Fitch Affirms Magnesita's IDRs at 'BB'; Outlook Revised to Stable

CHICAGO--()--Fitch Ratings has affirmed the foreign and local currency Issuer Default Ratings (IDRs) of Magnesita Refratarios S.A. (Magnesita) at 'BB' and its National Scale Ratings at 'AA-(bra)'. The Rating Outlook is revised to Stable from Negative. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The Outlook revision to Stable reflects an improvement in Magnesita's leverage. Fitch's base case indicates that the company's net debt to EBITDA ratio will reach 3.4x in 2016, with a decline to around 3.1x in 2017. These ratios compare with 4.8x in 2015. Improved global competitiveness and profitability gains primarily from a weaker currency, lower capex and interest payments are expected to enhance free cash flow generation (FCF). Cash generated by the sale of its talc business (estimated USD45 million, on net basis) should also help to reduce leverage during 2017.

The sluggish steel industry remains a challenge for Magnesita as it tries to grow its client base and operating cash flow. The company will remain reliant upon gains in North America market share and improved penetration of new markets to offset the weak performance of its Brazilian operations. Positively, over the last few years Magnesita has increased its geographic footprint, reducing its exposure to Brazil for approximately 30% of revenues.

The ratings include Fitch's expectation that Magnesita will continue to seek its conservative and proactive financial policy, underpinned by adequate cash holdings and a manageable debt schedule amortization in order to avoid refinancing risks.

Solid Business Profile; Vertical Integration

Magnesita's ratings are supported by its low-cost and vertically integrated business model, long-life mine reserves, and its position as the world's third largest refractory manufacturer in a highly fragmented market. The company's core business is refractory solutions, comprising 87% of BRL3.6 billion in revenues during the last 12-month period (LTM) ended on June 30 2016, followed by its services business line (6%), and its minerals segment (6%). The company has strong long-term relationships with customers throughout the world, including the largest Brazilian steel producers, as well as leading Brazilian and international cement producers.

Increasing Geographical Diversification

Magnesita is highly exposed to the cyclical steel industry, which accounted for 73% of consolidated revenues in June 2016. Over the past several years, the company has reduced its dependence on the Brazilian steel industry to a projected 27% of revenues in 2016 from 36% in 2012. Fitch expects this percentage to fall to a range of 20% to 25% in the medium term. Magnesita's market share for the Brazilian steel market is around 70%, but in other regions with improving steel industry prospects, such as the U.S., it has greater growth potential. Magnesita currently has an estimated U.S. market-share of around 20%.

Stable Margins

Despite weak Brazilian steel volumes and negative industry trends, Magnesita has been able to maintain relatively stable EBITDA margins. During the last 12 months, the depreciation of the Brazilian Real (BRL) bolstered the company's profitability and improved Magnesita's competitiveness in the international market. Fitch expects Magnesita's EBITDA to trend around 14%-15% during the next three years, which it is still sound compared to its peers which exhibit average EBITDA margins of around 12%.

Improved Operating Cash Flow

Magnesita's FCF going forward is expected to be benefited from lower capex due to the conclusion of the SAP roll-out, lower interest expenses as result of liability management, and more efficient working capital management. Under Fitch's base case scenario, Magnesita's CFFO, EBITDA and FCF for 2016 are expected to be approximately BRL278 million, BRL546 million and BRL57 million, respectively. These figures compare positively with BRL189 million, BRL462 million of CFFO and EBITDA, respectively and a negative FCF of BRL50 million. Fitch expects the company's capex to trend closer to around BRL220 million in 2016, down from BRL240 million in 2015.

Deleverage Trend

Stronger EBITDA generation, as a result of profitability gains from FX, has been supporting a deleverage trend for Magnesita. As of June 30, 2016, the company's total and net adjusted debt-to-LTM EBITDA ratios were 5.1x and 3.6x, respectively, compared to 7.5x and 5.0x by year-end 2014. Fitch's base case indicates that its net debt to EBITDA ratio will reach 3.4x in 2016, with a decline to around 3.1x in 2017. Per Fitch's 2017 forecast, Magnesita is expected to receive BRL148 million from the sale of its Talc Business.

KEY ASSUMPTIONS

--Low-digit revenue growth from 2016 onward;

--Softer but still resilient EBITDA margins - EBITDA margin in the 14%-15% range;

--Capex at around BRL220 million in 2016, slightly decline to BRL207 million in 2017 and BRL230milion in the next two years;

--Dividends at 25% from 2017 onwards;

--Cash balance remains sound compared to short-term debt;

--Reserve life replenished annually;

--No large-scale M&A activity.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

--An upgrade is unlikely in the medium term due to sluggish perspectives for the global steel industry and Magnesita's still weak operating cash flow basis compared to issuers in the 'BB' rating.

Negative: Future developments that may, individually or collectively, lead to a negative rating action:

--Prolonged downturn in the cyclical steel and cement markets that hampers production volumes globally more than expected;

--Market share erosion in Brazilian market;

--EBITDA margins declining below 14% on a sustained basis;

--Failure to reduce net adjusted leverage below 3.5x;

--Deterioration of adequate liquidity compared to short-term debt, leading to refinancing risk exposure;

--Large debt-funded M&A acquisition that adversely impacts Magnesita's capital structure on a sustained basis.

LIQUIDITY

Magnesita's liquidity is adequate. As of June 30, 2016, the company had BRL2.6 billion of debt, of which BRL536 million is due in the short term, while cash and marketable securities was solid at BRL752 million. The company's cash position is enough to meet all current debt maturities through 2017. Fitch expects it to access the credit market during 2017 in order to refinance maturities coming due in 2018 and 2019. Positively, Magnesita has demonstrated proven access to export credit lines that could also be an alternative source of future funding. The company's inability to carefully avoid refinancing risk within the near term, may pressure its ratings.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Magnesita Refratarios S.A.

--Foreign currency long-term IDR at 'BB';

--Local currency long-term IDR at 'BB';

--National long-term rating at 'AA-(bra)';

--Local Debentures issuance at 'AA-(bra)'.

Magnesita Finance Ltd.

--Senior unsecured ratings at 'BB'.

The Rating Outlook is revised to Stable from Negative.

Date of Relevant Rating Committee: Oct. 4, 2016

Additional information is available on www.fitchratings.com.

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012709

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Contacts

Fitch Ratings
Primary Analyst
Debora Jalles
Director
+1-312-606-2338
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Alejandra Fernandez
Director
+562-499-33-23
or
Committee Chairperson
Joe Bormann, CFA
Managing Director
+1-312-368-3349
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com