Rating Action Commentary
ֳ Revises Uzbek Metallurgical Plant's Outlook to Negative; Affirms IDR at 'BB-'
Thu 29 Feb, 2024 - 8:14 AM ET
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JSC Uzbek Metallurgical Plant
ֳ - London - 29 Feb 2024: ֳ has revised JSC Uzbek Metallurgical Plant's (UMK) Outlook to Negative from Stable, while affirming its Long-Term Issuer Default Rating (IDR) at 'BB-'.
The Outlook revision is driven by UMK's higher-than-expected leverage in 2023-2024 as the company's expansionary capex coincides with weaker market conditions and increased production costs. While we expect UMK's leverage to moderate from 2025-2026, its liquidity is tight and its flagship Casting and Rolling Complex project remains subject to execution risks. These factors exert pressure on UMK's 'b+' Standalone Credit Profile (SCP), which also reflects UMK's small, though increasing, scale and corporate governance limitations, as well as a solid position in the domestic market in Uzbekistan and moderate costs.
Based on ֳ's recently updated Government Related Entities (GRE) Rating Criteria, we rate UMK on a bottom-up basis, and give it a single-notch uplift to the SCP for the state support. UMK's support score is 25, which underlines 'Strong' expectations for support from the state, based on criteria definitions.
Key Rating Drivers
Responsibility to Support: We view UMK's decision-making and oversight by the government as 'Strong', given the state's 93% stake in the company and its control over the company's operating activity and investment programme. We assess precedents of support as 'Very Strong' as almost half of external funding for the Casting and Rolling project was provided by the state. This is despite the government not guaranteeing any of UMK's debt.
Incentive to Support: We assess UMK's preservation of government policy role as 'Strong' given the company accounts for 80% of all steel products produced in Uzbekistan and more than a third of steel products consumed within the country (this should increase to more than half after the Casting and Rolling project is commissioned). A UMK default would hit development of the national steel industry and may hinder the development of the construction and metals and mining sectors. However, we do not give UMK any scores for contagion risk, given its external debt is fairly small.
Leverage Peaking in 2023-2024: We expect UMK's gross leverage to peak in 2023-2024 at around 5x before it moderates to 3x in 2025 and below 3x in 2026-2027. Expected lower leverage is driven by higher projected EBITDA from 2025-2026 following the Casting and Rolling project commissioning and normalising capex, leading to positive projected free cash flow (FCF). The Negative Outlook reflects the risk that deleveraging could be slower than assumed in our rating case.
Waivers Received: UMK has already received waivers for possible leverage covenant breaches with some of its lenders based on its 2023 results. Our projections show that the covenant might also be breached in 2024, which could require additional waivers.
New Project Increases Scale/Diversification: The Casting and Rolling project is a transformative hot-rolled sheet project for UMK and the country's steel industry. The project will increase UMK's steel-making capacity to 2.1 million tons per annum (mtpa) from 0.9 mtpa and double its total capacity for finishing lines to 2.2mtpa. This provides diversity to its current output of longs (mostly used in the domestic construction sector) and grinding balls (mostly used by the domestic metals and mining sector).
Execution Risks: UMK has limited experience in delivering new projects and is exposed to the risk of cost overruns and delays. UMK expects the Casting and Rolling project to be commissioned by end-2024, though it is still in the process of obtaining the remaining funding from a syndicate of international commercial banks.
State Funding Obtained: The Casting and Rolling project is estimated to cost around EUR730 million, of which EUR140 million is covered by an equity injection from state-controlled Uzbekistan Funds for Reconstruction and Development (UFRD, received in 2021), EUR110 million in a loan from UFRD (received in 2023), around EUR90 million from local banks (received in 2019-2020), EUR190 million in a project finance facility, and the remaining EUR200 million from UMK's own sources.
We understand from management that UMK is planning to sign an inter-creditor agreement with its lenders to arrange for contractual subordination of the EUR110 million UFRD loan due in 2031. However, we are likely to continue including the loan in the debt quantum as it bears cash interest.
Normalising Margins: UMK's unit margin (EBITDA/unit) fell sharply in 2023 to a ֳ-estimated USD80/tonne, after a strong USD175/tonne on average in 2021 and 2022. This was due to compressed margins worldwide, to extreme weather conditions in early 2023 leading to electricity blackouts and idle production, and to increased energy tariffs in Uzbekistan and currency depreciation.
We expect unit margins to normalise at around USD100/tonne for 2024-2027, which coupled with almost a doubling in production volumes, should lift EBITDA to around USD200 million by 2026, from around USD100 million in 2024. We expect UMK's margins will continue to be supported by low energy prices relative to international peers' and its exclusive right to purchase and set the price for scrap metal in the domestic market. These forecasts, however, is subject to the Casting and Rolling project coming on-stream by early 2025.
