Fitch Assigns ChelPipe's IDR at 'BB-'; Outlook Stable
07 Dec 2016 8:36 AM
Fitch Ratings-Moscow-07 December 2016: Fitch Ratings has assigned Public Joint Stock Company Chelyabinsk Pipe-Rolling Plant (ChelPipe) a first-time Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'BB-' with Stable Outlook.
The IDR reflects ChelPipe's high 'BB' operational profile with a large share of value-added products (steel pipes), but is constrained by its significant exposure to Russian oil and gas sectors. The IDR and Stable Outlook reflect our view that ChelPipe's margins will remain robust, and deleveraging will continue over the next two to three years on positive free cash flow generation, resulting in funds from operations (FFO) gross adjusted leverage within 2.5x-3.5x from 2016.
KEY RATING DRIVERS
Established Regional Pipe Producer
ChelPipe is a top-three Russian steel pipe producer with two steel pipe plants in Urals, and 20%-25% market share in large-diameter pipes (LDP) and oil country tubular goods (OCTG), mainly used in the oil and gas industry. ChelPipe's market share in non-oil and gas pipe sectors eg machinery, energy and petrochemical seamless steel pipes is at least 50%.
The Russian pipe market is oligopolistic, with established local companies covering over 90% of steel pipe needs. ChelPipe's competitive advantage is relative proximity to Siberian and Far Eastern oil and gas fields, strong presence in non-oil and gas steel pipe markets, and integrated billet production. However, ChelPipe has yet to achieve a higher market share in margin-stable oilfield services and sales-boosting advanced pipes and pipe solutions.
LDP Segment Most Volatile
ChelPipe's sales exposure to the oil and gas market is 65%-70%. LDP accounts for 40%-50% of total sales volumes and is the company's most volatile segment due to erratic LDP consumption patterns in large Russian-focused oil and gas expansion projects. LDP demand is subject to further volatility if there are construction delays. Russian LDP companies face a temporary slowdown after the 2014-2015 construction peak and ahead of the ramp-up of projects such as Nord Stream-2 and Power of Siberia.
ChelPipe's non-LDP oil and gas-exposed sales are fairly stable. OCTG pipes are mostly used in Russian oil and gas companies' drilling operations that are focused on maintaining current oil output, which is relatively unaffected by weak oil prices as Russia remains a low-cost producer. We also expect other pipes markets to remain healthy, with particularly good demand in petrochemicals and machinery.
Volume Risk Dominates
ChelPipe's ability to pass through costs onto customers is either contractually cemented or effectively exercised through LDP supply tenders, as ChelPipe is unlikely to win or will withdraw if the pricing is not sufficiently marginal. However, this is offset by significant volume risk and associated margin dilution through a higher share of fixed costs at times when capacities are significantly underutilised. ChelPipe has been addressing this margin pressure with cost efficiency initiatives and increasing focus on advanced pipe solutions.
Longer-Term Pipe Demand Risks
Russian pipe companies may have to adapt to lower LDP demand once medium-term Russian oil and gas projects pass their 2017-2019 construction peak. The Russian oil and gas pipeline system is the second largest globally, but the consequent higher maintenance requirements following its ongoing expansion may not mitigate a longer-term demand slowdown after 2020 due to the rise in the liquefied natural gas trade and as energy consumption growth per capita decelerates.
Low Capex Underpins Deleveraging
ChelPipe's low capex is capped by provisions in its existing syndicated bank facility. We do not consider this negative as all Russian pipe producers have stopped significant expansion and refocused on product range development, oilfield services and/or cost optimisation. In addition, capex visibility remains strong, and aided by nil dividends underpins continued positive free cash flow generation and absolute debt reduction from 2014-2015 into 2016-2018.
Medium-Term Pressure on Coverage Metrics
The company's syndicated debt facility, RUB80bn of RUB88bn total debt outstanding at end-1H16, has an uneven interest payment schedule, with increased cash interest pressure in 2017-2019. ChelPipe's FFO fixed charge coverage metrics are therefore slightly above 2x over the next three years, lower than for most Russian peers. However, we believe that low capex and positive free cash flow, in addition to improving the credit profile, underpins ChelPipe's ability to control coverage metrics or even partly address them through raising cheaper financing.
Unsecured Creditors Potentially Subordinated
Syndicated creditors benefit from the pledge of most of ChelPipe's fixed assets and shares and are covered by guarantees from most operating companies and from ChelPipe's controlling shareholder, Mr Komarov. ChelPipe's future unsecured creditors are likely to be structurally subordinated to syndicated creditors until 4Q19 (unless any material portion of the fixed assets pledge is released) and this may translate into the respective senior unsecured rating being notched down from ChelPipe's IDR.
Corporate Governance Rating Discount
In line with its approach to other Russian corporates with concentrated ownership, Fitch applies the two-notch corporate governance discount to ChelPipe's IDR. ChelPipe's IDR excluding this discount is 'BB+'.
Fitch's key assumptions within our rating case for the issuer include:
- Pipe sales down by over 15% in 2016 before 4%-5% recovery in 2017-2019 driven by LDP
- Market overcapacity driving EBITDAR margin moderation to 17%-19% despite cost savings
- Modest capex and nil dividends leading to single-digit positive free cash flow and debt reduction
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
- Sufficient medium-term stream of large oil and gas projects protecting ChelPipe from deterioration in pipe demand visibility
- FFO gross adjusted leverage consistently below 2.5x (2015: 3.7x)
- FFO fixed charge coverage approaching 4x (2015: 2.1x)
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
- Protracted pipe demand pressure translating into EBITDAR margin of below 16%
- FFO gross adjusted leverage above 3.5x
- Tightening liquidity and/or FFO fixed charge coverage falling sustainably below 2x
ChelPipe's short-term debt fell in 1H16 to RUB12.4bn as RUB5.5bn of end-2015 short-term debt was reclassified back to long-term once a capex covenant waiver from UniCredit HVB was obtained. We expect ChelPipe's liquidity to improve but rely on positive free cash flow as the company's RUB8bn cash position only partly covers its RUB12bn of short-term debt at end-1H16. We expect ChelPipe's positive free cash flow generation and additional committed undrawn credit lines (eg Sberbank's EUR45m credit facility obtained in September 2016) to underpin its liquidity position in 2H16.
Dmitri Kazakov, CFA
+7 495 956 7075
Peter Archbold, CFA
+44 20 3530 1172
Fitch Ratings Limited
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London E14 5GN
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Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: firstname.lastname@example.org; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: email@example.com.
Date of Relevant Credit Committee: 30 November 2016
Summary of Financial Statement Adjustments
- Multiple of 6x (Russia) applied to RUB183m operating leases
- RUB3bn reclassified as Fitch-defined restricted cash from cash and cash equivalents
- RUB213m loss on PP&E disposal and RUB213m impairment of assets reclassified as non-operating items.
Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
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