Fixed Income Analysis /
Ukraine

Metinvest: Hold the bonds and watch the steel market

  • METINV bonds have sold off more than most Ukrainian corporates in recent weeks.

  • Steel prices have bottomed out in Europe, but uncertainty remains over coronavirus impact.

  • We think that the bonds have already paid their “cyclical” premium and reiterate Hold.

Tellimer Research
5 March 2020
Published byTellimer Research

Reiterating Hold. METINV bonds have sold off more than most Ukrainian corporates in recent weeks, both on concerns about the company’s profitability and the potential negative effects of coronavirus on the world economy. The METINV curve is 150-250bps over the sovereign and 140-150bps over MHPSA, the widest levels in 12 months. Signals from the steel market suggest that prices bottomed out in Q4 19 and Q1 20 will deliver an improvement. Despite taking a big hit on EBITDA in FY 19, net leverage remained within the covenant threshold, interest coverage raised no concerns and free cash flows were only marginally negative. In FY 20, the company’s liquidity requirement will reduce, together with capex, and if EBITDA remains at least flat yoy, in line with management guidance, net leverage would not exceed 3x and free cash flows could turn positive. The downside risk comes from coronavirus-dictated uncertainty which has kept all financial markets under pressure recently. An argument could be made to sell the bonds to minimise exposure to a cyclical industry that could be disproportionately affected in a negative scenario. However, we think that the bonds have already paid their “cyclical” premium and reiterate Hold.

Weak FY 19 misses our expectations. In FY 19, Metinvest’s revenues declined 9% yoy to US$10.8bn and EBITDA lost 52% yoy coming in at US$1.2bn, or US$1.0bn before the share of joint ventures (JVs). The company’s annual numbers were affected by particularly weak H1 and Q4 periods, when falling steel prices, tightening pellet premiums and accelerated UAH appreciation turned steel margins negative. With the metallurgical segment’s EBITDA wiped out, the consolidated EBITDA margin dropped 10ppts yoy to 11%. The resilient performance of the mining segment once again underpinned the benefits of Metinvest’s vertical integration. 

Steel prices have bottomed out in Europe, but uncertainty remains over coronavirus impact. Q4 19 proved to be the worst quarter of the year, with the company just about breaking even on the operating cash flow level (before release of working capital). In Q1 20, however, steel prices have shown positive dynamics in the EU, the key export market for Metinvest. Together with UAH depreciation at the start of the year, this could help the company show positive profitability in the steel business and improve consolidated performance. The market, however, remains fragile as the progression of the coronavirus outbreak threatens to cause disruption to the steel and iron ore markets. Metinvest’s management expects good results in Q1 20, on higher steel production and prices.

Leverage increased to 2.3x and is guided to stay under 3x in FY 20. In FY 19, Metinvest increased net debt by cUS$300mn to US$2.8bn, but the main reason behind a more than two-fold surge in leverage, to 2.3x (or 2.6x on an ex. JV basis), was lower EBITDA. Management expects EBITDA to be at least flat yoy in FY 20, which could put net leverage at 2.5x. An upside to EBITDA guidance could be realised if UAH continues to depreciate and prices for steel increase from their current levels. If the Q1 recovery proves to be short-lived, there is a risk of a further deterioration in EBITDA and an increase in leverage in FY 20. 

Liquidity in the spotlight, but capex reduction helps. In FY 19 Metinvest’s free cash flow turned negative as the company delivered a big investment programme amid compressing profit margins. In FY 20, Metinvest plans to reduce capex to US$650mn (incl, US$350mn on maintenance) and according to our estimates will require cUS$220mn to pay interest on debt. With relatively small cash reserves and limited borrowing capacity under the 3x debt incurrence covenant, these expenses will have to be financed from operating cash flows. If operating cash flows reach US$600-900mn, levels achieved in 2015-16, the company should have enough liquidity. A total of US$590mn debt falls due in 2020, which includes US$400mn of trade finance expected to be rolled over and a US$133mn PXF repayment. Liquidity requirements could increase if no refinancing options are available in 2020. Management believes that, if necessary, the PXF instalment can be repaid from cash flows and reserves.