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Rating Action:

Moody's downgrades Zangezur Copper Molybdenum Combine CJSC to B3; outlook developing

10 Apr 2020

London, 10 April 2020 -- Moody's Investors Service, ("Moody's") has today downgraded to B3 from B2 the corporate family rating (CFR) and to B3-PD from B2-PD the probability of default rating (PDR) of Zangezur Copper Molybdenum Combine CJSC (ZCMC), one of the largest exploration and mining companies in Armenia. The outlook on all ratings has been changed to developing from stable.

RATINGS RATIONALE

The downgrade of the company's CFR to B3 from B2 reflects increase in debt and leverage due to acquisition of a 75% of its own shares from the controlling shareholders for about $165 million in December 2019, modification of the company's streaming contracts, which resulted in the outflow of about $41.5 million in Q1 2020 amid deteriorating market environment and weak liquidity.

Average copper and ferromolybdenum prices were fairly high in 2019, at about $6,000 per tonne and $26 per kilogram, respectively, which allowed the company to generate Moody's-adjusted EBITDA of about $98 million (2018: $96 million). However, copper prices fell to about $4,900 per tonne as of early April 2020 compared with a $5,500-$6,500 per tonne range in 2019 while the price for 65% ferromolybdenum fell to about $20 per kilogram in early April 2020 from a $21-$29 per kilogram range in 2019. In October 2019 and December 2019 the company entered into agreement with its shareholders, CRONIMET Mining GmbH and Makur Erkati Gortsaran OJSC (Plant of Pure Iron), respectively, to acquire 60% and 15% of the share capital in ZCMC, respectively, for a total consideration of about $165 million. In accordance with the terms of the sales-purchase agreements (SPAs), ZCMC settled $65 million of the purchase consideration in December 2019 while the remining $100 million will have to be paid in two installments: $50 million until the end of 2020 and $50 million until the end of 2021. Moody's estimates that this transaction caused the company's leverage, as measured by Moody's-adjusted debt/EBITDA to increase to about 4.0x as of 31 December 2019 compared with Moody's initial estimate of about 2.0x as of the same date and with 2.3x as of 31 December 2018. Under the scenario of depressed copper and ferromolybdenum prices of about $5,000 per tonne and $20 per kilogram, respectively, the company's Moody's-adjusted leverage will be sustained at a fairly elevated level of about 4.6x as of 31 December 2020 potentially growing to 5.8x as of 31 December 2021 due to negative free cash flows in 2020-21, unless copper and ferromolybdenum prices recover and the company raises equity to materially reduce its debt.

Recognising the challenges, which the elevated debt could have on the company's credit profile, the company initiated a search for a strategic investor, to which it aims offering up to 50% minus one share in the share capital of ZCMC before cancelation of treasury shares. The company is in advanced stages of negotiation with the potential investors and estimates the closing of the sales-purchase transaction with the successful bidder by the year-end 2020 as highly probable. This transaction has fairly high execution risks amid copper price volatility and financial markets turmoil. Under the scenario when the company completes this transaction the company is capable to materially decrease its debt with Moody's adjusted debt/EBITDA falling towards 3.5x-3.8x as of year-end 2021 even under the fairly stressful assumption of copper and ferromolybdenum prices of about $5,000 per tonne and $20 per kilogram, respectively.

The company expects a bit more pronounced effect from the upcoming farming out of the minority stake in ZCMC to a potential investor on the company's balance sheet and estimates that this transaction would lead to leverage, as measured by company's reported debt/EBITDA falling to about 3.5x as of year-end 2020 and to about 2.8x-3.0x by year-end 2021.

