Fitch Ratings has upgraded Petropavlovsk plc's Long-Term Issuer Default Rating (IDR) and senior unsecured rating to 'B' from 'B-'.

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 USD500 million bonds due in November 2022 to underpin a further positive rating momentum.

KEY RATING DRIVERS

POX Hub Fully Operational: Petropavlovsk's POX hub at the Pokrovskiy mine in Russia's Far East region successfully ramped up its output in 2019 following its commissioning in November 2018, and contributed 179.5koz (thousand ounces), or 35% of the company's total 2019 output. The POX hub consists of four autoclaves, all fully operational and run independently, each with up to 125,000 tonnes of refractory ore annual processing capacity. The overall capacity sits in the range of 400-500koz and depends on the sulphur content of the refractory ores.

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 USD700-USD800/oz range in 2020, on par with the USD749/oz level in 2019, with all-in sustaining costs (2019: USD1,020/oz) broadly following TCC dynamics. Fitch expects post-2020 TCC to remain broadly within the USD700-USD800/oz range, as Pioneer's rising output and improving grades offset the falling grades of Malomir's depleting refractory ores.

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, USD80 million of USD125 million convertible notes due in 2024 have converted to ordinary shares. Several parties chose to increase their voting rights through the conversion before a requisitioned general meeting on 10 August 2020. Fitch views the conversion as credit positive due to its positive impact on leverage and reduction of interest payments.

Prepayment Facilities Treated as Debt: As of 31 December 2019, Petropavlovsk had gold prepayment facilities of USD187 million outstanding with Gazprombank and Sberbank, two major Russian banks. Petropavlovsk has relied on these gold prepayments to procure liquidity for i) bridge loans to IRC that were required to avoid using the guarantee; and ii) capex for the POX hub facility. This type of working capital funding is generally permitted under the Eurobond indenture.

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 March 18, 2020, Petropavlovsk reached an agreement with Stocken Board AG to sell a 29.9% stake in IRC (not rated) for a cash consideration of USD10 million. The sale is conditional upon Gazprombank agreeing to release Petropavlovsk from its obligation to guarantee IRC's debt. Fitch views the successful release of the guarantee as a credit positive but does not include it in its base case. The agency views the likelihood of these guarantees becoming payable by Petropavlovsk as low. Fitch includes USD160 million of guarantees in gross debt for 2019 and on a more conservative basis than guarantees schedule for the forecast period.

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 February 2020, Petropavlovsk's major shareholder changed once again, as Uzhuralzoloto (not rated), which is controlled by Konstantin Strukov, bought the stake held by Roman Trotsenko. The annual general meeting and subsequent requisitioned general meeting subsequently led to the removal of several board members and an investigation into the related party transaction.

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 Nord Gold SE (BB/Stable). Its scale is relatively large for the 'B' category, but it lacks diversification across mines. Its cost position is in the third quartile of the global gold cost curve and comparable to that of Nord Gold. Petropavlovsk is substantially larger than GeoProMining Investment Limited (B+/Stable) but has no diversification across metals, a higher cost position and higher leverage. Petropavlovsk is significantly smaller than First Quantum Minerals Ltd (B-/Stable), but has stronger leverage profile despite weaker margins.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer

A gold price of USD1,600/oz in 2020, including hedges and YTD performance. Prices of USD1,318/oz in 2021 and USD1,200/oz in 2022-2023, based on Fitch's gold price deck and adjusted by outstanding hedges.

Total gold production of 640 koz on average in 2020-2023, including third-party ores.

TCC of USD770/oz on average during 2020-2023, excluding third-party ores.

Capex of USD77 million in 2020, USD84 million in 2021, USD56 million in 2022 and USD42 million in 2023.

Dividend payments of USD30 million in 2021-2022 and USD20 million in 2023.

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 USD175 million, or 25% below its 2019 EBITDA to reflect mid-cycle price assumption.

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 USD500 million notes. The waterfall analysis output percentage on current metrics and assumptions was 50%.

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 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

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 USD247 million in 2020-2021 following an increase in production and very strong pricing. Petropavlovsk faces maturities in the next 12-18 months consisting of obligations under its prepayment facilities that totalled USD121 million at the end of June 2020.The company has a facility with Gazprombank totalling approximately USD330 million (based on 392koz limit at USD1,200/oz gold price and at 70% advance rate), available until May 2024. Fitch classifies prepayment facilities as debt.

Refinancing risk for the USD500 million notes due in November 2022 has decreased due to stronger cash generation and improved credit metrics. If Petropavlovsk deleverages more slowly than expected or its corporate governance constitutes a credit concern, the bulky nature of the Eurobond maturity would significantly expose the company to market conditions. The USD45 million convertibles notes due in 2024 do not attract equity credit but are likely to convert before maturity, as they are currently deep in the money.

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

Petropavlovsk plc has an Environmental, Social and Governance (ESG) Relevance Scores of '4' for management strategy and governance structure due to Fitch's view that its operational and financial decisions might be influenced by frequent changes in senior management, its majority ownership and board composition, which has a negative impact on the credit profile and is relevant to the ratings in conjunction with other factors.

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

LT	B 	Upgrade	RR4	B-
Petropavlovsk plc	LT IDR	B 	Upgrade		B-

senior unsecured

LT	B 	Upgrade		B-

VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

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