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Rating Action:

Moody's revises SUEK's outlook to negative; Ba2 ratings affirmed

21 Apr 2020

London, 21 April 2020 -- Moody's Investors Service, ("Moody's") has today affirmed the Ba2 corporate family rating (CFR) and Ba2-PD probability of default rating (PDR) of SUEK JSC (SUEK) as well as the Ba2 ratings assigned to the senior unsecured bonds issued by SUEK Finance, a Russia-domiciled wholly owned subsidiary of SUEK. The outlook on SUEK and SUEK Finance has been changed to negative from stable.

RATINGS RATIONALE

Average steam coal prices in the Pacific and Atlantic basins, as measured by Australia Newcastle and API2 benchmarks, fell in 2019 to $78/tonne and $61/tonne from $107/tonne and $92/tonne in 2018, respectively. Prices adjusted downward from these averages further in 2020. Moody's expects a very challenging year for the coal industry in 2020. The decline has been caused by falling gas prices, warmer weather in northeast Asia, increased nuclear generation in Japan and South Korea, stable coal supply and high coal and gas stocks in Europe. Based on the assumption of average steam coal prices in the Pacific and Atlantic basins of $65/tonne and $55/tonne, respectively, and exchange rate of 70 roubles per US dollar, Moody's expects that SUEK's EBITDA will amount to $1.9 billion in 2020 - down from $2.1 billion in 2019 and $2.8 billion in 2018, which will keep the leverage, as measured by Moody's-adjusted debt/EBITDA, at about 3.7x as of year-end 2020, above the agency's trigger for downgrade of 3.0x.

SUEK's leverage, as measured by Moody's-adjusted debt/EBITDA increased to 3.8x at the end of 2019 from 2.5x a year earlier (2017: 2.4x), driven primarily by the decrease in the company's Moody's-adjusted EBITDA by 23% to around $2.1 billion in 2019 due to lower seaborne thermal coal prices amid higher debt following recognition of lease liability under new IFRS 16 standard and M&A transactions in 2018-19 related to acquisition of energy generation and railcar businesses. In 2018, the company bought Siberian Generating Company (SGC) for $1.9 billion from the company's common shareholder (installed electricity capacity of about 10.9 gigawatts (GW)) consolidating about $1.6 billion of SGC's debt. In 2019, SUEK bought Reftinskaya GRES (installed capacity of 3.8 GW) for about $259 million and railcar leasing company Nitrohimprom for $425 million. In 2020, company bought Krasnoyarskaya GRES-2 for $157 million with the installed electricity capacity of about 1.3 GW.

Despite fairly challenging market environment in 2019, the company generated positive free cash flows, while the key reason behind a pick-up in reported debt and debt-like balances as of year-end 2019 compared with a year before was recognition of a lease liability under IFRS 16 "Leases" of nearly $1,209 million, including the lease liability of about $399 million related to the railcars under leasing, which were purchased following acquisition of Nitrokhimprom. Moody's expects the company to be able to continue generating positive free cash flows of about $400-$500 million per year in 2020-21 under a range of pricing scenarios, which will allow the company to reduce absolute amount of Moody's-adjusted debt to below its 2018 level by year-end 2021 with leverage, as measured by Moody's-adjusted debt/EBITDA falling to about 3.0x-3.3x by then.

Exports make up about half of SUEK's total coal sales volumes and 87% of SUEK's coal revenues. Domestically, its coal sales are mainly to power generators, including the company's captive power plants thanks to SUEK's diversification into this segment. SUEK's own power plants buy more than half of its domestic sales of thermal coal, reducing the company's business risk. SUEK's installed electricity capacity is now about 16.0 GW while the power generation segment will contribute up to 35% into SUEK's consolidated EBITDA in 2020.

The electricity and heat generation business, which SUEK had not been exposed to before acquiring SGC in 2018, is somewhat less volatile than thermal coal mining, which is sensitive to the performance of key thermal coal export benchmarks, and will contribute to financial metrics relative resilience at a time of coal prices volatility. However, substantial debt following these M&A transactions makes the company's rating weakly positioned in its Ba2 rating category amid currently low coal prices.

SUEK's Ba2 rating factors in (1) the company's status as a global thermal coal producer; (2) the company's competitive operating costs on the back of the weak rouble and cost-efficiency measures as well as the ability to manage its capital spending needs; (3) integration into power generation, which reduces volatility of financial metrics through the cycle; (4) its vast coal reserves and high operational diversification, with 27 operating sites; (5) the company's control over a considerable portion of its transportation infrastructure (including ports in Vanino, Murmansk and Maly, and a large railcar fleet), which improves stability and reduces costs of coal deliveries; (6) its high quality of coal products, and diversified domestic and international customer base; (7) its sustainable revenue from domestic sales, which is not linked to seaborne benchmark prices; and (8) the proximity of the company's mines to its power generation customers in Russia.