In December 2019, the company also modified its streaming agreements with two of its streaming customers in such a way that it accrued a contract asset (and obligation) of about $44 million in exchange for the right to settle the streaming obligation by cash rather than deliveries of copper concentrate with substantial discount, which shall save the company about $15-$20 million per annum of cash flows (the company's estimate) and will positively impact its working capital dynamics. As a result, the company's obligation under streaming contracts increased to $105 million as of 31 December 2019 from about $61 million as of 31 December 2018. The company settled about $34 million in Q1 2020 under its streaming obligation and has a fairly flexible maturity profile until 2031 with no repayments in 2021. Despite the positive impact on the profitability of the company's operations and working capital, this settlement negatively impacted the company's cash flows from operations in Q1 2020 and will result in negative free cash flow in 2020. Moody's does not view ZCMC's streaming transactions as debt financing. Therefore, the agency does not add the initial streaming payments to ZCMC's debt because Moody's views them more as a minority equity interest in a project or a forward sale transaction, with the underlying liability similar to deferred revenue. Modification of contracts does not substantially change the substance of agreements apart from the fact that the company improved the economics of its commodities sales under such contracts as it can now discharge its obligation via settling it by cash proceeds it receives from sales of copper concentrate at market value (without a discount).

The downgrade also incorporates Moody's view that difficult industry conditions will persist, continuing to pressure ZCMC's financial performance. The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The mining sector has been one of the sectors most significantly affected by the shock given its sensitivity to demand and sentiment. More specifically, the weaknesses in ZCMC's credit profile, including its exposure to copper metal have left it vulnerable to shifts in market sentiment in these unprecedented operating conditions and ZCMC remains vulnerable to the outbreak continuing to spread. Moody's regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety. Today's action also reflects the impact on ZCMC of the breadth and severity of the shock, and the broad deterioration in credit quality it has triggered.

As manufacturing activity slows globally, supply chain and logistical disruptions spread, and consumer confidence and spending wane, downward pressure on copper prices may sustain. China accounts for at least 50% or more of the global consumption of copper. Economic expectations strongly influence price movement. Moody's revised its growth forecasts downward for 2020 as the rising economic costs of the coronavirus shock and the policy responses to combat the downturn are becoming clearer. Moody's now expects G-20 real GDP to contract by 0.5% in 2020, followed by a pickup to 3.2% growth in 2021. Moody's also forecasts China real GDP growth of 3.3% in 2020 (substantially lower than its prior estimate of a 5.2% growth), followed by 6.0% growth in 2021.

Despite placing an equivalent of $55 million of local bonds in Q4 2019, ZCMC has weak liquidity, which requires ongoing efforts to term out debt coming due with a heavy reliance on relationship banks and its trader, Trafigura PTE, although Moody's recognises the company's established relationships with the local banks and good access to funding. As of 31 March 2020, the company had about $5 million of cash supported by long-term overdraft and revolver facilities totalling around $15 million from local banks. Moody's expects the company to generate operating cash flow of around $36 million under the assumption of copper and ferromolybdenum prices of $5,000 per tonne and $20 per kilogram, respectively, and receive $21 million from its former shareholder over the next 12 months. This liquidity barely covers the company's cash outflows, namely its short-term debt maturities of around $44 million, which the company aims to refinance at least in part in order to fund its capital spending requirements of about $40 million. The company has a track record of refinancing its upcoming debt maturities with its relationship banks under fairly stressful market conditions and is likely to be able to refinance part of its short-term maturities in case of need. The company's liquidity will be propped up by a $120 million facility from Trafigura PTE, which the company expects to sign in April 2020, of which about $42 million will be used to roll over the unamortised part under its existing $70 million facility which the company received in March 2019 and $78 million will be used for refinancing of existing credit facilities, working capital and capital spending requirements. Prepayment from Trafigura PTE will be offset through the delivery of copper concentrate on market terms over more than 3 years from date of the facility receipt. Prepayment from Trafigura PTE is accounted for as debt in the company's financial statements.

