Fitch Ratings has upgraded Russian diamond producer ALROSA Company Limited’s (ALROSA) Long-term foreign currency Issuer Default Rating (IDR) to ‘B+’ from ‘B’, removed it from Rating Watch Negative (RWN) and assigned a Stable Outlook. Fitch has also upgraded ALROSA’s senior unsecured rating to ‘B+’ from ‘B’ and removed it from RWN. ALROSA’s Short-term IDR is affirmed at ‘B’. The Recovery Rating for the senior unsecured debt is ‘RR4′.
The upgrade of ALROSA’s ratings reflects improvements in its stand-alone credit profile due to reduced operational and financial risks in addition to the expected growth of the global raw diamond mining industry. The new management’s measures taken in H2 2009 included RUB8.9bn (USD300m) of cost savings in 2009 (USD118m of which are permanent), more than RUB6.4bn (USD220m) of capex reduction, and the sale of non-core oil and gas assets worth USD620m which have been used to reduce debt levels. The company’s goal is to increase the number of long-term contracts with major international clients by three times to 70% of total sales in 2010. This would improve the stability of the company’s performance in market downturns. ALROSA also completed the refinancing of debt facilities, which were at risk of breaching covenants, and the reduction of the company’s absolute debt level by 15% y-o-y by end-December 2009.
Fitch expects 2010 global diamond jewellery consumption and prices to stabilise at H209 levels. The agency further expects restocking to continue, which may result in an increase in apparent demand for raw gemstones by 25%-40% y-o-y in 2010. Fitch forecasts an improvement in ALROSA’s financial performance in FY10 which may result in revenue and EBITDAR growth of 20-25% y-o-y. The agency also expects ALROSA’s EBITDAR margin in 2009 and 2010 to be 30%-34% (FY08: 26.2%). Nevertheless, Fitch does not expect diamond demand and prices to return to 2007 levels until at least 2012.
ALROSA’s stand-alone credit profile continues to be driven by its strong market position as one of the leading global producers in the highly consolidated diamond industry, together with significant mining reserves and a low cost base. Rating constraints include ALROSA’s high level of leverage, its exposure to possible downturns in diamond market cycles and related uncertainties regarding the long-term development of the diamond market and macroeconomic variables such as exchange rates and mining cost inflation. Fitch also notes that the continued switch to underground mining operations may increase pressure on ALROSA’s costs and EBITDAR.
ALROSA’s ratings continue to be driven by its legal, operational and strategic links with its ultimate parent, the Russian Federation (‘BBB’/'F3′/Stable), which directly owns 50.9% and controls more than 90% of the company and provides support to ALROSA. Fitch continues to apply its parent and subsidiary rating linkage criteria to ALROSA’s rating (for further information, please see the 19, June 2007 criteria report, entitled ‘Parent and Subsidiary Rating Linkage’, which is available on the agency’s website, www.fitchratings.com.). Fitch continues to believe there is a weak relationship between ALROSA and its shareholder because of the absence of formal state guaranties or cross-default provisions, operational integration, and the direct financing of ALROSA’s operations by the state. State support has nonetheless provided a two-notch uplift enabling a ‘B+’ rating. The factor which supports a two-notch uplift is timely, ongoing extraordinary government support in the form of procurement of the company’s output through Russia’s Ministry of Finance acting through the State Depository (Gokhran).
Fitch’s estimates ALROSA’s 2009 gross leverage (gross debt/EBITDAR) at 4.8x-5.2x, net leverage (net debt/EBITDAR) at 4.3x-4.8x, and 2010 gross and net leverage at 3.5x-3.7x and 3.0x-3.4x, respectively. Additionally, Fitch is concerned about low projected coverage ratios and expects the funds from operations (FFO)/fixed charges coverage ratio will be below 2.5x in 2009 and 2010. The agency expects Alrosa will be in compliance with its maintenance debt covenants in FY2009 and 2010. Fitch also notes that the list of permitted indebtedness of eurobond is quite broad and therefore ALROSA may be able to incur a required amount of debt without breaching its bond terms.
Fitch expects ALROSA to be free cash flow (FCF) break-even in 2009 and 2010 due to its reduction of capex. The Stable Outlook reflects Fitch’s expectation regarding a ongoing stabilization and gradual recovery of the diamond industry and that ALROSA will be able to roll-over maturing debt in 2010, either by refinancing existing short-term debt or by continuing support from state banks.
