL3.7 billion at year-end 2010.
Samarco's LTM EBITDA margin was 59% for the period, consistent since 2011 and 2010. The strong profitability during this time period was due to surging demand for pellets as steel mills sought more energy-efficient raw material inputs to offset higher energy costs, which began during the second half of 2009 and continued through to the first quarter of 2012. Samarco's remaining sales for the rest of 2012 are committed under existing contracts, providing strong visibility on annual sales volumes.
Low Cost Producer of Iron Ore Pellets:
Samarco's credit profile also benefits from its position as a low-cost producer of iron ore pellets. The company continues to remain competitive during difficult trading conditions due to its low cost iron ore transportation through its slurry pipelines. Samarco's Board approved construction of a third pipeline and fourth pelletizing plant (P4P) in April 2011. Once this major investment project is completed and operational by the start of 2014, the company's low cost position is expected to improve further. This cost-effectiveness allows Samarco to remain profitable even during periods of low prices and low pellet demand.
The company had a cash cost of iron ore pellet production that was 20% higher than in 2010. This cost increase was fully predicted by the company in 2010 due to their anticipation of higher input and operating costs. This low cost of production of Samarco compares healthily to the average spot price of iron ore pellets of around USD193 for 2011.
Sufficient Liquidity Profile:
Compared to other investment grade Brazilian corporates, Samarco holds relatively modest cash and marketable securities on its balance sheet. This position is dictated by Samarco's dividend payout ratio target, under normal operating conditions, of 100% of FCF to Vale and BHP Billiton. The company's cash and marketable securities as of June 30, 2012 were BRL355 (USD178) million, with additional one year credit lines from a number of different banks available of USD2.7 billion (from USD5.8 billion in total), providing further liquidity headroom.
Short-term debt to total debt is high at close to 40%, but this is due to Samarco's historical use of ACC/ACE Facilities (foreign exchange contracts) to fund working capital, and is consistent with historical levels of short term debt seen since 2006. Liquidity is also sufficient when measured by cash + CFFO / short term debt which indicates a ratio of 2.4x coverage for the LTM to June 30, 2012.
Financial Covenants Linked to Pre-Export Facilities:
Samarco is required to maintain a cash balance of 120% principal and interest from 2006 - 2013 due to a covenant linked to the company's USD800 million Pre-Export Financing Term Facility which funded the construction of the third pelletizing plant and second slurry pipeline. This equates to approximately USD122 million per year.
The company has maintained a cash balance in excess of this requirement essentially to bolster Samarco's capital structure above the minimum covenant requirement. There are also financial covenants linked to approximately 62% of the company's export receivables facilities. These covenant tests require Samarco's total or net-debt to EBITDA ratios not to exceed 3.0x, depending on the facility. Samarco does not breach these covenants under Fitch's Base Case.
Track Record of Low Leverage:
Samarco has exhibited low leverage ratios during the last five years. For the LTM to June 30, 2012, the company had a total debt to EBITDA ratio of 1.0x and net debt to EBITDA ratio of 0.95x. In 2011 and 2010, Samarco had total debt and net debt to EBITDA ratios of 1.1x and 1.0x, and 0.9x and 0.8x, respectively. LTM FFO adjusted leverage is also low at 1.1x when compared to the peak of 3.5x in 2009, while FFO fixed charge coverage is also strong at 32.9x. As of 2011, the company's five year rolling average total debt and net debt to EBITDA ratios were 1.5x and 1.4x, respectively. This track record of low leverage provides the company with strong covenant headroom as its heavy investment period ramps-up over the next two years.
Capex to Increase Leverage:
Leverage is expected to continue to increase over the next two years mainly as a result of the company's P4P investment. Total capital expenditures from 2012 to 2016 are estimated at around USD4.5 billion in total, with the P4P project comprising about USD3 billion of this amount. Funding for these projects will derive from cash freed up by lower dividend payments to Vale and BHP Billiton during the investment period and a combination of other debt and/or equity financing options. These investments will see Samarco's production capacity increase from 23 million dry metric tons (DMT) per year currently to around 30 million DMT per year by 2014 - 2015.
Samarco's total debt as of June 30, 2012 was BRL4.3 billion, an increase from BRL3.4 billion at the end of 2010. Debt is expected to peak at over BRL8 billion by 2014 as the P2P project nears completion, declining thereafter. Samarco's debt profile during 2011 was comprised of 40% short-term debt, mostly consisting of Advances on Export Contracts (ACC) used to finance working capital, and 60% long-term debt, mostly Pre-Export Advances used for capex. The company's average debt term was 2.8 years at year end 2011. This is weaker than average for the rating category. Fitch expects Samarco's net debt to EBITDA ratio to increase to around 1.7x for 2012 and 2.2x in 2013.
Negative FCF Generation Expected to Continue:
Samarco's FCF after capex and dividends is expected to remain negative until 2015 as a result of increased capital expenditures for the P4P project. This is in addition to the continued dividend payments expected to be made to Samarco's parents. Fitch calculates Samarco's FCF generation as positive before dividends, and would expect BHP Billiton and Vale to scale down dividends if operating conditions required additional liquidity, as seen during 2009. In 2011, the company's FCF was negative BRL450 million after capex of BRL1.3 billion and dividends of BRL2.8 billion. This indicates an improvement on negative FCF of BRL872 million seen in 2010 after capex of BRL278 million (prior to P4P) and dividends of BRL3.3 billion.
FFO and CFFO generation has been historically strong for the company, due to its highly profitable business model. In 2011, FFO was BRL3.6 billion and CFFO benefited from a small working capital inflow to remain unchanged at BRL3.6 billion. This performance improved on FFO of BRL2.9 billion and CFFO of BRL2.7 billion in 2010, when there was a working capital outflow of BRL268 million due to the return to stronger production volumes following the downturn in 2009. Fitch expects FFO to remain in the region of BRL3 billion during 2012 and to exceed this amount from 2014.
Lower Iron Ore Pellet Prices expected During Second Half of 2012:
Samarco's sales contracts were based on the quarterly iron ore pricing system during 2011, and have since transitioned to a mix of quarterly and monthly contracts depending on the customer, based on the average spot price for the preceding period. Lower demand for iron ore products in recent months as a result of the on-going European sovereign debt crisis and a slowdown in growth in China has led to a significant decrease in prices.
This will impact Samarco's profitability during 2H12 with Fitch base case projections indicating an EBITDA margin around 48% for 2012. Iron ore pellet prices in China fell from highs of around USD200 per metric ton in September and October 2011 to around USD130 - USD140 currently. Pellet prices averaged around USD170 per metric ton for the first seven months of 2012.
What Could Trigger a Rating Action
Samarco is essentially a one-product company, a policy dictated by its parent companies. A prolonged period of low demand for iron ore pellets could lead to a negative rating or outlook action. Samarco exports virtually all of its production, and as a result, it generates most of its revenues in U.S. dollars. However, operating costs are primarily denominated in Brazilian reais and therefore poses foreign exchange risk that could also deteriorate the company's credit profile. Iron ore pellets are also susceptible to substitutes during troughs in the industry cycle.
Ratings could be downgraded if a combination of factors mentioned above resulted in Samarco's credit ratios to significantly weaken, in particular if its net debt to EBITDA ratios reaches above 2.5x on a sustained basis. Additionally, the company's ratings could be pressured if the ratings of BHP Billiton and Vale were to be downgraded.
Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'National Ratings - Methodology Update' (Jan. 19, 2011);
--'Evaluating Corporate Governance' (Dec. 13, 2011);
--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
National Ratings Criteria
Evaluating Corporate Governance
Parent and Subsidiary Rating Linkage