OREANDA-NEWS. September 07, 2015.  Fitch Ratings has affirmed PJSC Uralkali's Long-term Issuer Default Ratings (IDR) at 'BB+' with the Negative Outlook. The foreign currency senior unsecured rating on Uralkali Finance Limited's notes has been affirmed at 'BB+'.

The ratings and Outlook reflect Uralkali's weakening financial metrics, which are balanced by one of the most robust operational profiles in the global fertiliser sector. Factoring in the recently announced USD1.32bn share buyback, we now forecast Uralkali's funds from operations (FFO) net adjusted leverage at 3.2x in 2015, a modest increase from the 3.0x we had expected before the buyback announcement.

A robust cost position allows Uralkali to deleverage using operational cashflows, even under weak market conditions. However, our base case, which assumes healthy dividends in the region of USD0.5bn per annum from 2016 onwards but no further buybacks, shows leverage remaining above our downgrade trigger of 2.5x to 2018. The Negative Outlook reflects the risk that shareholder distributions will not moderate, resulting in leverage being sustained well above 2.5x beyond 2015.

The Outlook is likely to remain Negative until there is certainty around the future pace of deleveraging and shareholder returns, following Uralkali's departure from its previously communicated deleveraging target. A continued aggressive financial policy is likely to lead to negative rating action.

KEY RATING DRIVERS
Share Buybacks Increase Leverage
The announced USD1.32bn share buyback follows the USD1.1bn share buyback completed in June 2015, and will be funded by new bank debt (USD800m) and available cash. The earlier buyback resulted in Uralkali's free float shrinking to 23% from 28%, and the recent buyback could reduce this further to 9%. This may cause Uralkali's global depository receipts (GDRs) to be delisted from London Stock Exchange, leaving Moscow-based MICEX as the only stock exchange where Uralkali's equity is traded.

The share buybacks are accompanied by increased uncertainty on future dividend outflows as the company continues to adopt a less predictable discretionary dividend policy. This comes at a time of lower production following the Solikamsk mine accident, which has led to accelerated capex, and weaker-than-expected potash price recovery, meaning FFO adjusted net leverage will rise above 3x in 2015.

Lower Production, Moderate Capex
The flood accident at Uralkali's Solikamsk-2 potash mine in 4Q14 resulted in output reduction to around 11mt in 2015 from 12.1mt in 2014. Production is not expected to return to 2014 levels until 2018 when new potash fields come on line. Uralkali has therefore accelerated expansion capex over the medium-term to restore production volumes and global market share over the next few years. Uralkali's decrease in earnings from lower production is, however, offset by rouble depreciation, which is contributing to lower rouble-based production costs versus US dollar-denominated revenues.

Pricing Broadly Flat
The break-up of the BPC potash cartel resulted in intensifying competition on prices since late 2013 as Uralkali fought to regain lost market share. This was a stark departure from the supply discipline that had characterised the market and underpinned the resilience of potash prices through the cycle. Spot potash prices remain at depressed levels of around USD300/t, reflecting the fundamental rebasing of potash prices at a lower level. Fitch forecasts a prudent USD5/t increase in potash prices per year in 2016-2017. However, we believe that low potash prices will continue, given significant excessive capacity in the market as well as potential capacity coming on in Canada and a low grain price environment in the short term.

Leverage Drives Negative Outlook
Under our base case, Uralkali's vertical integration and competitive cost base should support EBITDA margins of 55%-60% through the cycle. Under Fitch's forecast, FFO net leverage will increase to 3.2x in 2015 following its two share buybacks. We expect it to remain above our downgrade trigger of 2.5x until 2018, due to higher capex as well as lower prices and production. This, together with Uralkali's departure from its deleveraging target and a less predictable discretionary dividend policy, drives the Negative Outlook.

Corporate Governance
Fitch has extended the corporate governance discount to Uralkali to two notches from one notch, following the previous USD1.1bn share buyback and the commencement of a discretionary dividend policy. The above-average corporate governance that Uralkali's diversified shareholding structure, listing on LSE and MICEX and robustness of financial strategy provided was no longer deemed relevant. Fitch also views that Uralkali's several majority shareholders may have allied interests despite the presence of independent directors, and a less concentrated shareholder structure would not necessarily imply a balance of interests across all stakeholders. Fitch therefore applies a two-notch corporate governance discount to Uralkali, on a par with its Russian peers with a concentrated ownership structure.

Country and Industry Risks
Rating constraints include Uralkali's full exposure to the potash demand cycle. In Fitch's view, combined with the high contribution of emerging markets to revenues (64% in 2014, excluding Russia), this implies higher earnings volatility than for more diversified peers. Although these markets present strong growth potential, they also tend to exhibit more erratic demand patterns than mature agricultural regions. Operational risks are also higher in mining potash than other fertilisers as water-soluble salt deposits are susceptible to flooding. Finally, the ratings are constrained by the higher-than-average legal, business and regulatory risks associated with Russia (BBB-/Negative/F3).

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Uralkali include
-- USD300/t potash export price in 2015 with prudent USD5/t annual growth in 2016-2017
-- Output gradually recovering to 12mt by 2018 from 11mt in 2015
-- USD/RUB at 60 in 2015, rising to 55 thereafter
-- Modest capex acceleration to USD0.7bn-USD0.8bn in 2016-2018 from USD0.4bn in 2015
-- Shareholder distributions of USD0.5bn annually from 2016

RATING SENSITIVITIES
Negative: Future developments that could lead to negative rating action include:
--A further lower rebasing of potash prices, material disruptions and decrease in production or a continued aggressive financial policy resulting in FFO net leverage above 3x in 2016 and materially above 2.5x thereafter

Positive: Future developments that could lead to positive rating action include:
--A stable and transparent financial policy resulting in FFO net leverage moving below 3x in 2016 and towards 2.5x over the next two years, which could lead to the Outlook being revised to Stable.
--A stable and transparent financial policy, coupled with an improvement in potash pricing and higher production, resulting in FFO net leverage sustainably below 1.5x, which could lead to an upgrade.

LIQUIDITY
Uralkali's liquidity is adequate with USD2.5bn of available cash at end-2014 and USD1.1bn free cash flow generation forecast over 2015, against USD0.7bn short-term financial obligations and USD2.4bn share buybacks. Unless significant shareholder distributions are made liquidity for 2016 is also adequate, assuming USD800m bank loans raised to fund the second buyback are long-term, and strong free cash flow generation. Uralkali continues to have access to capital markets, as demonstrated by its recent signing of a four-year pre-export financing loan of USD655m.