Reiterate Hold. Weak steel prices in Europe and normalisation in the iron ore market combined with the margin-diluting effect of UAH appreciation will keep Metinvest’s profitability, cash flows and leverage under pressure in 2020. However, a strong starting position in terms of leverage (1.3x) and liquidity, strengthened by the recent bond placement, could support METINV bonds through the steel market headwinds. METINV’s spread to the sovereign has already widened materially to 110-150bps, having traded as tight as 50bps inside UKRAIN in 2019. Unless Metinvest’s profitability begins to recover, we expect the bonds to underperform the sovereign, and MHPSA and KERPW, which are both better positioned to weather the challenges that next year will bring.
Weak steel prices and strong UAH put pressure on profitability. Steel prices came off their peaks in mid-18 and have been declining since then. According to our calculations, Metinvest’s average realised steel price in 9M 19 was 9% yoy lower. This seemingly small decrease when combined with the margin-dilutive effect of UAH appreciation and cost inflation materially reduces the profitability of Metinvest’s metallurgical operations. The mining segment, which benefited from high iron ore prices, growing volumes and an improving product mix, partially offset the metallurgical EBITDA fallout. However, in 9M 19, Metinvest’s revenues fell by 6% yoy to US$8.5bn, EBITDA was down 39% yoy at US$1.2bn and the EBITDA margin (excluding the results of the joint ventures – JVs) narrowed by 7pts to 13% (Table 1).
Cyclically increasing leverage. If revenues and EBITDA stay on their 9M 19 course, net leverage could approach 2x by end-19. This still leaves plenty of room under the 3.0x debt incurrence threshold and does not compromise cash flows, which we estimate fully cover the planned US$1bn of capex (including cUS$0.6bn maintenance) and cUS$200mn interest. If sentiment in the steel market does not improve and UAH continues to strengthen, Metinvest’s leverage could increase further in 2020. The company partially refinanced 2023 peak maturities with new US$500mn notes due 2029 and EUR300mn bonds due 2025 issued in September. We estimate that Metinvest’s short-term debt – US$380mn trade finance and cUS$200mn of loans and bonds – was nearly fully covered by US$570mn pro-forma cash, suggesting the company is prepared for a rainy day.
Market environment to remain challenging in 2020. More than 60% of Metinvest’s exports went to Europe in 9M 19, a region where economic growth has been decelerating, and steel prices remain under pressure. Based on the relationship between Metinvest’s realised steel prices and the benchmark steel price index, we expect them to decline further in Q4. Additional downside pressure on margins comes from the rapid UAH appreciation – this tends to push up costs for exporters, who earn most of their revenues in hard currency and pay most of their expenses in local currency.