OREANDA-NEWS. March 25, 2016. Fitch Ratings has downgraded Ferrexpo plc's (Ferrexpo) Long-term Issuer Default Rating (IDR) and Ferrexpo Finance Plc's senior unsecured rating to 'CC' from 'CCC' and removed them from Rating Watch Negative (RWN). The Recovery Rating on the senior unsecured rating is 'RR4'. Ferrexpo's Short-term IDR has been affirmed at 'C'.

The downgrade reflects Fitch's view that the risk that Ferrexpo will deplete its remaining cash reserves over the next six to 12 months has increased, using our iron ore price assumptions of USD45/t in 2016 and given no extension of its pre-export financing (PXF) maturities/amortisation announced to date. Ferrexpo's current liquidity position remains weak with no measures to boost liquidity announced since September 2015 when we placed the ratings on RWN. However, we understand that the company is currently investigating various measures to increase available liquidity. Ferrexpo currently faces monthly PXF maturities payments through to July 2016 (USD17.5m) which must be met from internal cash generation.

KEY RATING DRIVERS
Liquidity Limited by Debt Maturities
While Ferrexpo continues to generate positive free cash flow (FCF), most if not all of it is directed towards meeting PXF principal repayments and bond coupon payments, resulting in a gradual reduction in liquidity over the period to November 2016. Fitch considers that management is likely to undertake non-operational actions to restore liquidity to an acceptable margin of safety in light of the current volatility in commodity price, currency and inflation rates.

Competitive Cost Producer
Ferrexpo's operating cost position sits within the first quartile of the global pellets cost curve. In 2015, cash costs improved significantly compared with the previous two years, mainly due to currency depreciation dynamics (50% of operating costs are linked to the hryvnia) and a sustained drop in energy prices. These resulted in a 30% decrease in costs in 2015, reaching USD32 per tonne, down from USD46 in 2014. Energy costs now represent approximately 50% of total costs, and should continue to contribute to a further reduction in comparative cost levels in 2016.

Ukrainian Risk Exposure
Ferrexpo's operating base is in Ukraine. The country has recently experienced high domestic inflation, combined with significant currency depreciation (85% in 2015 vs. USD and greater than 125% since 2014), and some delays in VAT repayment by the state. However, military conflict in the Donbass region has not directly impacted Ferrexpo's operations and transport infrastructure due to their location in the Poltava region, approximately 425km north of Donetsk.

Continuing Profitability
Cash costs improvements, together with the pellet premium received over the benchmark 62% iron ore price, have significantly offset the 30% drop in top line revenues that followed the fall in iron prices. As a result, Fitch expects Ferrexpo's profitability to remain stable, with an EBITDA margin ranging between 30%-35% in the medium term. Ferrexpo's funds from operations (FFO)-adjusted gross leverage was 3.4x in 2015 (vs. 3.6x in 2014) and will decline in 2017 due to our expectations of slight EBITDA improvement resulting from iron ore prices recovery, as well as of debt reduction, both in absolute terms.

Iron Ore Premium Pellet Producer
In February 2016, 62% iron ore prices averaged USD46 per tonne, down approximately 30% yoy and down 62% since February 2014, reflecting oversupply in the global market and in particular a slowdown in demand from the Chinese steel industry.

However, Fitch expects the demand for premium quality pellets to remain sound. We expect premium pellet supply to be limited in the next couple of years due to the disrupted supply from Samarco and the high capital cost of new pellet plants additions. Ferrexpo compares favourably with its competitors in the premium pellet market. It has long-term contracts with European producers and enjoys European pellet premiums of around USD25 per tonne compared with Chinese premiums of USD12 per tonne as of February 2016.

KEY ASSUMPTIONS
- Fitch iron ore price deck: USD45/t in 2016 and 2017, USD50/t in 2018, USD50/t in the long term
- Forecast price premium for pellets based on FY15 realised premium
- Production volumes: 11.7mt per year iron ore pellets in 2016
- USD40m capex in 2016 and USD50m onward
- USD/UAH27 in 2016

RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Default becoming imminent or inevitable, including a payment default or a debt restructuring in a form we would consider a distressed debt exchange'

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Strengthening of Ferrexpo's liquidity position due to new sources of financing, a sustainable renegotiated debt maturity profile or higher than expected iron ore prices.

LIQUIDITY
As of December 2015 the company's cash balance was USD35m vs. USD196m in short-term debt to be repaid in 2016 and USD54m of coupon/interest payments. The short-term debt is composed of (i) monthly PXF amortisations of USD17.5m until July 2016; (ii) USD45m of quarterly PXF instalments starting in November 2016; and (iii) USD28m of other debt.

We forecast that the company will generate approximate USD150m-USD190m of FCF in 2016 (post interest/coupon). We estimate that the company's liquidity position is not adequate as it will be just enough to service the company's debt, working capital and capital expenditures for the next six to 12 months, while remaining exposed to further fluctuations in iron ore prices, currency and energy costs movements.