DBRS Downgrades Sherritt International to BB (high); Places Rating Under Review - Negative

DBRS has today downgraded Sherritt International Corporation’s (Sherritt or the Company) Senior Unsecured Debt to BB (high) from BBB (low) and placed the rating Under Review with Negative Implications following the Company’s February 25, 2009 announcement of significantly deteriorating operating performance in its Metals and Oil and Gas units in Q4 2008 and a large increase in the cost estimate of its Ambatovy Project (Ambatovy). The rating downgrade is the result of Sherritt’s rising non-Ambatovy-related debt in 2008 and poor results from the Company’s Metals and Oil and Gas operations, which have led to poorer credit metrics and increased financial risk. The Company has been placed Under Review with Negative Implications in view of Sherritt’s limited access to credit and a poor business outlook for 2009. In addition to facing the need to resolve funding for Ambatovy, Sherritt is expected to come under additional financial strains in 2009. If the Company is required to use its cash resources to fund operating units that face steep declines in product prices, or to meet funding requirements for Ambatovy, credit metrics can be expected to deteriorate to a point that they may not support the BB (high) rating, leading to further rating actions.

Sherritt (40% interest) and its Ambatovy partners Sumitomo Corporation, Korea Resources Corporation and SNC-Lavalin Inc. (60% interest) have announced an approximate 30% increase in the capital cost estimate for the development of Ambatovy in Madagascar to US$4.5 billion (100% basis), excluding any accrued financing charges. The Company and its partners have a US$2.1 billion project loan facility for Ambatovy in place, but with the significant increase in estimated costs, this facility will not be sufficient to complete the project. Drawdowns on project financing totaled US$1,070 million (100% basis) as at December 31, 2008, and project construction is estimated to be 44% complete.

Sherritt has unexpectedly indicated that it expects Ambatovy construction to proceed as planned, rather than to slow down the project to limit near-term funding needs. During 2009, Sherritt forecasts Ambatovy capital expenditures of US$1.8 billion (100% basis), US$0.6 billion of which is expected to be funded by project financing drawdowns. Sherritt’s share of the remaining 2009 expenditures (US$480 million) is only partially fundable from its remaining partner loan facility (an estimated US$173 million not drawn at year-end 2008), meaning that the Company will have to provide approximately US$307 million in funding from other sources or else its interest in the project will be negatively impacted.

Sherritt has indicated that it is engaged in advanced discussions with its partners on a mechanism to fund the remaining equity component of the capital cost without jeopardizing Sherritt’s balance sheet strength and liquidity. If a funding mechanism can be agreed upon, it is likely to significantly reduce the cash flow the Company can expect from Ambatovy. If Sherritt utilizes its cash resources and available non-project financing capacity to fund its Ambatovy needs, the Company’s financial flexibility would be severely restricted at a time of difficult market conditions for some of its operating units.

In addition, Sherritt reported deteriorating results from existing operations, with a net loss of $290 million for 2008, including $571 million of writedowns taken in the fourth quarter, compared with earnings of $89 million in 2007. EBITDA for 2008 was $581 million, down 23% from 2007.

For the fourth quarter of 2008, Sherritt lost $592 million, largely driven by write downs. Fourth-quarter EBITDA showed a loss of $1.5 million and, before corporate and other costs of $3.2 million, was only $4.1 million, down from the $201 million per-quarter average seen in the first three quarters of 2008. Positive results in the Company’s Coal and Power segments were offset by losses in Metals and Oil and Gas, where commodity prices dropped significantly.

Additionally, Sherritt lost approximately 26% of its Cuban oil production when the Cuban government unexpectedly terminated Block 7 leases on Cuba’s north coast held by Peberco Ltd. (Peberco) and farmed into by Sherritt. Although Sherritt has received approximately US$60 million from Peberco as a result of the lease termination, oil production from Cuba will decline in 2009. Sherritt feels that the termination of the Peberco lease was the result of a specific agreement between the Cuban state oil company and Peberco, and that it will not affect leases directly held by Sherritt and its subsidiaries.

With nickel, cobalt and oil prices currently well below fourth-quarter 2008 levels and lower oil production, DBRS expects 2009 net cash contributions from its Cuba-related Metals and Oil and Gas segments to be minimal. Additionally, Sherritt has indicated that the expansion program at its Power operations in Cuba will continue, utilizing cash flow from that unit. This will leave Sherritt’s Canadian Coal unit to cover corporate overhead, financing and other costs in 2009.

Coal performed well in 2008, with EBITDA from Prairie Coal Operations of $160 million and Mountain Coal Operations of $37 million. The EBITDA contribution from Prairie Operations is expected to increase in 2009, as it was acquired only part way through 2008. Prices and volumes for coal from Prairie Operations are expected to remain steady in 2009. Contributions from Mountain Operations are more volatile due to the nature of the international markets they serve. Coal Operations’ 2009 capital plan includes completing an activated carbon project at Prairie Operations for approximately $27 million and re-opening a mine at Mountain Operations, estimated to cost between $8 million and $10 million excluding equipment leases anticipated, in addition to sustaining capital for both divisions. DBRS expects that cash from the Coal segment will be able to cover these capital costs, as well as corporate overhead, financing and other costs in 2009, providing some additional liquidity to the Company. If Coal fails to live up to expectations, or if other divisions need any cash input, credit metrics will deteriorate, leading to a potential downgrade.

Sherritt’s cash-on-hand was $501 million and its liquid short-term investments were $107 million at year-end 2008 and the Company has indicated that it is in compliance with financial covenants. The Company has short-term revolving credit facilities that are subject to renewal in 2009. These facilities can provide up to $200 million in borrowing capacity, depending on working capital and other measures. The main facility includes a covenant that requires the Company’s debt-to-EBITDA ratio to be less than 2.65:1 at the end of each quarter. Current capacity of these facilities is estimated at $160 million, and the Company has indicated that $97 million was drawn in mid-February 2009. These facilities provide Sherritt with a significant portion of non-project-specific borrowing capacity. The expected reduction in 2009 EBITDA, as a result of declining commodity prices, may make the renewal of these facilities more difficult or expensive, resulting in reduced liquidity for the Company.

Resolution of the Under Review with Negative Implications status of Sherritt’s rating can be expected if the Company can successfully arrange financing for Ambatovy that does not draw on current liquidity resources; successfully renew or replace its maturing short-tem credit facilities; and demonstrate sufficient cash generation from operations to preserve existing financial flexibility.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Mining, which can be found on our website under Methodologies.

This is a Corporate rating.