Fitch Affirms Samarco's IDRs at 'BBB'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the 'BBB' foreign and local currency Issuer Default Ratings (IDRs) of Samarco Mineracao S.A. (Samarco), as well as its 'BBB' senior unsecured notes ratings. Fitch has also affirmed Samarco's National Rating at 'AAA(bra)'. The Rating Outlook is Stable.

KEY RATING DRIVERS

Highly Profitable Operations

Samarco has a long track record of consistent high profitability. The company's latest 12 months (LTM) to March 31, 2014 EBITDA margin was 53.9%, and has consistently remained above 50% over the last decade except during the global credit crisis of 2009, when it was 42% and 2007 when it was 45%. The more recent strong profitability was due to surging demand for pellets as steel mills sought more energy-efficient raw material inputs to offset higher energy costs, which began during the second half of 2009 and continued through to the first quarter of 2014. Samarco regularly commits its entire production up to a year in advance through its long-term contracts with customers. For the LTM ended March 31, 2014, Samarco generated net revenue of BRL7.2 billion and LTM EBITDA of BRL3.8 billion.

Low-Cost Producer of Iron Ore Pellets

Samarco's credit profile benefits from its position as a low-cost producer of iron ore pellets and geographical revenue diversification. The company continues competitive during difficult trading conditions because of its low-cost iron ore transportation through its slurry pipelines. The P4P project started its operations in March 2014, following a total capex of approximately BRL6.4 billion. The project will allow the company's low-cost position to improve further and remain profitable even during periods of low prices and lower pellet demand. Samarco ships 97% of its production to steelmakers in 20 countries. In 2013, the company had 41 customers' distributed across Africa/Middle East (29%), Europe (20%), China (15%), Americas (14%) and other Asian markets (22%). Unusually for producers of seaborne iron ore products, Samarco's sales exposure to China is modest.

Positive BRL Devaluation Effect

Samarco's revenues reached a high of BRL7.2 billion in 2013 from BRL6.5 billion in 2012. This increase was mainly attributable to the depreciation of the Brazilian Real versus the US Dollar with the average exchange rate at 2.16 BRL/USD in 2013 compared to 2.04 BRL/USD in 2012. Both years exhibited similar average pellet prices of USD154 per dry metric ton (DMT) and the company sold similar iron pellet and fines volumes of around 22 million DMT. Samarco is well placed to benefit from the expected continued devaluation of the BRL with 98.7% of its 2013 revenues generated in USD, while its costs were 67.5% in BRL (32.5% in USD). The company's debt profile closely reflects this currency split with USD denominated debt comprising 98% of total debt and BRL local debt comprising 2%.

Lower Pellet Prices Expected

Fitch's pellet price assumptions for Samarco in 2014 have a starting point of USD100 per metric ton (China import iron ore fines 62% CFR basis), as indicated by the agency's recently updated mid-cycle commodity price assumptions, taking into account expectations for pricing vis-a-vis the iron ore surplus expected over the next few years. This price is then adjusted for 65% iron ore content and the mix of Blast Furnace (BF) and Direct Reduction (DR) pellets (higher Fe content of 67.5%), adding a conservative pellet premium of USD35 per DMT, and deductions relating to freight to reach USD122 per DMT for the year. Fitch's longer term pellet price assumptions decrease to USD111 per MT using the same approach with a USD90 per metric ton mid-cycle commodity price assumption for iron ore from 2015 onwards.

Sufficient Liquidity Profile

Compared to other investment-grade Brazilian corporates, Samarco holds relatively modest cash and marketable securities on its balance sheet. This position is dictated by Samarco's dividend payout ratio target, under normal operating conditions, of 100% of free cash flow (FCF) to Vale and BHP Billiton. The company's cash and marketable securities as of March 31, 2014 were BRL1.2 billion compared with short-term debt of BRL960 million. The company uses a combination of ACC/ACE financing alongside uncommitted bank lines as an additional source of liquidity when required. Liquidity is also strong when measured by cash plus cash flow from operations (CFFO)/short-term debt which indicates a ratio of 4.8x coverage for the LTM ended March 31, 2014. Fitch would expect Vale and BHP Billiton to reduce dividends paid by Samarco should the company require further liquidity, as seen during 2012.

Leverage Increase due to Investments

Samarco has exhibited low leverage ratios during the past five years, but debt has increased every year since 2010 as a result of the P4P and third pelletizing plant project, as expected. For the LTM to March 31, 2014, the company had a net debt-to-EBITDA ratio of 2.1x. In 2013 and 2012, Samarco had net debt-to-EBITDA ratios of 2.2x and 1.5x, respectively.

