OREANDA-NEWS. June 04, 2015. Fitch Ratings has affirmed Nitrogenmuvek Zrt's (Nitrogenmuvek) Long-term foreign currency Issuer Default Rating (IDR) at 'B+' and senior unsecured rating at 'BB-' with a Recovery Rating of 'RR3'. The Outlook is Stable.

The ratings and Outlook reflect adequate forecast operational performance and credit metrics that are expected to dip below rating guidance in 2015 before improving to guidance levels from 2016. Nitrogenmuvek's cash position, following the 2013 USD200m bond, is expected to fall as a result of high capital expenditure, which will push up net leverage over the next two years.

The ratings continue to be supported by the company's share of the Hungarian market and by the protection offered by high transportation costs for potential competing importers, as well as good liquidity. Constraints include low product diversification and sensitivity to nitrogen fertiliser price cyclicality, limited geographical diversification and single site operations.

KEY RATING DRIVERS:
Sales Growth, Resumed Production
Production in 2014 was strong and is expected to remain strong over the next two years following production suspension in 2013. This was a result of an electrical system failure resulting in damages to the nitric acid plant, and unplanned building maintenance works interrupting the calcium ammonium nitrate (CAN) production. 2014 sales returned to above historical levels and the EBITDA margin increased to 23% from 11% in 2013. We expect both to remain strong due to volume increases, including from new businesses.

New Businesses Pressure Margins
Nitrogenmuvek is expanding its business segments to cover grain and seed trading for local farmers, pesticide and seed sales and a direct sales division. Fitch believes that the expansion into new business segments will boost sales but will have a dilutive impact on the EBITDA margin. Although these businesses have lower margins than the fertiliser business, they will help improve Nitrogenmuvek's brand names and market coverage, which will lead to higher volumes and demand for fertilisers in the longer term.

The rating base case assumes margins of 18%-20% over the next two years. Margins were previously forecast to be as high as 28% due to Nitrogenmuvek's competitive raw material sourcing, an extensive local distribution network with associated market intelligence, strong recognition for the Petiso brand, production flexibility, and domestic demand exceeding its production capacity. Fitch forecasts a margin of around 18%-20% due to the low pricing environment for nitrogen fertilisers and due to lower margin new business segments.

Fitch still believes that a 20% margin is suitable for a 'B+' rating of a fertiliser company of this size, and views the expansion into the new business areas as beneficial for longer term growth. The new businesses are expected to contribute up to around 30% of total sales by 2017.

Capex Programme Increases Net Leverage
Net funds from operations (FFO) adjusted leverage has historically been negative due to the group's large cash reserves following the issuance of a seven-year 7.875% USD200m senior unsecured bond in 2013. The proceeds of this issuance were used on CAN focused capex, which will increase the ammonia plant capacity to 1400 tonnes per day from Q4 2015, a new nitric acid plant from 2017 and a new CAN granulation plant in 2016. Leverage is therefore forecast to turn positive (1.4x in 2015, increasing to 1.9x by 2017) before falling after 2017 as earnings from the finished projects commence.

Gross FFO adjusted leverage decreased to 3.6x at end-2014 (4.6x at end-2013) as a result of the increase in sales as well as a lower cash dividend in relation to 2013's performance, offset by higher capex. Our rating case projects a reduction in gross leverage to 2.5x by end-2016 following a peak at end-2015, assuming no new issuance.

Neutral Impact of CAN Focus
Nitrogenmuvek will face greater price exposure and volatility following its decision to solely focus on CAN and ammonia sales. However, CAN is more suitable for the markets in which Nitrogenmuvek sells to due to its ease in transporting and its environmentally sound qualities, and attracts a higher premium for Nitrogenmuvek compared with Urea. Fitch notes that production flexibility exists and Nitrogenmuvek can alter production to CAN and Urea if market dynamics improve.

Large Domestic Market Share
Nitrogenmuvek is the only producer of nitrogen fertilisers in Hungary and has a 71% share of the market. Barriers to entry include capital investment vs. return on investment for the small regional market size, lead time of four-five years for a new plant, high ground transportation costs for importers (landlocked country) and import tariffs for non-EU producers.

Long-term Demand Fundamentals
The global fertiliser sector's long-term demand outlook is strong and supported by reducing arable land, growing population and meat consumption, and biofuel production. Nitrogenmuvek is also expected to benefit from the higher growth potential of Hungary and neighbouring central European countries, where nitrogen fertiliser use per hectare remains below that of mature agricultural markets, especially CAN as it suits Europe's environmental regulations for fertilisers and is easy to store.

High Exposure to Price Volatility
Nitrogenmuvek lacks the diversification of its international peers, which leaves it substantially exposed to nitrogen prices volatility, as evidenced by the forecast reduced EBITDA margin over the next two years. The group is also exposed to volatility in natural gas prices, its main raw material. The latter is partly mitigated by its access to spot and short-term purchases on European gas hubs and contracts on spot base.

FX Risk
Nitrogenmuvek has no US dollar-denominated revenues which exposes them to convertibility and translation risk on the USD200m notes. Therefore a strong appreciation of the USD (as was the case in 2014) and a strong depreciation of the HUF or EUR could result in deterioration in the group's credit metrics due to the mismatch between operating cash flows and the US dollar-denominated debt.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
-Mid-single digit revenue decline in core fertiliser sales in 2015 on weaker pricing environment, followed by increases of around 10% for 2016 and 2017 as new capacity comes on stream.
-Stable operating margin in the core fertiliser operations.
-Capex of around HUF80bn over 2015-2017.
-Ramp up of non-fertiliser businesses to around HUF40bn by 2017, with low single-digit EBITDA margin.

RATING SENSITIVITIES
An upgrade is unlikely due to the capex programme and the scale and limited diversification of the company.

Future developments that could lead to negative rating action include:
- Shareholder distributions, excessive capex spend and a weak fertiliser price environment resulting in ongoing FFO adjusted net leverage above 2.0x, or expectations of long term FFO adjusted gross leverage above 2.5x.
- Sharp deterioration in fertiliser prices or demand with a sustained drop in the EBITDA margin of core fertiliser operations to below 20%.

LIQUIDITY AND DEBT STRUCTURE
Good Liquidity:
Cash and short term deposits amounted to HUF63.7bn at end-2014 (HUF59.3bn at end-2013) against maturing debt of HUF1.9bn (2013: HUF2.1bn). Liquidity is also supported by EUR40m of unused revolving facilities maturing in 2020.

Free cash flow was positive at end-2014 at HUF2.7bn but is forecast to remain negative to 2017, leading in an increase in FFO net adjusted leverage. However Nitrogenmuvek will maintain ample headroom under its net debt to EBITDA incurrence covenant (3:1) and currently has sufficient liquidity for the next two years. NitrogenMuvek continues to evaluate new funding opportunities, which Fitch assumes can be used for additional capex or M&A.