Hi, came across this ratings note from fitch (which I haven’t...

Hi, came across this ratings note from fitch (which I haven’t heard of before) and thought I’d share.

https://www.fitchratings.com/research/corporate-finance/fitch-revises-nickel-mines-outlook-to-negative-affirms-rating-at-b-22-05-2022

Fitch Ratings - Sydney/Jakarta - 22 May 2022: Fitch Ratings has revised the Outlook on Indonesia-based Nickel Mines Limited's (NIC) Long-Term Issuer Default Rating (IDR) to Negative from Stable, and affirmed the IDR at 'B+'. Fitch has also affirmed NIC's USD325 million senior unsecured notes at 'B+' with a Recovery Rating of 'RR4'.

The Outlook revision is due to increasing liquidity risks from contagion related to the problems faced by NIC's sole off-taker, Tsingshan Holding Group Co., which made a loss on its short nickel position in early March 2022. Tsingshan is also NIC's majority shareholder with a 21.15% stake through Shanghai Decent Investment. A consortium of hedge bank creditors that has a standstill agreement with Tsingshan agreed not to close out the positions against the company or to make further margin calls on the existing positions. We understand that Tsingshan has since closed a number of the positions in an orderly manner, which would ease the overhang for the banks.

The Negative Outlook also reflects the risk of NIC failing to access to additional funding to make a scheduled USD212 million acquisition payment for PT Oracle Nickel Industry (ONI) due December 2022. We believe free cash flow generation in 2022 may be insufficient to cover part of the scheduled payment - although NIC's strong rotary kiln electric furnace (RKEF) margin could alleviate the need for additional funding. Nevertheless, we have affirmed the ratings in light of NIC's strong cash flow generation and competitive cost position.

KEY RATING DRIVERS

Sole Counterparty Exposure: Tsingshan has a commitment to buy all of NIC's nickel pig iron (NPI) production. It also has the equity interest and provides technical oversight and ancillary services within the ecosystem in the Indonesia Morowali Industrial Park (IMIP), which contains NIC's assets. The reliance on Tsingshan highlights NIC's concentration risk, but we believe their interests are aligned, as NIC is an important raw-material supplier to Tsingshan. NIC's operations and cash flow remained stable during 1Q22, despite Tsingshan's stress.

Financial Data Limitations: Tsingshan is a private company for which we do not have detailed financial information. Still, we believe the risk of Tsingshan not meeting its obligations to NIC is captured in the rating. This is supported by the Tsingshan group of companies being the world's largest stainless steel producer and NIC being a critical part of its supply chain. However, we believe NIC's reliance on Tsingshan creates contagion risk, especially as NIC has a large funding gap in the acquisition payment due over the next 12 months.

Acquisition Funding Gap: We expect free cash flow (FCF) to stay positive through to 2023, supported by a strong EBITDA margin, the absence of major capex and steady shareholder returns. This will keep NIC's debt/EBITDA below 2.0x during the period (FY21: 1.7x). However, we estimate that NIC's FCF generation is likely to be insufficient to cover the entire ONI acquisition payment in December 2022. NIC acquired a 30% stake in ONI through a mix of internal cash and equity issuance.

Nonetheless, NIC has a record of raising equity to fund acquisitions to limit the rise in leverage. NIC has raised USD106 million through institutional placements and issued USD106 million in additional shares to Tsingshan in 2022 to support its ONI acquisition.

Rising Production: We expect NIC's nickel production scale to more than double to above 100,000 tonnes (t) by 2023, from around 40,000t in 2021. This will be supported by subsidiary PT Angel Nickel Industry (ANI) commencing full production in 4Q22 and ONI starting production in 2023, reaching full capacity in 3Q23. ANI has obtained its sales licence after the full commissioning of four RKEF lines in May 2022. NIC believes ONI's progress will allow it to begin its first NPI tap by end-February 2023.

