Fitch Affirms Uranium One at ‘BB-‘; Outlook Stable
Fitch Ratings-Moscow/London-22 November 2016: Fitch Ratings has affirmed Canada-incorporated Uranium One Inc.’s (U1) Long-Term Foreign Currency Issuer Default Rating (IDR) at ‘BB-‘. The Outlook is Stable. A full list of rating actions is at the end of this commentary.
U1’s IDR includes a three-notch uplift from its standalone ‘B-‘ assessment for support from its state-owned parent, JSC Atomic Energy Power Corporation (Atomenergoprom, BBB-/Stable). We view the strategic and operational ties as strong between the two, but note that more robust legal ties, eg, guarantees for a large portion of U1’s debt, would result in closer rating alignment.
Soft uranium prices have resulted in a delay in U1’s deleveraging, which we originally expected by end-2017. As one of the lowest-cost producers globally, the company is well placed to withstand the current low price environment. Moreover, Atomenergoprom has significantly increased its support, mainly through inter-group loans to U1 that could account for nearly half of its debt at end-2016. We are focusing on 2018-2019, when we expect the uranium price and production cycle to be past its trough. This is reflected in the affirmation despite U1’s leverage exceeding our negative guidance in 2017.
Using triuranium octoxide (U3O8) spot prices of between USD24 per pound (lb) in 2017 and USD28/lb in 2020, we expect U1’s funds from operations (FFO), including dividends from JVs, to improve in 2018 and its FFO adjusted gross leverage to approach 4x by end-2018.
KEY RATING DRIVERS
Strategic Uranium Mining Asset
U1’s low-cost U3O8 production is important for Atomenergoprom, the world’s leader in uranium fuel production, nuclear power plant engineering, fabrication and construction, and a top nuclear power utility. Atomenergoprom is an integral part of State Atomic Energy Corporation Rosatom (Rosatom). With 39% of the global 2015 uranium enrichment market share, Rosatom needs low-cost feedstock to maintain enrichment margins and requires contracted uranium supply to attract reactor customers.
U1 is one of the lowest-cost uranium producers globally and the fourth-largest by attributable production volumes. Its production comes from joint ventures (JVs) in Kazakhstan with JSC National Atomic Company Kazatomprom (Kazatomprom, BBB-/Stable). U1 has an off-take agreement with Rosatom for over half of its production, predominantly at spot-based prices. As Rosatom’s international uranium marketing arm, it also has long-term off-take agreements with customers worldwide.
‘B-‘ Standalone Profile
U1’s standalone creditworthiness is constrained by its small size, dependence on production and dividends from the JVs, single-commodity exposure, and high current FFO adjusted gross leverage. U1 depends almost exclusively on dividends from JVs to service debt. From 2016, the company has consolidated 70%-owned SMCC and Betpak Dala JVs instead of using equity method accounting. However, dividend payouts from the JVs should still be approved by both U1 and Kazatomprom, as with other JVs.
In 9M16, U1 received USD118m in dividends from JVs, up from USD54m a year ago. U1’s JVs are generally debt-free and distribute most of their free cash flow as dividends. In 2016, U1 expects total attributable production of 12.5m lbs of U3O8, flat yoy.
Low-Cost Production Beneficial
U1 mines nearly all of its uranium using the in-situ leaching or recovery (ISR) method. In 3Q16, the company reported cash costs of USD7/lb, compared with USD10/lb in 3Q15 and USD13/lb in 3Q14, down on weak tenge and cost optimisation. In recent years, the company’s average realised uranium prices closely matched spot price, distinguishing it from some other miners eg, Kazatomprom, which sell their uranium at a mix of long-term and spot prices. However, fixed contract prices and price floors have had a more pronounced impact in the depressed price environment. U1’s average realised price in 3Q16 was USD30/lb, five dollars higher than the average spot price.
Uranium Prices Remain Volatile
In November 2016, spot uranium prices reached a 12-year low of USD18.5/lb. In 10M16, average spot prices fell to USD27/lb, down from USD36.5/lb in 2015, as producers faced with lower volumes and low-price bids continued to off-load abundant supplies. Uranium stockpiles have reached over 1.4bn lbs, according to Ux Consulting (UxC). In 2016, primary production and secondary supplies of 207m lbs U3O8 are expected to exceed UxC’s base case demand of 186m lbs U3O8, including inventory build-up.
