ACRA assigns BBB+(RU) to Elgaugol Ltd, outlook Stable

The credit rating assigned to Elgaugol Ltd (hereinafter, the Company, Elgaugol) is based on its strong market position and the strong assessment of the Company’s business profile, which in turn is determined by the low cost of coal production and the availability of a resource base. The Company’s rating is supported by the high assessment of geographical diversification of sales and a high level of corporate governance. At the same time, the low financial risk profile assessment reflects high debt load and low liquidity.

Elgaugol is the holder of a license for the development of one of the world’s largest high quality coking coal deposits with reserves of more than two bln tons. The coal of this deposit has a very low concentration of sulfur, phosphorus and nitrogen, which makes it premium in the global market. Elgaugol is part of the Elga Coal Complex (ECC), which also includes Elga-road Co. Ltd (operator and owner of the 321 km long Elga-Ulak railway line) and Elga-Trans LLC (service company for servicing the Elga-Ulak railway line and ensuring cargo transportation). ECC is managed by “Management Company “Elga Coal” LLC, which, like the entire ECC, is currently wholly owned by A-Property LLC (the ultimate beneficial owner is A. A. Avdolyan). In 2021, it is planned to complete the transaction to dispose 5% to RT-Business Development LLC (ACRA rating — BBB+(RU), outlook Stable).

Key rating assessment factors

Strong market position. In 2020, Elgaugol produced seven mln tons of coal and shipped 5.6 mln tons to consumers. By 2023, the Company plans to increase the supply of premium coking coal concentrate to the global market up to nearly 30 mln tons in line with the approved strategy. Considering the proximity to the markets of the Asia-Pacific region, the Company has the opportunity to increase the volume of supplies to the global market.

The strong business profile reflects the Company’s strong position in several subfactors, such as production costs and a resource base. The geological feature of the Elginsky coalmine, which is being developed using an open-pit method, allows the Company to produce coal at one of the lowest cost rates not only in Russia, but also in the world (the 1st quartile of the global cost curve). The Company’s reserves amount to more than two bln tons of coal, of which nearly 1.9 bln tons is premium coking coal (the Zh brand). Given a target production level of around 45 mln tons per year, as set by the Company’s strategy, this guarantees up to 100 years of operations. However, the “Product diversification” subfactor was given low assessment, since the Company is engaged exclusively in coal mining and conversion.

The high geographical diversification assessment is due to the significant volume of exports (100% starting from 2021) in the sales structure, while the geography of exports is still limited to the market of China, which is the world’s largest consumer of coking coal. In the future, as production volumes grow, the Company plans to expand the geography of supplies to all countries of the Asia-Pacific region, especially to South Korea and Japan, as well as India, — the countries, which place high demands on the quality of coking coal. The ”Concentration on one field” subfactor was highly assessed, although production is carried out at a single section. The Company produces coal using an open-pit method, while the Elginsky coalmine is new. This gives it an advantage over many other deposits, especially those located in Russia’s largest coal basin, Kuzbass, which are characterized by a significant level of depletion (hence, subsoil users of these deposits have to develop them via underground mining). This in turn increases production costs and requires stricter safety requirements.

High level of corporate governance. Despite a short period of ownership of the ECC assets, the management of “Management Company “Elga Coal” LLC succeeded in creating conditions for an increase in production volumes at the deposit and, what’s also important, ensuring the possibility of exporting extracted coal in full. The Company has clear guidelines when it comes to the expansion of coal production and processing at five new processing plants, which will be commissioned by the end of 2023. In order to reduce the risks of changes in the profitability of supplies, the Company has reached an agreement with Chinese processing plants on the supply of rough coal with the subsequent sale of concentrate in the Chinese market. This will allow to maintain a high return on sales for a period that is necessary for the commissioning of the Company’s own processing plants. The management of the ECC assets has been delegated to “Management Company “Elga Coal” LLC, under which the Board of Directors and the Management Board have been formed. The Company’s Board of Directors (consists of five directors, including one independent member) determines the strategic objectives and tasks of ECC; it is currently in the process of setting up the key committees to address issues in the field of risk management, audit, investment and dividend policies, employee incentive schemes, employee compensation, etc. The “Group structure” subfactor was highly assessed due to the clear and simple structure of ECC. The “Financial transparency” subfactor was assessed at an average level for the corporate segment.

