April 5, 2012 / 5:37 PM / 5 years ago

TEXT-S&P cuts Essar Steel Algoma

Overview	
     -- We are lowering our ratings on Sault Ste. Marie, Ont.-based Essar 	
Steel Algoma Inc. (ESA), including our long-term corporate credit rating on 	
the company to 'CCC+' from 'B-'.	
     -- At the same time, we are placing all our ratings on ESA on CreditWatch 	
with developing implications. 	
     -- The downgrade and CreditWatch placement reflect what we view as the 	
risk ESA faces as it refinances its US$350 million revolving credit facility 	
due June 20, 2012, which could cause liquidity pressures to escalate rapidly 	
in the next several months.	
     -- We could lower the ratings further if ESA does not address its weak 	
liquidity position within the 90-day horizon of this CreditWatch or raise the 	
ratings if the company refinances in a manner that preserves US$100 million 	
liquidity on a sustainable basis.	
	
Rating Action	
On April 5, 2012, Standard & Poor's Ratings Services lowered its long-term 	
corporate credit rating on Sault Ste. Marie, Ont.-based Essar Steel Algoma 	
Inc. (ESA) to 'CCC+' from 'B-'. Standard & Poor's also lowered its issue-level 	
rating on the company's senior secured notes to 'B' from 'B+'. The '1' 	
recovery rating on the debt is unchanged. In addition, Standard & Poor's 	
lowered its issue-level rating on the company's senior unsecured notes to 	
'CCC' from 'CCC+'. The '5' recovery rating on this debt is unchanged.	
	
At the same time, we placed all our ratings on ESA on CreditWatch with 	
developing implications. CreditWatch with developing implications means we 	
could raise, lower, or affirm the ratings.	
	
The downgrade and CreditWatch placement reflect what we view as the risk that 	
ESA faces as it refinances its US$350 million revolving credit facility due 	
June 20, 2012, which could cause liquidity pressures to escalate rapidly over 	
the next several months.	
	
Rationale	
If ESA does not refinance its revolver in a timely manner, we believe that the 	
company's thin cash position and volatile operating cash flows would be 	
insufficient to maintain liquidity above US$100 million, which we estimate is 	
necessary to cover its major uses of cash this year, specifically raw material 	
cost purchases, mandated pension cash requirements, maintenance capex 	
spending, and cash interest payments on its senior notes. These cash uses 	
would be in addition to the company repaying drawings outstanding on the 	
credit facility when it expires in June. We expect that the US$221.7 million 	
outstanding at Dec. 31, 2011, has likely decreased by more than US$50 million 	
through the first three calendar months of 2012 (ESA's financial year-end is 	
March 31), given that the company is now drawing down seasonal inventory built 	
up through the latter portion of the 2011 calendar year. Finally, we do not 	
incorporate into our assumptions any parental support from Essar Steel 	
Holdings Ltd. (not rated).	
	
We believe that ESA's operating performance is improving, with stronger 	
earnings likely in fiscal 2013 amid stable steel prices and input costs, as 	
well as increasing volumes. That said, we believe the credit facility is 	
critical in supporting the company's day-to-day operations, the absence of 	
which could strain its ability to purchase raw materials. We assume that ESA 	
will generate debt to EBITDA of about 6x in fiscal 2012, which we believe will 	
translate into positive free operating cash flow and EBITDA interest coverage 	
above 2x.	
	
Recovery analysis	
For the complete recovery analysis, see the recovery report on ESA to be 	
published on RatingsDirect on the Global Credit Portal following this report.	
	
CreditWatch	
We will resolve the CreditWatch once we have reviewed the company's progress 	
in refinancing its revolver. 	
	
We could lower the ratings further if ESA does not address its weak liquidity 	
position within the 90-day horizon of this CreditWatch.	
	
Related Criteria And Research	
     -- Methodology and Assumptions: Liquidity Descriptors For Global 	
Corporate Issuers, Sept. 28, 2011	
     -- General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009	
     -- Criteria Guidelines For Recovery Ratings On Global Industrials 	
Issuers' Speculative-Grade Debt, Aug. 10, 2009	
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008	
	
Ratings List	
Ratings Downgraded And Placed On CreditWatch Developing	
                           To                   From	
Essar Steel Algoma Inc.	
Corporate credit rating    CCC+/Watch Dev/--    B-/Negative/--	
Senior secured             B/Watch Dev          B+ 	
  Recovery rating          1                    1	
Senior unsecured           CCC/Watch Dev        CCC+	
  Recovery rating          5                    5

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