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Rating Action:

Moody's changes outlook on TMK's B1 rating to stable from negative; affirms ratings

28 Feb 2018

London, 28 February 2018 -- Moody's Investors Service (Moody's) has today changed to stable from negative the outlook on the ratings of PAO TMK, one of the world's largest producers of steel pipe products for the oil and gas industry. Concurrently, Moody's has affirmed TMK's B1 corporate family rating (CFR), B1-PD probability of default rating (PDR) and the B1 senior unsecured rating assigned to the notes issued by TMK Capital S.A., a wholly owned subsidiary of TMK. The outlook of TMK Capital S.A. has also been changed to stable from negative.

"Our decision to change the outlook on TMK's rating to stable mainly reflects a significant improvement in the financial and operating performance of its American division, complemented by the resilience of its Russian operations to oil price volatility. It also factors in our expectation that the company will be able to reduce leverage and maintain adequate liquidity," says Artem Frolov, a Vice President-Senior Credit Officer at Moody's.

RATINGS RATIONALE

Today's change of TMK's outlook to stable and affirmation of its ratings primarily reflect (1) a rebound in the performance of TMK's US-based operations from the trough 2016 level on the back of higher oil prices; (2) continuing resilience of the company's Russian business to volatile oil prices, rouble exchange rate, feedstock prices and declined demand for large-diameter pipes (LDP); and (3) Moody's expectation that TMK will reduce its leverage towards or below 4.5x Moody's-adjusted gross debt/EBITDA in 2018, with a potential for accelerated deleveraging should the initial public offering of the company's US-based subsidiary take place.

Financial and operating performance of TMK's American division has improved considerably throughout 2017 owing to growing drilling activity in North America driven by higher oil prices. In the first nine months of 2017, TMK's US business increased its sales to 472 thousand tonnes from 189 thousand tonnes a year earlier, and generated $72 million EBITDA, as opposed to a negative $63 million for the first nine months of 2016. Stronger performance of the American division was the key factor driving the growth of TMK's Moody's-adjusted EBITDA by 18% to $679 million in the 12 months ended 30 September 2017 from $573 million in 2016.

Moody's estimates Brent/WTI oil prices will be in a $40-$60 per barrel price band for the medium-term, compared with the 2017 average Brent price of $54 and year-to-date average of $67. Prices in the upper half of the estimated oil price band, let alone above, and higher drilling efficiency will support increased oil production and demand for oil country tubular goods (OCTG) in the US. Therefore, Moody's expects the performance of TMK's American division to continue to improve in 2018, unless average oil prices fall below the medium-term price band.

TMK's Russian operations have proved to be resilient to the low oil price environment, owing to the depreciation of the Russian rouble and flexible tax system, which have cushioned the impact of low oil prices on the domestic oil companies' upstream margins. As a result, drilling activity and demand for seamless OCTG, TMK's key product category, in Russia remained healthy. Although demand for LDP has fallen significantly from the 2015 peak, TMK's exposure to this segment is fairly limited, at less than 10% of revenue. TMK's margins have also shown resilience in the last three years, despite short-term fluctuations, with Moody's-adjusted EBITDA margin staying around or above 15%. TMK's margins are supported by the company's integration in the production of steel billets and its ability to pass on, at least partly, the volatility in feedstock costs to its customers, owing to a sizeable share of formula-based contracts.

Moody's expects that a combination of increased earnings of American division and sustainable solid earnings of Russian division will allow TMK to reduce its leverage towards or below 4.5x by year-end 2018 from 5.2x as of 30 September 2017. Deleveraging in 2018 may be more pronounced should the company proceed with the initial public offering of its US-based subsidiary IPSCO Tubulars Inc. The timing of the transaction and the use of proceeds have not been announced so far. Moody's expects that TMK would primarily use the proceeds to repay part of its outstanding debt, in line with the company's aim to reduce its net debt/EBITDA to 3.0x by the end of 2019.

TMK's B1 rating continues to take into account (1) the company's wide product range and technological advancements; (2) leading market position in Russia in high-margin seamless OCTG; (3) operating and geographical diversification, with meaningful production assets in the US and Europe, although the US operations' revenue and EBITDA are strongly dependent on oil price and have shown significant volatility in 2014-17; (4) fairly high profitability owing to integration in steelmaking operations and cost-cutting measures; (5) moderate capital spending; (6) Moody's expectation that the company will generate sustainable positive post-dividend free cash flow, although the rating agency estimates that free cash flow was negative in 2017, as a result of the accelerated increase in inventory in the US division on the back of market recovery; and (7) the company's continuing commitment to deleverage and maintain adequate liquidity, although deleveraging will take time.

TMK's rating also factors in (1) the company's significant exposure to the oil and gas sector; (2) Moody's expectation that oil and gas prices will remain volatile, potentially exerting pressure on the operating and financial performance of the company's US assets; (3) the company's high customer concentration; (4) its elevated leverage and exposure to the volatile rouble exchange rate and steel prices; and (5) the company's dependence on covenanted committed credit facilities to remain liquid.

RATIONALE FOR STABLE OUTLOOK

The stable outlook reflects Moody's expectation that the company will be able to reduce its leverage below 4.5x over the next 12-18 months, and its financial metrics, free cash flow generation and liquidity will be commensurate with its B1 rating on a sustainable basis.

WHAT COULD CHANGE THE RATINGS UP/DOWN

Moody's could upgrade TMK's ratings if the company were to (1) reduce its Moody's-adjusted gross debt/EBITDA to below 3.0x on a sustainable basis; (2) generate sustainable positive post-dividend free cash flow; and (3) maintain healthy liquidity.

Moody's could downgrade the ratings if (1) the company were unable to reduce its leverage, with Moody's-adjusted gross debt/EBITDA remaining above 4.5x on a sustained basis; (2) the company fails to generate positive free cash flow on a sustained basis; or (3) its liquidity were to deteriorate.

TMK is Russia's largest and one of the world's largest producers of steel pipe products for the oil and gas industry, operating 26 production sites across the US, Russia, Romania, Canada, Kazakhstan and the Sultanate of Oman. The largest share of TMK's shipments comprises high-margin OCTG, including tubing, casing and drill pipes, complemented with line, large-diameter and industrial pipes, as well as an entire range of premium connections. In 2017, TMK shipped 3.8 million tonnes of steel pipes, including 2.7 million tonnes of seamless pipes. In the 12 months ended 30 September 2017, the company generated revenue of $4.1 billion and Moody's-adjusted EBITDA of $679 million. TMK's largest shareholder is Dmitry Pumpyanskiy who controls a stake of around 65.1% in the company.

The principal methodology used in these ratings was Steel Industry published in September 2017. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Artem Frolov
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service Limited, Russian Branch
7th floor, Four Winds Plaza
21 1st Tverskaya-Yamskaya St.
Moscow 125047
Russia
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Victoria Maisuradze
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
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Client Service: 44 20 7772 5454

No Related Data.
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