Turnaround delivered. Petropavlovsk has been successfully rebuilding its operating and financial credibility over the past year. The company (1) finished, tested and launched the state-of-the-art pressure oxidation facility (POX), (2) refinanced its debt and, (3) has recently benefitted from rallying gold prices.
We upgrade POGLN 22s to Buy. Positive developments in the company’s credit profile changed sentiment around the POGLN 22s causing the bonds to rally since the beginning of the year. Having come a long way from a distressed to high-yield level, POGLN 22s still have an upside. We expect POGLN 22s to continue to converge with the low-yielding Russian corporate bond universe and expect currently indicated 750bps z-spread to tighten to 600-650bps.
Improved operating profile – the POX, refractory ore and third-party concentrate. The POX facility has unlocked Petropavlovsk’s refractory ore reserves, paving the way for future production growth. However, the company’s existing mining operations cannot fully load the new facility. Hence, in the short-term, the way to maximise cash flows from the POX is to process third-party concentrate. Management is considering buying third-party concentrate and processing it at the POX. This is likely to increase working capital requirements. The company’s gold sale contracts with a leading Russian bank allows it to receive prepayments within a revolving limit of up to 175Koz in 2019-2020, which could be used to finance the working capital.
Supportive commodity markets – gold above US$1,400/oz and iron ore above US$120/t. For the first time since 2013, gold prices surged above US$1,400/oz. According to our estimates, the company could generate US$140-160mn in operating cash flow assuming production and cash costs meet management guidance. Iron ore at multi-year highs suggest that Petropavlovsk’s associate IRC could be in a good shape to service its debt without Petropavlovsk having to step in as a guarantor.
Refinancing lifts liquidity pressure. The company has just completed early refinancing of US$100mn convertible bonds due 2020 with a new US$125mn 5-year convertible issue. In 2019, IRC refinanced a US$240mn loan guaranteed by Petropavlovsk and reduced its contingent liabilities due to lower annual payments and changes to the guarantee structure. Besides, IRC has repaid US$57mn worth of bridge loans to Petropavlovsk.
Deleveraging is in sight. In 2018, the company produced 422Koz of gold. Revenue was US$500mn, EBITDA at US$143mn, net leverage at 4x and interest coverage at 2.4x. In 2019, we expect Petropavlovsk to increase revenues to US$650mn and EBITDA to US$175mn, based on 450-500Koz production guidance, US$850-900/oz total cash cost guidance and US$1,350/oz average gold price. Net leverage is likely to reduce to 3.5-4x and the interest coverage ratio to recover to c3x level. With production outlook and current gold prices increasing operating cash flows, and reduced liquidity pressure after the refinancing of convertible bonds and the IRC loan, we view the credit as improving.