The reactor re-starts in Japan have taken much longer than the industry anticipated. There are currently two operating reactors there, in addition to five approved for re-start. UxC had expected as many as 13 Japanese reactors online by end-2016 (see ‘Uranium Prices May Remain Under Pressure Until 2020’ dated January 2016 at www.fitchratings.com). Globally, there are 60 reactors under construction including 37 in Asia, mainly in China, India, and South Korea.
Producers are responding by mothballing mines and cancelling projects. In 2016, Canada’s Cameco is suspending its Rabbit Lake mine operations, and curtailing mines in Wyoming and Nebraska, which will reduce net primary production by 5m lbs U3O8. Australia’s Paladin Energy is halting mining at Namibia’s Langer Heinrich and over the next two years will process lower grade stockpiles there, reducing production by up to 1.0m-1.5m lbs U3O8 per year.
Fitch’s key assumptions within our rating case for U1 include:
– Increase in attributable uranium production to 13.5m lbs from 12.5m lbs in 2016.
– U3O8 spot prices of USD28/lb in 2016, USD24/lb in 2017 – 2018, USD25/lb in 2019 and USD28/lb in 2020.
– Broadly stable USD/KZT exchange rate in 2016-2020 averaging 1/330.
– Annual consolidated capex and other investments of USD35m.
– No dividend distributions to shareholders.
Positive: Future developments that could lead to positive rating action include:
– Evidence of stronger legal linkage with the parent, ie, financial guarantees for a large portion of U1’s debt, cross default provisions that included U1 or a higher share of U1’s debt provided by the parent.
– Improved financial profile, e.g., FFO-adjusted gross leverage of below 3x and FFO fixed charge cover of at least 4x on a sustained basis, which would be positive for U1’s standalone profile.
Negative: Future developments that could lead to negative rating action include:
– Weakening linkage with the parent, eg, the inability to obtain timely refinancing from the parent company or its subsidiaries, which could result in Fitch reviewing the current level of parental support.
– Weak liquidity due to lower than expected dividends from JVs as a result of sustained depressed uranium prices.
– Failure to improve the financial profile by end-2018 including FFO adjusted gross leverage of above 5x and FFO interest coverage of less than 2x based on uranium price assumptions, which would be negative for the standalone profile.
Parent Funding Strengthens Liquidity
At 30 September 2016, U1 had USD220m of unrestricted cash, while its short-term debt included a USD34m rouble bond repayment plus a USD61m FX swap payment on that bond. Atomenergoprom provided U1 with a USD95m loan to help pay down these obligations.
The company plans to pre-repay its outstanding USD210m Eurobond due in 2018 later this year. Atomenergoprom has agreed to provide an amortising three-year USD165m loan and a USD50m short-term loan, at interest rates materially lower than the Eurobond’s coupon. Assuming that the Eurobond is repaid and the USD50m credit line remains undrawn, we expect inter-group debt from the parent to make up 45% of the total at end-2016. U1’s remaining third-party debt consists of a rouble bond due in 2020 with a swap-adjusted principal equal to USD390m.
FULL LIST OF RATING ACTIONS
Uranium One Inc.
– Long-Term Foreign Currency IDR: affirmed at ‘BB-‘; Outlook Stable
– Long-Term Local Currency IDR: affirmed at ‘BB-‘; Outlook Stable
– Short-Term Foreign Currency IDR: affirmed at ‘B’
– Short-Term Local Currency IDR: affirmed at ‘B’
– Senior unsecured rating: affirmed at ‘BB-‘
Uranium One Investments Inc.’s USD300m 6.25% notes due 2018
– Senior unsecured rating: affirmed at ‘BB-‘
Summary of Financial Statement Adjustments
– Operating leases: Fitch adjusted U1’s debt by adding 6x the annual operating lease expense of USD1.6m.
– Not readily available cash: Fitch estimates that U1 needs USD5m of cash on balance for various corporate purposes such as working capital funding and deducts this amount from U1’s readily available cash.
– FX debt hedge: Fitch adjusts U1’s RUB2.5bn and RUB12.5bn rouble bonds by the effect of rouble to US dollar FX swaps, so that the dollar-denominated principals are equal to USD95.4m and USD389.9m, respectively.