Credit Quality Of Russian Steel Companies: Standard

1
Credit Quality Of Russian Steel Companies
Standard Poors View On Key Rating Drivers

• Elena Anankina
• Director
• elena_anankina_at_standardandpoors.com
• 7 095 7834130

2
Standard Poors Ratings on Russian Companies
(as of June 7, 2005)

• OAO Magnitogorsk Metallurgical Kombinat (MMK,
  BB-/Stable)
• OAO Severstal (B/Stable)
• Novolipetsk Steel (BB/Stable)

3
Russian Steel Companies Key Rating Factors

• Strengths
• Competitive cost position
• Often captive raw materials supplies
• - But are mining assets part of the rated
  entity?
• Low labor and energy costs, environmental
  regulations less strict
• Better resilience to cycles
• Higher profitability and cash flow generation
  under currently favorable industry environment
• Typically moderate levels of net debt and high
  cash balances at YE2004
• Gradual (albeit volatile) growth of the domestic
  market

• Weaknesses
• High capex requirements
• Position of land-locked commodity producers in a
  cyclical industry, export dependency
• Governance is the key often complex group
  structures, significant related party
  transactions etc.
• Risks of operating in Russia
• Higher than the risk of sovereign default
• Comprises institutional factors like regulation,
  law enforcement, corporate governance
  environment, financial system, etc.

4
Will Increased Capacity Push Steel Cycle Down??

• 1Q2005 EU reduced crude steel output by 0.3,
  while Russian steel production increased by 2.7
• Arcelor (BBB/Stable/A-2) in March 2005 announced
  1 mln MT flat production cut in Europe after 14
  fall in demand in the EU
• Most Russian steelmakers invest cash windfall in
  de-bottlenecking and increasing capacities
• Russias steel production has been growing
• Impact on global steel prices will depend on
  demand dynamics in China and other emerging
  markets

5
Key Rating Driver How the Cash Windfall
Generated During 2003-2005 Will Be Allocated?

• Typically high cash balances at YE2004 thanks to
  free operating cash flow generation and access to
  financing on the market
• MMK YE2004 1.3 bln debt on BS (SP adds 1.7
  bln transactions, 1.9 bln cash
• Severstal YE2004 (Russian GAAP) 1.4 bln debt on
  BS (before Euro430mln deal with Lucchini), 1.5
  bln cash
• Typical use of windfal cash
• Capital expenditure hike throughout the industry
• Acquisitions to protect raw materials supply
  NLMK (Stoylensky), Mechel (Yakutugol) etc.
• Acquisitions to diversify outside Russia
  (Lucchini and Rouge by Severstal etc.)
• Quality and transparency of new acquisitions
  will be the key rating drivers
• Transparency and governance Standard Poors
  adjusts companies debt for large transactions at
  the shareholder level
• Asset composition changes Russian risk remains
  important as long as majority of free cash is
  generated in the country