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Rating Action:

MOODY'S RAISES HYLSA'S SR UNSEC'D DEBT RATINGS TO B3 FROM Caa3; OUTLOOK STABLE

11 Aug 2004
MOODY'S RAISES HYLSA'S SR UNSEC'D DEBT RATINGS TO B3 FROM Caa3; OUTLOOK STABLE

New York, August 11, 2004 -- Moody's Investors Service has raised Hylsa, S.A. de C.V.'s (Hylsa) senior unsecured debt ratings to B3 from Caa3. The upgrade is based on Hylsa's sharply improved operating performance and use of cash flow for debt reduction, stemming from improved steel industry fundamentals. The rating also reflects the significant volatility inherent in the steel industry and the associated volatility in Hylsa's earnings and cash flow. The outlook for the ratings is stable.

Ratings upgraded:

$139 million senior unsecured notes, due 2007, raised to B3 from Caa3.

$161 million senior unsecured notes, due 2010, raised to B3 from Caa3.

Senior unsecured issuer ratings raised to B3 from Caa3.

Senior implied rating raised to B2 from Caa2.

Moody's ratings acknowledge that current financial leverage of 2.0 times is moderate, and that both earnings and cash flows are now at record highs due to favorable market conditions. Nevertheless, the ratings reflect Hylsa's continuing exposure to the volatility inherent in the steel industry as 88% of its sales volumes are generated from spot sales. The company also has exposure to commodity input costs albeit these are mitigated by the versatility of its metallic charge and by its energy hedges. At current debt levels, Hylsa's leverage could become quite high during intervals of constrained profitability. Moody's notes that the company's default in the first quarter 2002 was remedied by its ultimate parent company, Alfa S.A. de C.V., through a recapitalization. Alfa repaid a portion of Hylsa's debt, contributed additional capital, and restructured a portion of Hylsa's debt obligations to the Hylsamex S.A. de C.V., intermediate holding company. Alfa is currently in the process of spinning-off its investment in Hylsamex S.A. de C.V., and thereby Hylsa, as a separate public entity in an effort to generate more value for Alfa's own shareholders. Moody's notes that this spin-off will also terminate Hylsa's access to the financial support that it formerly enjoyed from Alfa.

Favorable industry dynamics driven by rising global demand for steel are reflected in Hylsa's sharply improved financial performance. Second quarter 2004 results exceeded robust first quarter levels with shipments of 746,100 tons at an average revenue per ton of US$650 (both metrics are record highs for Hylsa), compared with 645,200 tons and revenues of US$443 per ton during the second quarter of 2003. Costs per ton are managed, in part, by Hylsa's ability to employ either direct reduced iron (DRI) from its own Hylsa Mines subsidiary, or steel scrap in its metallic charge; as well as by its use of natural gas hedges. Although new natural gas hedges were entered into at higher prices, the variable cost increase was almost entirely offset by elevated fixed cost absorption. Hylsa's ability to employ either DRI or scrap as well as its ability to produce higher margin steel products result from its US$1.7 billion of capital investments since 1990 for upgrades to, and vertical integration of, its steel making facilities. This substantial investment began generating acceptable returns as recently as the second quarter of 2004 when returns on assets (LTM EBIT / average total assets) reached a high of 10.1% from an unacceptably low 1.2% in the fourth quarter of 2003. Hylsa's incremental profit and cash flow have enabled it to reduce total debt by about US$85 million during the first half of 2004, thereby sharply lowering its leverage ratio to 2.0 times at June 30, 2004 from 5.5 times at year-end 2003. An additional US$75 million of debt reduction has taken place in the current quarter.

The stable rating outlook acknowledges volatility in Hylsa's prospective revenues, profitability and cash flow, as well as the company's fairly small credit facility of US$40 million, due July 2005, that supports rising working capital needs as production rates increase. In Moody's opinion, Hylsa's financial performance will benefit from increasing global demand for steel, higher prices and capacity utilization over the balance of 2004. While its financial metrics are likely to strengthen beyond typical B2 (senior implied) averages, Hylsa's vulnerability to a reversal of these factors and its challenged financial history warrant its position in the rating category. Incorporated into Moody's outlook is Hylsa's exposure to currency exchange rates; its revenues are US dollar-denominated but about 33% of its cost structure is Mexican peso-based, an appreciation of the Mexican peso may have a significant impact on Hylsa's profitability. At the same time, by borrowing in US dollars, Hylsa has established a natural currency hedge for its debt obligations. Downward pressure on the company's outlook or ratings may result from a releveraging of the company's balance sheet for additional major capital investments, or acquisition activity, or to support operating costs should global demand wane. Upward pressure may be applied to the senior unsecured debt ratings should Hylsa virtually eliminate secured debt from its capital structure, or maintain improved cash flow to debt ratios.

The rating notch between the senior implied and senior unsecured ratings is reflective of the US$244 million of secured facility A debt (unrated) that remained outstanding at quarter end (subsequently reduced to US$169 million on August 9, 2004), and the US$47 million secured obligation with Bancomext. In Moody's opinion, as secured obligations represented a meaningful 43% of Hylsa's total obligations at June 30 and were still meaningful at 36% on August 9, the unsecured ratings should reflect their contractual subordination.

Hylsa's total debt of about US$661 million at the end of the second quarter represented 2.0 times its LTM EBITDA and 33% of its book capitalization. Coverage of interest, based on LTM EBIT, was adequate at 3.0 times and should improve as the effect of recent debt repayments filters through LTM interest expense. Free cash flow strengthened notably to roughly US$57 million in the second quarter alone. Over the balance of 2004, free cash flow should remain robust as Hylsa's capital spending needs are light, and dividend payments are non-existant. Beyond 2004, dividends to shareholders may be initiated that could represent a meaningful disbursement of cash and thereby impede prospective debt reduction. Moody's notes that Hylsa has manageable near-term debt maturities of US$31 million, as well as liabilities for pension and benefit obligations of approximately US$117 million (as of 12/31/03). The company's liquidity position at quarter end consisted of roughly US$63 million in cash on hand and an undrawn credit facility.

Hylsa S.A. de C.V., headquartered in Monterrey, Mexico, is a wholly-owned steel making subsidiary of Hylsamex S.A. de C.V., which will be entirely spun-off from its ultimate parent company, Alfa S.A. de C.V., in February 2005. Through June 30, 2004, Hylsa reported LTM revenues of about US$1.4 billion.

New York
Mark Gray
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Grace Kennedy
Asst Vice President - Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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