Leverage Ratios Expected to Remain Stable

Samarco's net debt-to-EBITDA ratio is expected at around 2.2x in 2014 and to remain at similar levels through 2017 under Fitch's Base Case. Fitch previously expected to see a decrease in leverage from 2014 as a result of the higher pellet volumes following the launch of P4P project and resulting lower capex.

Fitch's revised view is based upon the lower average iron ore prices expected in 2014 and the next few years, notwithstanding higher volumes and lower capex. Funding for P4P has been achieved through cash freed-up by lower dividend payments to Vale and BHP Billiton during the investment period and a USD1 billion senior unsecured notes issuance in October 2012 followed by an additional USD700 million in October 2013. These investments will see Samarco's production capacity increase from 22 million DMT in 2013 to around 27 million DMT in 2014, rising to 30 million DMT per year by 2015. Samarco's total debt as of March 31, 2014 was BRL9.2billion, an increase from BRL6 billion at the end of 2012, reflecting the issuance of the senior unsecured bonds during the period.

Strong Cash Flow Generation

Fitch views Samarco's cash flow generation as robust due to its low cost structure, with the company's annual FCF position dictated by the amount of dividends paid to its parent companies. Fitch would expect BHP Billiton and Vale to continue to scale down dividends if operating conditions required additional liquidity, as seen both recently and historically. In 2013, the company's FCF was negative BRL1.9 billion after large capex of BRL2.7 billion and high dividends of BRL2.6 billion. FFO was BRL3.5 billion and after a small working capital outflow, CFFO reached BRL3.3 billion. This performance compares to FFO of BRL3.0 billion and CFFO of BRL3.1 billion in 2012.

Fitch expects FFO of approximately BRL3 billion during 2014 in its Base Case projections, then remaining at around BRL2.7 billion thereafter reflecting a lower pricing scenario.

Significant Contingent Liabilities

Samarco is subject to a large number of pending judicial and administrative proceedings in various courts and with government agencies. They have arisen as a result of the company's normal course of operations and include tax, civil, labor and environmental issues. Management has made a provision for these contingencies in an amount considered sufficient to cover cases considered as probable losses. They amounted to BRL177 million in 2013 and are not considered material in the context of the rating. Samarco also has other contingent liabilities that amount to BRL4.5 billion related to tax, civil, labor, environmental and social contributions on net income (CSLL) for which no provisions have been made. This is due to the company's legal assessment that losing is not probable, but that it is possible. The company only makes provisions for probable loss.

Should Samarco lose some or all of these cases, the expected outcome would be a payment scheme similar to REFIS that would take place over a long time period, hence mitigating any rating impact. Possible penalties arising from an unsuccessful outcome could be paid should Vale and BHP Billiton choose not to take dividends for one to two years. Fitch considers these contingent liabilities as an event risk.

Strong Parental Ownership

Samarco benefits from its ownership under two industry leaders, Vale S.A. (Vale: Long-term IDR 'BBB+' by Fitch) and BHP Billiton Limited/Plc (BHP Billiton: Long-term IDR 'A+'), with each company owning 50% of Samarco. Fitch believes Samarco's two strong shareholders, with combined operating EBITDA in 2013 of over USD50 billion, would support Samarco in the event of a sovereign-related liquidity crisis due to reputational risk.

RATING SENSITIVITIES

Dependency on Iron Ore Pellet Demand

Samarco is a one-product company, a policy dictated by its parent companies. Demand dynamics for iron ore pellets are improving, although they currently remain vulnerable to substitutes during troughs in the industry cycle. A prolonged period of low demand for iron ore pellets could lead to a negative action. Ratings could also be downgraded if Samarco's credit ratios weaken significantly, in particular if its total debt-to-EBITDA ratio exceeds 2.5x on a sustained basis. Rating upgrades are currently unlikely given the single-product nature of the company.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014);

--'National Ratings - Methodology Update' (Jan. 19, 2011).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=851594

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Contacts

Fitch Ratings
Primary Analyst
Jay Djemal, +1 312-368-3134
Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Debora Jalles, +55 21 4503 2629
Director
or
Tertiary Analyst
Ricardo Carvalho, +55-21-4503-2627
Senior Director
or
Committee Chairperson
Joe Bormann, CFA, +1 312-368-3349
Managing Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Jay Djemal, +1 312-368-3134
Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Debora Jalles, +55 21 4503 2629
Director
or
Tertiary Analyst
Ricardo Carvalho, +55-21-4503-2627
Senior Director
or
Committee Chairperson
Joe Bormann, CFA, +1 312-368-3349
Managing Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com