Downgrading to Sell. Metinvest’s yield curve shifted up considerably after its sister company DTEK Energy announced a debt restructuring. Looking at METINV bond prices, a fair question to ask is, where are they more likely to go next: up or down? In search of the answers, we turn to the steel and iron ore markets for guidance. What we see are seriously declining steel prices and softening iron ore, trends that will increase pressure on Metinvest’s profitability. According to our estimates, the company needs a minimum US$560mn-690mn to meet interest payments, capex commitments and repay maturing debt in 2020, but has limited (US$290mn) cash reserves to fall back on. Hence, Metinvest’s ability to generate sufficient cash flows in 2020 has become the key variable and the main credit criterion. We are concerned that, with continued pressure on commodity prices, Metinvest’s EBITDA could substantially fall or turn negative in Q2. In this environment, there is little upside in holding METINV bonds. We downgrade the METINV 23s, 26s and 29s to Sell.
Steel and iron ore prices are yet to respond to the double blow of falling oil and COVID-19. After a disappointing Q4 19, when Metinvest’s EBITDA was negative US$21mn, on the back of falling steel prices and rapidly appreciating UAH, 2020 started on a positive note. Steel recovered, UAH weakened and the Q1 20 outlook was upbeat. Everything changed in March, when the OPEC+ agreement fell apart, sending oil prices to 20-year lows (as of mid-last week) and the EU leading economies went into lock-down to contain the spread of COVID-19. Recession in the EU, the main export market for Metinvest, looks increasingly likely in 2020, leaving little room for a positive view on commodity prices. All that suggests that the brief Q1 recovery in steel prices has already reversed, even if we have not yet seen it in the numbers. According to Bloomberg, prices have started to adjust: hot-rolled coil (HRC) FOB Black Sea, an export benchmark price for Ukraine, is down to Q4 19 levels. Iron ore is also coming off, as indicated by China spot import prices. These levels are still significantly higher than during the 2015-16 cyclical downturn, but the situation is deteriorating quickly.
UAH has not depreciated enough to offset negative prices. According to Metinvest (footnote to the FY 19 financials), a 25% UAH depreciation could generate additional US$130mn a year in after-tax profit if all other variables remain unchanged. Assuming a linear relationship between the exchange rate and its effect on profitability, a 17% ytd depreciation in 2020 could bring an extra US$88mn to the P&L or US$22mn a quarter. This is likely to support cash flows, but is not nearly enough to compensate for the negative effect of declining prices.
Liquidity and cash flow outlook. In these turbulent times, our key focus is on liquidity. Metinvest reported US$291mn cash at the end of January and total debt of US$3,027mn. From the FY 19 disclosures, we know that the company has US$133mn of PXF amortisations in 2020 and cUS$350mn committed capex, out of US$650mn planned for the year. According to our calculations, interest on bonds and loans will amount to cUS$210mn in 2020. Trade finance facilities (US$400mn) are, by their very nature, short term and could be expected to rolled over in the normal course of business, an assumption that may change as the situation develops. Altogether, Metinvest’s funding requirements sum up to US$560mn-1,000mn in 2020. Our low estimate includes only interest and committed capex; the high estimate also incorporates PXF repayment and strategic capex. Under our current projections, Metinvest could generate sufficient cash flows to cover US$560mn, but the situation is evolving and a lot depends on steel and iron ore prices. Arguably, short-term debt could be refinanced, but it is not yet clear whether credit markets will remain open for highly leveraged (as Metinvest will soon become) commodity players.