“The Baa1/P-2 ratings reflect South32’s position as a substantial diversified mining company, benefitting from solid product, operational, and geographic diversity”, says Moody’s VP and senior analyst Matthew Moore.
Stable credit rating
“At the same time the rating reflects South32’s low cost operations, relatively low capital expenditure requirements, and our expectation that the company will maintain a conservative financial profile with low financial leverage and absolute debt levels over the next 12 to 24 months”, adds Moore.
He goes on the say that the rating is constrained by the company’s exposure to volatile commodity prices and demand, with several of its commodities expected to continue to face pricing pressures over the next 12-to-24 months.
However, Moore says that South32’s stable outlook reflects Moody’s expectation that the company will continue to pursue a conservative financial profile and that commodity prices will remain at levels that will allow South32 to generate sufficient earnings and cash flow to sustain credit metrics that will remain at strong levels for the rating over the next 12 to 24 months.
“Under our base case sensitivities for commodity prices, we expect that South32 will maintain very strong credit metrics for the rating over the next 12 to 24 months with adjusted debt-to-EBITDA likely to be less than 1.0x and CFO (minus dividends)-to-debt above 90%” says Moore, adding that this compares to Moody’s tolerance level for the rating of maintaining adjusted debt-to-EBITDA below 2.25x and CFO (minus dividends)-to-debt above 35%.
Moody’s expect that South32 will over time pursue growth opportunities that could involve an increase in financial leverage, but the rating incorporates its expectation that the company will be committed to maintaining its financial profile at a level that would continue to support its Baa1/P-2 ratings.
Solid business profile
South32 has a solid business profile characterised by significant operational and product diversity with ten commodities produced and solid market positions across each of those commodities.
The company is diversified geographically by revenue generation and end customer. The company’s production is spread across five countries with the largest contributions from Australia and South Africa and with no end market representing more than 12% of revenue generation in the 2014 financial year.
Although South32 is a mid-tier mining company by scale as measured by group revenue and EBITDA, the company’s operations still have significant scale within their respective commodities and benefit from established infrastructure with sizable and high quality reserves and resources.
Moody’s expects South32 to maintain solid liquidity levels for the rating. “We also expect the company to have US$650 million of cash on its opening balance sheet and generate annual cash flow from operations for the next 12 to 24 months of around $1.4 to 1.8 billion, says Moore, adding that this will be more than adequate to cover our expectations for cash outflows, primarily capital expenditures and dividends, over the period.
In addition to cash on hand and cash flow generation, South32 will also benefit from a $1.5 billion five year syndicated revolving credit facility, says Moore.
“Given South32’s position as a new operating entity and the soft near term outlook for several of the commodities it produces, we do not expect the ratings to be upgraded over the next 12-to-24 month, notes Moore, adding that the ratings could be upgraded if South32 is able to maintain stable production levels and improvements in its cost position such that we expect the company to sustain credit metrics indicative of higher ratings.
This includes maintaining adjusted debt-to-EBITDA below 1.5x and CFO (minus dividends)-to-debt above 45% through the cycle. We would also expect EBIT margins to improve to above 20% on a sustained basis and for South32 to remain free cash flow positive to consider an upgrade, he says.
However, Moody’s believes that the ratings could be downgraded if commodity prices decline beyond its current expectations causing margins and cash flow to decline to levels that lead to significant credit metric deterioration. Ratings could also be downgraded if the company embarks on large debt funded acquisitions or shareholder initiatives which pressure its credit metrics.
Specifically, if debt-to-EBITDA is sustained above 2.25x or if CFO (minus dividends)-to-Debt falls below 35%.