Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has revised JSC Uzbek Metallurgical Plant’s (UMK) Outlook to Negative from Stable, while affirming its Long-Term Issuer Default Rating (IDR) at ‘BB-’.

The Outlook revision is driven by UMK’s higher-than-expected leverage in 2023-2024 as the company’s expansionary capex coincides with weaker market conditions and increased production costs. While Fitch Ratings expect UMK’s leverage to moderate from 2025-2026, its liquidity is tight and its flagship Casting and Rolling Complex project remains subject to execution risks. These factors exert pressure on UMK’s ‘b+’ Standalone Credit Profile (SCP), which also reflects UMK’s small, though increasing, scale and corporate governance limitations, as well as a solid position in the domestic market in Uzbekistan and moderate costs.

Based on Fitch’s recently updated Government Related Entities (GRE) Rating Criteria, Fitch Ratings rate UMK on a bottom-up basis, and give it a single-notch uplift to the SCP for the state support. UMK’s support score is 25, which underlines ‘Strong’ expectations for support from the state, based on criteria definitions.

Responsibility to Support: Fitch Ratings view UMK’s decision-making and oversight by the government as ‘Strong’, given the state’s 93% stake in the company and its control over the company’s operating activity and investment programme. Fitch Ratings assess precedents of support as ‘Very Strong’ as almost half of external funding for the Casting and Rolling project was provided by the state. This is despite the government not guaranteeing any of UMK’s debt.

Incentive to Support: Fitch Ratings assess UMK’s preservation of government policy role as ‘Strong’ given the company accounts for 80% of all steel products produced in Uzbekistan and more than a third of steel products consumed within the country (this should increase to more than half after the Casting and Rolling project is commissioned). A UMK default would hit development of the national steel industry and may hinder the development of the construction and metals and mining sectors. However, Fitch Ratings do not give UMK any scores for contagion risk, given its external debt is fairly small.

Leverage Peaking in 2023-2024: Fitch Ratings expect UMK’s gross leverage to peak in 2023-2024 at around 5x before it moderates to 3x in 2025 and below 3x in 2026-2027. Expected lower leverage is driven by higher projected EBITDA from 2025-2026 following the Casting and Rolling project commissioning and normalising capex, leading to positive projected free cash flow (FCF). The Negative Outlook reflects the risk that deleveraging could be slower than assumed in our rating case.

Waivers Received: UMK has already received waivers for possible leverage covenant breaches with some of its lenders based on its 2023 results. Our projections show that the covenant might also be breached in 2024, which could require additional waivers.

New Project Increases Scale/Diversification: The Casting and Rolling project is a transformative hot-rolled sheet project for UMK and the country’s steel industry. The project will increase UMK’s steel-making capacity to 2.1 million tons per annum (mtpa) from 0.9 mtpa and double its total capacity for finishing lines to 2.2mtpa. This provides diversity to its current output of longs (mostly used in the domestic construction sector) and grinding balls (mostly used by the domestic metals and mining sector).

Execution Risks: UMK has limited experience in delivering new projects and is exposed to the risk of cost overruns and delays. UMK expects the Casting and Rolling project to be commissioned by end-2024, though it is still in the process of obtaining the remaining funding from a syndicate of international commercial banks.

State Funding Obtained: The Casting and Rolling project is estimated to cost around EUR730 million, of which EUR140 million is covered by an equity injection from state-controlled Uzbekistan Funds for Reconstruction and Development (UFRD, received in 2021), EUR110 million in a loan from UFRD (received in 2023), around EUR90 million from local banks (received in 2019-2020), EUR190 million in a project finance facility, and the remaining EUR200 million from UMK’s own sources.

Fitch Ratings understand from management that UMK is planning to sign an inter-creditor agreement with its lenders to arrange for contractual subordination of the EUR110 million UFRD loan due in 2031. However, Fitch Ratings are likely to continue including the loan in the debt quantum as it bears cash interest.

Normalising Margins: UMK’s unit margin (EBITDA/unit) fell sharply in 2023 to a Fitch-estimated USD80/tonne, after a strong USD175/tonne on average in 2021 and 2022. This was due to compressed margins worldwide, to extreme weather conditions in early 2023 leading to electricity blackouts and idle production, and to increased energy tariffs in Uzbekistan and currency depreciation.

Fitch Ratings expect unit margins to normalise at around USD100/tonne for 2024-2027, which coupled with almost a doubling in production volumes, should lift EBITDA to around USD200 million by 2026, from around USD100 million in 2024. Fitch Ratings expect UMK’s margins will continue to be supported by low energy prices relative to international peers’ and its exclusive right to purchase and set the price for scrap metal in the domestic market. These forecasts, however, is subject to the Casting and Rolling project coming on-stream by early 2025.

Global Steel Moderate Recovery: Fitch Ratings expect steel markets in 2024 to be more robust than a year ago, aided by a recovery in demand ex-China, falling costs and a slight rise in prices in China, India and Europe. Producer margins in China will continue recovering from 3Q23 as supply falls and buoyant manufacturing and green energy infrastructure offset the sluggish property sector.

Fitch Ratings rate UMK on a bottom-up basis, and give it a single-notch uplift to its SCP for state support. UMK’s ‘b+’ SCP is in line with that of JSC Almalyk Mining and Metallurgical Complex (Almalyk) (BB-/Stable; SCP: b+), and one notch higher than that of JSC Uzbekneftegaz (UNG; BB-/Stable; SCP: b).

Almalyk’s rating is equalised with that of Uzbekistan due to strong ties between the two. Almalyk’s scale by EBITDA is larger than that of UMK and its leverage is lower even though Almalyk is also implementing a transformative growth project (Yoshlik).

UNG’s rating is equalised with that of Uzbekistan due to strong ties between the two. UNG’s strong links with the state are underpinned by a significant share of state-guaranteed debt, and also by UNG’s presence in the Eurobond market. UNG’s ‘b’ SCP is under pressure from tight liquidity and high leverage.

UMK’s size is comparable to that of China-based Guangyang Antai Holdings Limited (B/Stable), whose rating considers its strong industry position among Chinese stainless-steel producers, diversified product offering in both stainless and carbon steel, and moderate financial metrics. However, the Chinese producer faces risks associated with its trading business, substantial external guarantees - some of which are to high-risk counterparties - and limited funding sources.