RATIONALE FOR DEVELOPING OUTLOOK

The developing outlook reflects the fact that at this stage the long term capital and shareholding structure of the company remains uncertain. The outlook balances the potential for a strengthening of the balance sheet from the planned disposal of up to a 50% minus one share in the company to a strategic investor, which could be credit positive, if reinforced by prudent financial policies and strengthened liquidity, and the risk that the scenario not leading to a material deleveraging amid low copper or molybdenum prices and elevated debt following acquisition of 75% of own shares could create further negative rating pressure on the B3 rating, which at that point would become weakly positioned. Further direction of the rating will also consider the impact of the shareholding structure changes on the company's financial policies, risk tolerance and liquidity management.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

The ratings are unlikely to be upgraded in the near term given the currently weak operating environment, significant execution risks related to farming out of a minority stake in the company to a potential strategic investor and projected negative free cash flow in 2020-21. Over time, Moody's could upgrade the ratings if the company (1) raises new equity and uses the proceeds to reduce leverage, as measured by Moody's-adjusted debt/EBITDA, to below 3.5x while sustaining an EBIT margin of at least 8%; and (2) consistently demonstrates prudent liquidity management with liquidity cushion sufficient to weather volatility in copper and molybdenum prices over 18 months horizon.

Moody's could downgrade the ratings if (1) the company's leverage, as measured by Moody's-adjusted debt/EBITDA, deteriorates to above 4.5x on a sustained basis; (2) weak liquidity is not timely addressed; or (3) operating metrics (production, metal content, recovery) materially weaken.

ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) CONSIDERATIONS

ZCMC's mining activities are exposed to environmental and safety risks, in particular to the potential collapses or leakages of tailings dams. However, these risks are somewhat mitigated by the company's operational track record and continuous investments focusing on increasing beneficiation efficiency, expanding capacity for the tailings dams and enlarging processing capacity within the grinding process. The company operates Artsvanik tailings dam with the design capacity of 390 million cubic meters (m3) and actual volume of 250 million m3, which is located 36 kilometers from ZCMC on the Artsvanik river, where the company performs ongoing restoration works and which will operate until at least 2031, with annual fill-in volume of 12 million m3. The second tailings dam, Hanqasar, which is located on the river Geghi, is not currently operational, and will be subject to restoration works in 2022-25. New tailing facility is being planned in-pit, at the mined out part of the mine, which the company estimates will allow for water reusage possibility as it will be close to its current mining operations and will allow to reduce ZCMC's environmental footprint.

ZCMC has a concentrated ownership structure with 25% of the company owned by the company's management and a private investor, and 75% of the company's shares being treasury shares, which the company expects to cancel during 2020. The company's board of directors lacks independent members. ZCMC used to have substantial related party transactions, which included molybdenum processing under tolling scheme and molybdenum sales, which were conducted with the companies under common control on an arm's length basis. Inter alia, molybdenum concentrate was processed at the Plant of Pure Iron and AMP Holding LLC under a tolling arrangement at a fixed fee into ferromolybdenum and was exported by ZCMC on an arm's length basis to Cronimet Mining AG and Cronimet Metal Trading AG, which used to be ZCMC's direct parent and the company under common control, respectively. Following acquisition of a 75% stake in the company from its former shareholders, Makur Erkati Gortsaran OJSC (Plant of Pure Iron) and CRONIMET Mining AG, the transactions related to molybdenum processing and molybdenum sales via the above mentioned entities continue, however only AMP Holding LLC could be considered as a related party as its controlled by the company's management. The company has substantial balance of loans given to its former shareholders of about $21 million as of 31 December 2019, which the company expects will be repaid by year-end 2020.

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Mining published in September 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1089739. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

COMPANY PROFILE

Zangezur Copper Molybdenum Combine CJSC (ZCMC) is one of the largest exploration and mining companies in Armenia. The company principally produces copper concentrate and molybdenum from its single open-pit mine. Moody's estimates that the company generated revenue of $455 million and Moody's-adjusted EBITDA of $98 million in 2019. ZCMC is privately owned by the company's management and a private investor (25%), while 75% of the company's shares are treasury shares, which the company expects to cancel during 2020.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security 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.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

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

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

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.

Denis Perevezentsev, CFA
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service Limited, Russian Branch
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Russia
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Victoria Maisuradze
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
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No Related Data.
© 2020 Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

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