At the same time, the rating takes into account (1) the high sensitivity of SUEK's earnings and leverage to the volatile thermal coal prices in seaborne markets and the rouble exchange rate; (2) the company's exposure to thermal coal; (3) its sizeable railway expenses, which mainly depend on the level of regulated cargo transportation tariffs in Russia; (4) the company's reliance on available credit facilities to maintain adequate liquidity; (5) SUEK's history of fairly aggressive liquidity management, as the company tends to address its large refinancing needs shortly before debt maturity dates, on the back of continued access to domestic and international debt financing; (6) the risks related to the company's concentrated ownership structure, although mitigated by good corporate governance; and (7) the uncertainty regarding the long-term development of carbon emission regulation, which could weaken global demand for thermal coal.

The rating action incorporates Moody's view that difficult industry conditions will persist, continuing to pressure SUEK's financial performance in 2020. 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 significantly affected by the shock given its sensitivity to demand and sentiment. More specifically, the weaknesses in SUEK's credit profile, including its exposure to steam coal have left it vulnerable to shifts in market sentiment in these unprecedented operating conditions and SUEK 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 SUEK of the breadth and severity of the shock, and the broad deterioration in credit quality it has triggered. SUEK operates in the sector considered essential for the Russian economy, which provides for the uninterrupted operations despite the measures taken in Russia to contain the spread of coronavirus and selective lock-downs in certain sectors and regions. SUEK has been included in the list of Russia's strategic entities, which would allow the company to tap certain sources of state support, in case of need, amid fairly challenging macro conditions.

The company has adequate liquidity. As of 31 December 2019, SUEK's liquidity comprised $176 million in cash and equivalents, around $1.8 billion in available credit facilities, part of which was committed, with final maturities beyond the following 12 months, and more than $1.7 billion in operating cash flow, which Moody's expects the company to generate over the same period. This liquidity would be sufficient to cover the company's short-term debt maturities of around $1.8 billion, and capital spending of nearly $1.2 billion, including lease payments, over the following 12 months. Moody's expects that the company will be able to extend the upcoming debt maturities in due course and views the related refinancing risk as low because of SUEK's continued access to international and domestic debt financing.

RATIONALE FOR THE NEGATIVE OUTLOOK

The negative outlook reflects low steam coal prices and the uncertainty with respect to the near-term recovery of the seaborne market, which may delay the company's deleveraging over the next 12-18 months.

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

Upgrade is not likely in the current market environment. However, over time Moody's could upgrade SUEK's rating if the company were to (1) reduce its total debt and Moody's-adjusted total debt/EBITDA to below 2.0x; (2) generate positive post-dividend free cash flow; and (3) maintain healthy liquidity and build a track record of addressing its upcoming debt maturities in advance, on a sustainable basis.

Moody's could downgrade the ratings if (1) the company's Moody's-adjusted total debt/EBITDA were to exceed 3.0x on a sustained basis; (2) the company was unable to generate positive post-dividend free cash flow; or (3) its liquidity were to deteriorate materially.

ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) CONSIDERATIONS

Environmental, social, and governance factors will have a growing impact on SUEK's credit quality. Moody's also believes that investor concerns about the coal industry's ESG profile are intensifying and coal producers will be increasingly challenged by the access to capital issues in the future. A growing portion of the global investment community is reducing or eliminating exposure to the coal industry with greater emphasis on moving away from thermal coal. The aggregate impact on the credit quality of the coal industry is that debt capital will become more expensive over this horizon, particularly in the public bond markets, which will lead to much more focus on individual coal producers' ability to fund their operations and articulate clearly their approach to addressing environmental, social, and governance considerations.

Governance risks are an important consideration for all debt issuers and are relevant to bondholders and banks because governance weaknesses can lead to a deterioration in a company's credit quality, while governance strengths can benefit a company's credit profile. Similarly to its domestic peers, SUEK has a concentrated ownership structure - Andrey Melnichenko is the company's principal ultimate beneficiary. Concentrated ownership structure creates the risk of rapid changes in the company's strategy and development plans, revisions to its financial policy and an increase in shareholder payouts that could weaken the company's credit quality. The risk is mitigated by the company's commitment to a conservative financial policy. Corporate governance function is exercised through the oversight of independent members, which make up four out of eight of the board of directors' seats, as well as via relevant board's committees with the audit committee being chaired by an independent director.

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

SUEK JSC (SUEK) is the holding company of one of the world's largest thermal coal producers and one of Russia's largest producers of thermal coal, electricity and heat. The company operates 19 opencast mines, eight underground mines and ten coal-washing plants in eight geographical regions, mostly in Siberia and the Russian Far East, as well as 26 power generation stations in Siberia. In 2019, the company generated revenue of $7.5 billion and Moody's-adjusted EBITDA of $2.1 billion. SUEK owns rail infrastructure, rail rolling stock, the Vanino Bulk Terminal (a coal terminal at Vanino in the Sea of Japan), the ice-free Murmansk Commercial Seaport in the northwest of Russia and a 49.9% stake in the Maly Port in the Russian Far East. The company's principal ultimate beneficiary is Andrey Melnichenko.

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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21 1st Tverskaya-Yamskaya St.
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Russia
JOURNALISTS: 44 20 7772 5456
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David G. Staples
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
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No Related Data.
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