Improving Asset Diversification: Higher production at ANI, which is located in Indonesia's Weda Bay Industrial Park, will boost NIC's asset diversification. NIC's current assets, including ONI, are in the IMIP. The full operation of ANI and ONI will increase NIC's capacity to 102,000t a year by 2023, from 30,000t currently.

Solid EBITDA Margin: We expect an EBITDA margin of around 35%-36% through to 2023 (2021: around 36%). NIC's strong EBITDA margin of 42% in 1Q22 was supported by stable raw-material costs amid IMIP's centralised procurement and inventory management. NIC's solid cash cost position at its NPI facilities should help it weather the impact of commodity price fluctuations on selling prices and input costs. The purchase of nickel ore and thermal coal accounts for around 30%-40% and 25%-30%, respectively, of NIC's costs.

The strong margin should also be supported by the similar economic models at ANI and ONI. NIC's RKEF processing facilities - PT Hengjaya Nickel Industry (HNI) and PT Ranger Nickel Industry (RNI) - are strategically located at IMIP. Indonesia is one of the world's largest nickel producers and the Morowali regency has some of the country's largest nickel ore deposits. A ban on raw ore exports and close proximity to ore supply give NIC the advantages of cheaper raw-material prices and low logistic costs.

DERIVATION SUMMARY

We believe NIC has a better credit profile than Guangyang Antai Holdings Limited (B/Stable). Guangyang Antai's larger operational scale and revenue generation, as China's third-largest stainless-steel producer, are offset by NIC's solid cash cost position and credit metrics. Guangyang Antai's business profile and margin are weighed down by its increasing exposure to the lower-margin trading business.

NIC's cash flow generation is significantly better, with an EBITDA margin of above 35%, supported by a strong cash cost position. In comparison, Guangyang Antai's EBITDA margin is less than 5%. We expect NIC's net debt/EBITDA to be lower than Guangyang Antai's above 2.5x. However, NIC's Negative Outlook reflects its liquidity risk from the absence of a funding facility to cover its December acquisition payment.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

- Stable production at HNI and RNI in 2022-2023

- Full production at ANI to commence in 3Q22 and full production at ONI to commence in 3Q23

- EBITDA margin of around 35%-36% in 2022-2023

- Minimal capex at subsidiaries, as major investment projects were recently completed

- USD525 million acquisition of ONI to be paid incrementally from 4Q21 until 1Q23

KEY RECOVERY RATING ASSUMPTIONS

The recovery analysis assumes that NIC would be reorganised as a going concern in bankruptcy rather than liquidated. We assume a 10% administrative claim.

Our going-concern EBITDA estimate reflects our view of a sustainable, post-reorganisation EBITDA level upon which we base the enterprise valuation.

Our going-concern EBITDA estimate of USD240 million reflects the mid-cycle nickel price and stable RKEF operations at HNI and RNI, as ANI just recently commissioned its RKEF. We use a multiple of 5x to estimate a value for NIC because of its geographical concentration in Indonesia and smaller operational scale compared with peers, despite stronger growth prospects following ANI's production commencement.

The going-concern enterprise value corresponds to a 'RR1' Recovery Rating for the senior unsecured notes after adjusting for administrative claims. Nevertheless, we rate the senior unsecured bonds at 'B+' and 'RR4' because NIC's operating assets are located in Indonesia. Under our Country-Specific Treatment of Recovery Ratings Criteria, Indonesia is classified under the Group D of countries in terms of creditor friendliness and Recovery Ratings are subject to a cap at 'RR4'.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- The Outlook may be revised to Stable if NIC is able to improve liquidity or demonstrate access to debt or the capital market to enable it to meet its acquisition payment

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- Deteriorating liquidity position

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Hi, came across this ratings note from fitch (which I haven’t heard of before) and thought I’d share.

https://www.fitchratings.com/research/corporate-finance/fitch-revises-nickel-mines-outlook-to-negative-affirms-rating-at-b-22-05-2022