Fitch Ratings has upgraded
The Outlook is Stable. Fitch has also upgraded the guaranteed notes issued by Petropavlovsk 2016 Limited, the group's main financing vehicle subsidiary, to 'B' from 'B-'. The notes' Recovery Rating is 'RR4'.
The upgrade reflects significant strengthening in Petropavlovsk's financial profile following improved operational results, strong gold pricing and a partial convertible bond conversion resulting in deleveraging. The agency now expects funds from operations (FFO) gross leverage to decline to 2.5x in 2020 (2019: 4.3x) and to average 3.0x in 2020-2023.
The frequent and currently ongoing changes in the structure of shareholders, Board of Directors and management limit our visibility of the company's future strategy and financial policies and constrain the rating as captured by the Stable Outlook.
The forecast strengthening in the financial profile would need to coincide with the improvement of corporate governance practices and their track record and refinancing plans for the
KEY RATING DRIVERS
POX Hub Fully Operational: Petropavlovsk's POX hub at the Pokrovskiy mine in
In 2020, Petropavlovsk targets processing 300kt-330kt (thousand tonnes) of ore (2019: 188kt) at its POX hub, using around 180kt of refractory ores from Malomir and Pioneer and 120kt-150kt for higher-grade ores from third parties. Its post-2020 plan is to further boost ore processing volumes to the 370kt-430kt range while increasingly replacing third-party ore with Malomir and Pioneer refractory ores. The latter is linked to the 3.6mt (million tonnes) flotation plant project at Pioneer and a 3.6mt capacity addition at Malomir on top of the current capacity of 1.8mt. These projects are scheduled to commence in 4Q20 and late 2021/early 2022, respectively, depending on financing availability and the timing of Board approval.
POX Hub Unlocked Refractory Reserves: The launch of the POX hub is a transformative event for Petropavlovsk as it allows the facility to treat refractory ores, representing 99% of reserves at Malomir and 76% at Pioneer, or 71% of YE19 reserves across all three producing mines. The POX hub will allow Petropavlovsk to maintain production using refractory ores, as YE19 mine life for nonrefractory ores is less than two years for Malomir and five years for Pioneer. Refractory ores boost the overall group's mine life to 18 years based on 2019 production levels (excluding third-party concentrate) processed at the POX hub.
Costs Position Stabilising: Petropavlovsk guides total cash costs (TCC; excluding third-party concentrate) within the
The POX hub's use of third-party concentrate is EBITDA-accretive but will dilute margins and boost the group's TCC, especially in 2020-2021, when third-party concentrate will account for 30%-33% of the group's gold sales before reducing to around 25% in 2022 and decreasing further thereafter.
Convertible Conversion: Through multiple conversion events,
Prepayment Facilities Treated as Debt: As of
Fitch reclassifies gold prepayments received as financial debt and includes them in its leverage ratios. The agency expects Petropavlovsk to redeem these prepayment facilities by delivering gold over the next 24 months.
Sale of IRC Ongoing: On
Strong Deleveraging: Improved operational profile and solid market fundamentals support our forecast for material deleveraging. However, the forecast credit metrics are subject to the new strategy and financial policy to be determined following the ongoing change in the board composition, shareholding and management structure.
As of YE19, the group reported FFO gross leverage of 4.3x, down from 7.9x as of YE18, including the off-balance sheet guarantee. Fitch expects Petropavlovsk's FFO gross leverage to improve to about 2.5x by YE20, which is much stronger than the 4.0x figure it previously forecast.
The deleveraging is driven by a projected increase in FFO due to higher production volumes, as demonstrated by strong 1H20 production of 321 koz (2019: 225 koz), which in turn is driven by solid mining operations and significant sourcing of third-party ores that accounted for 107 koz of gold production in 1H20. Higher production volumes and corresponding lower TCCs in 2020-2023 are expected to result in stable leverage despite a declining price deck. We forecast FFO gross leverage to fluctuate around 3x over 2021-2023.
Corporate Governance in Focus: In
Disagreements among major shareholders have previously led to changes in management and board members, sometimes with a negative impact on the company's operating performance. The current iteration of boardroom and management changes is less likely to have an impact on operations but remains a contingent risk.
As a result, we maintained the ESG scores of 4 for Management Strategy and Governance Structure sub-factors. While we believe the company's operational profile may be more resilient to the ongoing corporate governance pressures, lack of sustainable improvement in governance practices, including the establishment of stable board and management structure and consistent financial policy, is a rating constraint. This is reflected in the Stable Outlook despite forecast deleveraging.
DERIVATION SUMMARY
Petropavlovsk is smaller in scale and asset diversification than higher rated
KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
A gold price of
Total gold production of 640 koz on average in 2020-2023, including third-party ores.
TCC of
Capex of
Dividend payments of
Key Recovery Analysis Assumptions:
The recovery analysis assumes that Petropavlovsk would be considered a going-concern in bankruptcy and that the company would be reorganized rather than liquidated.
Petropavlovsk's recovery analysis assumes a post-reorganisation EBITDA at
A distressed EV/EBITDA multiple of 4.0x has been used to calculate post-reorganisation valuation and reflects the company's corporate governance pressures compared to peers and higher third quartile cost position on the global gold cost curve.
After deduction of 10% for administrative claims and taking into account Fitch's Country-Specific Treatment of Recovery Ratings Rating Criteria, our waterfall analysis generated a ranked recovery in the RR4 band, indicating a 'B' rating for the
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Improvement in corporate governance including stability in board and management composition; and established management strategy and financial policies translating into FFO gross leverage remaining below 3.0x (2019: 4.3x) on a sustained basis.
Petropavlovsk being released from its obligation to guarantee IRC's debt from Gazprombank.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
FFO gross leverage above 4.0x on a sustained basis.
Aggressive dividend policies or further deterioration of corporate governance resulting in operational disruptions and/or weakening of credit metrics.
Deterioration in liquidity profile.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
LIQUIDITY AND DEBT STRUCTURE
Strong Free Cash Flow (FCF) Generation: Fitch expects Petropavlovsk's liquidity position to be bolstered by positive FCF generation of around
Refinancing risk for the
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.
ESG CONSIDERATIONS
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of '3' - ESG issues are credit-neutral or have only a minimal credit impact on the entity, due to either their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
RATING ACTIONS
ENTITY/DEBT RATING RECOVERY PRIOR
Petropavlovsk 2016 Limited
senior unsecured
LTB Upgrade RR4 B-
Petropavlovsk plc LTIDR B Upgrade B-
senior unsecured
LTB Upgrade B-
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
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