OREANDA-NEWS. Fitch Ratings has assigned Ireland-based Steel Funding Limited's (Steel Funding) recent bond issue a final senior unsecured rating of 'BBB-'. This rating is in line with the 'BBB-' rating of the current loan participation notes (LPNs) issued by Steel Funding Limited.

The notes are issued with limited recourse to Steel Funding and for the sole purpose of funding a loan to PJSC Novolipetsk Steel (NLMK). The notes rank pari passu with all other unsubordinated and unsecured indebtedness of NLMK and will be used to fund the cash tender offer of its 2018/2019 existing bonds as announced on 31 May 2016 and partly for general corporate purposes and refinancing of its current debt.

NLMK is rated Long-Term Foreign and Local Currency Issuer Default Rating (IDR) 'BBB-,' senior unsecured 'BBB-' and National Long-Term 'AA+(rus)'. The Long-Term IDRs and National Long-Term ratings are on Negative Outlooks. The Outlook is capped by the Negative Outlook on the Russian sovereign. NLMK's uncapped ratings would be 'BBB-'/Stable.

The ratings of NLMK continue to reflect its strong self-sufficiency in raw materials, low production costs, geographical diversification and conservative financial policy.

KEY RATING DRIVERS

Gross Leverage Marginally Higher

Total debt, including NLMK Belgium Holdings' (NBH) debt guaranteed by NLMK, declined to USD2.9bn at end-2015 from USD3.4bn at end-2014. Despite this, funds from operations (FFO)-adjusted gross leverage marginally increased to 1.9x, as the decrease in debt was not enough to offset a fall in FFO. However, an increase in cash balance led to FFO-adjusted net leverage improving slightly to 1.0x from 1.2x. Fitch expects FFO-adjusted gross leverage to remain largely flat at end-2016.

Resilient Operating Performance

NLMK's ability to increase export sales of semi-finished products to captive rolling mills in Europe and the US as well as to third parties should help support resilient operating performance in 2016 and largely compensate for a decline in domestic demand. Total sales volume grew 4.8% in 2015, despite declining domestic steel consumption, outperforming that of Russian steel peers whose sales growth was either slower or negative. NLMK has also benefited from strong demand for large diameter pipes in Russia, through its supply of high-quality slabs to pipe producers. We expect this to continue in 2016.

Higher Dividend Pay-out

NLMK's current dividend policy stipulates a 50% pay-out of net income or cash flow if net debt/EBITDA is below 1.0x or 30% pay-out of net income or cash flow if net debt/EBITDA is above 1.0x. On 22 April 2016, NLMK's Board recommended dividends for 4Q15 of RUB2.4/share alongside total dividends for 2015 of RUB41.7bn (USD678m at the average exchange rate for 2015 of 61.3), yielding a pay-out ratio of almost 70% of the company's net profit in 2015. Fitch expects NLMK's dividend pay-out ratio to average 65% of net income during 2016-2019. Between 2016 and 2018, this will on average be 2x higher than the last three years.

Profitability to Remain Sound

Rouble weakness against US dollar offset the negative effect on profitability caused by weak steel prices in 2015, resulting in a slight increase in EBITDA margin to 24% last year. Although Fitch expects the rouble weakness against US dollar to persist, it will not be enough to offset the 15% fall in steel prices forecast by Fitch for 2016, which should result in an EBITDA margin decline to 23% this year. Our base case forecasts NLMK's EBITDA margin to remain above 20% during 2016-2019, driven by cost cutting initiatives, improved self-sufficiency in pellets and a gradual appreciation of the RUB against US dollar from 2017 on oil price recovery, and by a marginal recovery in steel prices.

Foreign Assets Marginal Contributor

NLMK's international rolling assets, including associate NBH, made an EBIT loss in 1Q16 of USD32m but contributed USD4m at EBITDA level during the same period. Hence, performance has improved since 1Q15 when prices were materially higher. This suggests that reorganisation of the assets is gradually showing positive results. Fitch expects NLMK's foreign division to be profitable in 2017, due to a recovery in steel prices and efficiency improvements.

Pellet Plant on Schedule

NLMK is making progress with its main investment project, the construction of a 6 million tonnes per annum (mtpa) pellets plant at Stoylensky GOK, to reach 100% self-sufficiency in pellets by end-2016. The plant, which we expect will be commissioned in 2H16, will help NLMK reduce its dependence on third-party pellet supplies and reduce costs by USD200m per year. The total cost of the plant is USD650m, with an implied payback period of three years.

Corporate Governance

Although we regard NLMK's corporate governance as above the Russian sector average we continue to notch down the rating by two notches. This notching factors in the Russian business and jurisdictional environments and the ownership concentration in NLMK.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Up to 2% sales volume decline in 2016, followed by an average 1.4% growth per year

- 15% decline in average realised steel prices in 2016, followed by a 5% growth per year in 2017-2018

- Average RUR/USD exchange rate of 75 in 2016, trending towards 57 by 2019

RATING SENSITIVITIES

Positive: Future developments that could lead to positive rating actions include:

- An revision of the Outlook on the Russian sovereign to Stable. Otherwise, we believe that no further positive action is likely without a fundamental change in the company's business profile.

Negative: Future developments that could lead to negative rating action include:

- Negative rating action on the Russian sovereign

- EBITDAR margin below 16% on a sustained basis

- Failure to maintain FFO-adjusted gross leverage below 1.5x (or FFO-adjusted net leverage of 1.0x) on a through-the-cycle basis

LIQUIDITY

NLMK's liquidity position is strong with USD1.7bn of cash and short-term investments (Fitch classifies USD200m as restricted cash) and USD1.1bn of unutilised committed bank credit lines, compared with USD0.6bn of short-term borrowings as at 31 March 2016 (of which around 50% are revolver lines for working capital financing). The company's significant repayments in 2018-2019 due to the maturity of its USD700m and USD470m Eurobonds are being moved to 2023 as the recent transaction (tender offer and 7Y Eurobonds placement) helped to refinance a large portion of its Eurobond maturities.