The financial risk profile constrains the rating. The scale of the Company’s business (FFO before net interest payments and taxes, weighted for the period of 2019 and 2024, is below RUB 30 bln, production volume, weighted for the same period, is around 12 mln tons per year, according to the conservative scenario) is assessed as average for the Russian corporate segment in the field of production. Profitability is at a very high level (FFO margin before interest payments and taxes, weighted for the period of 2019 and 2024, exceeds 33%). According to ACRA estimates, the average profitability will be around 36% in the forecast period (2021–2024). The Company’s debt load is assessed as high. At the end of 2020, the Company’s total debt amounted to RUB 127 bln, it was mainly short-term and driven by financing of the transaction for the purchase of the ECC assets by “A-Property” LLC. The Company plans to refinance its debt in 2021 to ensure it becomes long-term (in the form of a syndicated loan) with a comfortable repayment schedule. Based on the Company’s conservative scenario, ACRA expects that the ratio of total debt to FFO before net interest payments will amount to 5.8x by the end of 2021 compared to 18.0x at the end of 2020; by 2023, this ratio will decrease to 2.8x as operating cash flow increases due to the higher enrichment levels and, consequently, a growth in profitability. The qualitative assessment of debt load, which is at a low level, may improve after the Company’s loan portfolio refinancing. The debt service indicator (the ratio of FFO before net interest payments to interest payments) will total 2.2x at the end of 2021 vs. 5.5x in 2020, and will increase to 4.4x by the end of 2023.

According to ACRA estimates, the Company’s liquidity is at a low level, given peak repayments in the short term and an exceptional dependence on bank financing. The qualitative liquidity assessment may improve after the Company’s loan portfolio refinancing.

According to the conservative scenario, the Company’s FCF, weighted for the period of 2019 and 2024, is estimated at a high level of 8.1% (even taking into account moderate dividends), which implies sufficient cash flow to reduce the debt load. At the same time, the FCF ratio takes into account the peak in capital expenditures and investments in working capital in 2021–2023.

Key assumptions

  • Prices for coking coal concentrate at USD 149 per ton in the forecast period, for rough coking coal at USD 112 per ton;
  • Capital expenditures, as per the Company’s business plan, at a level sufficient for the commissioning of five processing plants by 2023 and ensuring the carrying capacity of the Elga-Ulak railway line for exports of 100% of the produced coal;
  • Conservative dividend payments, considering a priority for the lower debt load.

Potential outlook or rating change factors

The Stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18-month horizon.

A positive rating action may be prompted by:

  • Decrease in debt load (gross debt to FFO before net interest payments) below 5.0х along with a growth in the ratio of FFO before net interest payments to interest payments above 5.0х;
  • Improvement in the qualitative assessments of debt load and liquidity due to loan portfolio refinancing.

A negative rating action may be prompted by:

  • Deterioration in liquidity due to the derailed plans for short-term debt refinancing;
  • Decrease in FFO before net interest payments to interest payments below 2.5х.

Rating components

SCA: bbb+.

Adjustments: none.

Issue ratings

No outstanding issues have been rated.

Regulatory disclosure

The credit rating of Elgaugol Ltd has been assigned under the national scale for the Russian Federation based on the Methodology for Credit Ratings Assignment to Non-Financial Corporations Under the National Scale for the Russian Federation, and the Key Concepts Used by the Analytical Credit Rating Agency Within the Scope of Its Rating Activities.

A credit rating has been assigned to Elgaugol Ltd for the first time. The credit rating and its outlook are expected to be revised within one year following the publication date of this press release.

The credit rating was assigned based on the data provided by Elgaugol Ltd, information from publicly available sources, as well as ACRA’s own databases. The credit rating was assigned based on the IFRS financial statements of Elgaugol Ltd for 2018–2019, and RAS statements for 2020. The credit rating is solicited, and Elgaugol Ltd participated in its assignment.

In assigning the credit rating, ACRA used only information, the quality and reliability of which was, in ACRA’s opinion, appropriate and sufficient to apply the methodologies.

ACRA provided no additional services to Elgaugol Ltd. No conflicts of interest were discovered in the course of credit rating assignment.

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