(The following was released by the rating agency)
-- Mongolia-based MMC has high mineral and customer concentration; it's also exposed to the country's untested and evolving regulatory environment.
-- MMC's reduced project development risk, first-quartile cost position, and moderate debt levels partly offset these limitations.
-- Given these factors, we are assigning our 'B+' corporate credit rating to the company and a 'B+' issue rating to its proposed senior notes.
-- The stable outlook reflects our expectation that MMC's coal sales will grow steadily and profitability will be sustainable over the next two years.
Standard & Poor's Ratings Services on March 14, 2012, assigned its 'B+' long-term corporate credit rating to Mongolia-based Mongolian Mining Corp. (MMC). The outlook is stable. At the same time, we assigned a 'B+' issue rating to the proposed issue of senior notes due 2017.
The rating on MMC reflects the company's mineral concentration to coking coal, customer concentration risks, and its exposure to an untested and evolving regulatory environment in Mongolia (BB-/Positive/B). The company's reduced project development risk, first-quartile cost position, and moderate debt levels partly offset these limitations.
MMC's high mineral concentration exposes its cash flows to coking coal price swings, and ties it closely to the cyclical Chinese steel sector. MMC's 100% exposure to a fairly concentrated base of Chinese clients exacerbates this risk, in our opinion. The concentration subjects the company to counterparty risk and to its clients' bargaining power. In addition, potential bottlenecks within the transportation system in China could indirectly affect MMC's competitive position as a coal supplier to the Chinese market, compared with domestic market participants located closer to the end market.
In our view, Mongolia's untested mining regulatory framework could affect MMC's cash flow stability. We believe the government is still calibrating its policy towards the mining sector to balance economic development and social considerations. While the risk of expropriation of private mines is remote, in our opinion, currently favorable tax and royalty regimes could give the government some leeway to raise mining taxes without making current or prospective projects uneconomical.
We expect MMC to increase production with limited additional capital spending, highlighting its project-execution strength. The company completed major infrastructure projects in 2011 and 2010. The involvement of Australia-based mining services company Leighton Mining as the contractor for MMC's Ukhaa Khudag (UHG) mine and the lack of significant weather-related risks also mitigate production ramp-up risk, in our opinion.
We estimate that the company could still be marginally profitable on a gross margin basis (excluding selling, general and administrative expenses) even if its average selling price declines by about 35%. We also expect cash costs to remain fairly stable over the next two to three years, given the predictable nature of the fees that the company pays to Leighton.
We consider MMC's financial risk profile as "significant," as defined under our criteria, primarily because of its moderate leverage. We project the ratio of total debt to EBITDA at 2.6x in 2012, declining to 2.1x in 2013. Coal sales are likely to be about 7.2 million tons in 2012 and 10.6 million tons in 2013. We expect gross profit per ton of coal sold of US$35-US$45 over the next three years under our base-case scenario, translating into an EBITDA margin of 35%-40%. Additional EBITDA and cash flows from greater coal sales would temper a potential increase in absolute debt by 2014 if a planned railway project proceeds. We expect MMC's financial risk profile to remain within our "significant" category under this scenario.
The issue rating on the proposed senior notes reflects the 'B+' long-term corporate credit rating on MMC. The issue rating is subject to our review of the final issuance documentation, and confirmation of the amount and terms of the notes. Energy Resources LLC, MMC's main operating subsidiary, and other subsidiaries unconditionally guarantee the proposed notes. The notes are subordinated to about US$169 million of senior bank loans from the European Bank for Reconstruction and Development (EBRD; AAA/Stable/A-1+), Nederlandse Financierings-Maatschappij voor Ontwikkelingslanden N.V. (FMO), and Deutsche Investitions und Entwicklungsgesellschaft mbH (DEG). The notes are secured by first liens on the capital stocks of MMC's subsidiary guarantors, including Energy Resources LLC. MMC expects to use the proceeds from the proposed notes for capital expenditure, working capital, and general corporate purposes.
In our view, MMC's liquidity is "adequate," as defined in our criteria. The company's liquidity is sensitive to coking coal prices and production volumes. Nevertheless, we believe the company can fund its short-term debt repayment and capital spending with its internal cash flows, cash balance, and the proceeds from the proposed notes. We expect MMC's liquidity sources to exceed its liquidity needs by about 1.2x or more over the next 12 months. We also anticipate that the company's liquidity sources will exceed its needs even if EBITDA declines by 20%.
Our liquidity assessment incorporates the following factors and assumptions:
-- Liquidity sources over the next 12 months include our expectation of about US$240 million of funds from operations (FFO). The company had about US$227.8 million in cash and cash equivalents as of Dec. 31, 2011. We also factor into MMC's liquidity sources the expected proceeds from its proposed notes and funds under a committed bank facility from Standard Bank PLC and ING Bank N.V. whose amount is currently being negotiated.
-- Liquidity needs over the next 12 months include our expectation of about US$535 million in capital expenditure, about half of which MMC will dedicate to the railway project. Liquidity needs also include about US$334.8 million in short-term debt and the US$85 million repayment of the company's convertible bond. We have not factored any dividend distribution into our 2012 financial forecast.
The stable outlook reflects our view that MMC is likely to significantly increase its sales volume and maintain its profitability range over the next two years, further supporting cash flow protection. We expect its coal sales to rise to about 7.2 million tons in 2012 and about 10.5 million tons in 2013, while the gross profit per ton should remain at US$35-US$45. These assumptions would translate into a ratio of total debt to EBITDA of 2x-3x and a ratio of FFO to total debt of 25%-35%.
We could revise the outlook to positive or raise the rating if the company develops a longer operating track record, resulting in improved visibility over its financial performance and a stronger financial risk profile, with a ratio of total debt to EBITDA below 2x and FFO to total debt above 35% on a sustained basis. This could materialize due to a combination of: (1) coal sales exceeding 7.5 million tons in 2012 and 950,000 tons on a monthly basis over the first six months of 2013 because of more rapid ramp-up than anticipated; and (2) gross profit per ton exceeding US$50 on a sustainable basis because of higher coking coal prices or lower mining costs.
We could revise the outlook to negative or lower the rating if MMC's production ramp-up or coal sales are lower than we expect or if coking coal prices decline materially, with a ratio of total debt to EBITDA above 3.5x and a ratio of FFO to total debt below 20%. This could materialize due to a combination of: (1) coal sales falling below 6 million tons in 2012 and 750,000 tons on a monthly basis over the first six months of 2013 because of slower ramp-up, or coal sales interruptions; and (2) gross profit per ton declining below US$35 on a sustainable basis because of lower coking coal prices and higher mining costs or royalty rates.