Global Steel Moderate Recovery: We expect steel markets in 2024 to be more robust than a year ago, aided by a recovery in demand ex-China, falling costs and a slight rise in prices in China, India and Europe. Producer margins in China will continue recovering from 3Q23 as supply falls and buoyant manufacturing and green energy infrastructure offset the sluggish property sector.
Derivation Summary
We rate UMK on a bottom-up basis, and give it a single-notch uplift to its SCP for state support. UMK's 'b+' SCP is in line with that of JSC Almalyk Mining and Metallurgical Complex (Almalyk) (BB-/Stable; SCP: b+), and one notch higher than that of JSC Uzbekneftegaz (UNG; BB-/Stable; SCP: b).
Almalyk's rating is equalised with that of Uzbekistan due to strong ties between the two. Almalyk's scale by EBITDA is larger than that of UMK and its leverage is lower even though Almalyk is also implementing a transformative growth project (Yoshlik).
UNG's rating is equalised with that of Uzbekistan due to strong ties between the two. UNG's strong links with the state are underpinned by a significant share of state-guaranteed debt, and also by UNG's presence in the Eurobond market. UNG's 'b' SCP is under pressure from tight liquidity and high leverage.
UMK's size is comparable to that of China-based Guangyang Antai Holdings Limited (B/Stable), whose rating considers its strong industry position among Chinese stainless-steel producers, diversified product offering in both stainless and carbon steel, and moderate financial metrics. However, the Chinese producer faces risks associated with its trading business, substantial external guarantees - some of which are to high-risk counterparties - and limited funding sources.
Key Assumptions
- Volumes in line with management's guidance to double by 2026 when the Casting and Rolling project is in full production
- Average EBITDA margin of around 15% in 2024-2027
- Capex peaking in 2023-2024 due to investments in the Casting and Rolling Complex, and normalising from 2025
- Outstanding funding from international commercial banks of EUR190 million to be received in 2024
- No dividends in 2024-2025
RATING SENSITIVITIES
UMK:
Factors That Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:
-- As the ratings are on Negative Outlook, we do not expect a positive rating action at least in the short term. Reducing execution risks of the Casting and Rolling project (eg. progress towards completion in line with schedule), improved liquidity, as well as EBITDA gross leverage stabilising at below 3x could lead to a revision of the Outlook to Stable
Factors That Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:
-- Material weakening of ties between the company and the state
-- EBITDA gross leverage consistently above 3x
-- Unremedied liquidity issues
-- Negative rating action on Uzbekistan
For Uzbekistan (See February 2024 Rating Action Commentary)
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
-External Finances: A marked worsening of external finances, for example, via a large and sustained drop in remittances or a widening in the trade deficit, leading to a significant decline in FX reserves.
-Public Finances: A marked rise in the government's debt-to-GDP ratio or an erosion of sovereign fiscal buffers, for example, due to an extended period of low growth, loose fiscal stance or crystallisation of contingent liabilities.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
-Macro: Consistent implementation of structural reforms that promote macroeconomic stability, sustain strong GDP growth prospects and support better fiscal outturns.
-Public Finances: Confidence in a durable fiscal consolidation that enhances medium-term public debt sustainability.
-Structural: A marked and sustained improvement in governance standards.
Liquidity and Debt Structure
Tight Liquidity: At end-2023 UMK's cash balance was minimal and it had no undrawn committed credit lines. UMK's liquidity is tight in view of its capex-related negative FCF in 2024 (around USD135 million, according to ֳ's estimates) and short-term debt (around USD70 million, some of which can be rolled over). We expect the liquidity gap to be funded by a EUR190 million project finance loan UMK is finalising with a consortium of international commercial banks. We assume that in case this funding is delayed UMK should be able to receive additional support from the government.
UMK's liquidity position should improve in 2025 after the Casting and Rolling project commences operations and ramps up production, and as its FCF turns positive.
Issuer Profile
UMK is a small state-owned producer of long steel products and grinding balls in Uzbekistan.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Public Ratings with Credit Linkage to other ratings
UMK's IDRs are linked to Uzbekistan's sovereign ratings.
ESG Considerations
JSC Uzbek Metallurgical Plant has an ESG Relevance Score of '4' for Financial Transparency due to below-average quality of financial disclosure (eg. lack of interim financials), which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. ֳ's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on ֳ's ESG Relevance Scores, visit /topics/esg/products#esg-relevance-scores.
Additional information is available on
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.
APPLICABLE CRITERIA
APPLICABLE MODELS
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
- Corporate Monitoring & Forecasting Model (COMFORT Model), v8.1.0 (1)
ADDITIONAL DISCLOSURES
ENDORSEMENT STATUS
| JSC Uzbek Metallurgical Plant | UK Issued, EU Endorsed |