DBRS Confirms Sherritt International at BB (high); Removes from Under Review with Negative Implications

DBRS has today confirmed Sherritt International Corporation’s (Sherritt or the Company) Senior Unsecured Debt at BB (high) following the Company’s announcement that it has finalized financing arrangements with respect to the Ambatovy Project (Ambatovy or the Project). The financing will allow Sherritt to fund its 40% pro rata share of Ambatovy shareholder funding obligations with new, non-recourse loans provided by the other Project partners. Although the new funding comes at a significantly higher cost, it means that Sherritt will not have to seek additional outside sources of financing to maintain participation in Ambatovy. Overall, DBRS expects that Sherritt will generate positive free cash flow in 2009 from its existing operations (primarily the Coal and Power units), despite poor operating results in Q4 2008 and Q1 2009 (reflecting the economic downturn and bottom-of-the-cycle conditions). Accordingly, Sherritt’s financial metrics are expected to be consistent with a BB (high) rating in the near to medium term, resulting in a stable outlook and leading DBRS to remove Sherritt’s rating from Under Review with Negative Implications, where it was placed February 27, 2009.

Sherritt has finalized Ambatovy financing arrangements in such a manner that its partners in the Project will provide new, non-recourse loans allowing the Company to fund its 40% pro rata share of obligations. Sherritt will not have to seek additional outside sources of financing to maintain participation in Ambatovy. Additionally, Sherritt will remain as Project operator. DBRS notes that these new partner loans will be at much higher rates of interest than the original partner loans (LIBOR + 7% vs. LIBOR +1.125%), causing a shift in the economic value of the project away from Sherritt and toward the partners providing the loans. The existing Project partner loans (reported at US$135 million at March 31, 2009) will be reduced to, and remain at, approximately US$ 85 million until repayment. Additional financing from the Company’s partners will form part of the higher-cost, new Partner loans, which will only be repayable through Sherritt’s share of distributions from the Ambatovy project.

Sherritt’s Ambatovy partners will have the right at any time to exchange some or all of the new loans for Sherritt’s equity interest in the Project, up to a maximum of 15% interest (i.e., a reduction in Sherritt’s interest in Ambatovy from 40% to 25%). However, this right is subject to the senior Project lenders’ consent and Sherritt’s right to repay the new partner loans to avoid dilution. If the capital costs of Ambatovy were to exceed US$4.52 billion and Sherritt did not provide its pro rata share of funding for the cost overrun, the Project partners could further dilute Sherritt’s interest, even if this were to result in Sherritt’s interest in the Project falling below the 25% threshold. There are no other penalties to Sherritt for any failure to fund its pro rata share of shareholder funding.

Under the new financing arrangements, Sherritt also receives additional completion guarantee protection related to the US$2.1 billion senior Project financing. Each of the partners has agreed to provide letters of credit to the senior lenders to cover any guarantee obligation of Sherritt not covered by the existing cross-guarantees (US$598 million) up to Sherritt’s pro rata share of the Project loan (US$840 million or 40% of the Project loan). If Sherritt’s Project partners fail to provide the letters of credit as and when required, no further borrowing under the senior project financing can occur and no obligation to Sherritt would be incurred.

The Company has also recently renewed its $140 million, 364-day revolving credit facility. This has helped alleviate DBRS’s previous concerns regarding Sherritt’s near-term liquidity, although it has been achieved at an increased interest cost. The resolution of the Ambatovy funding mechanism, the renewal of the 364-day facility and the Company’s ability to maintain positive net free cash flow (before Ambatovy capital needs) – combined with its $790 million cash and short-term investments on hand at March 31, 2009 – provide Sherritt with sufficient liquidity and financial flexibility to support its current rating.

Looking forward, DBRS expects that Sherritt’s Metal and Oil and Gas units will continue to provide minimal but positive EBITDA for the rest of 2009 and that the bulk of EBITDA will come from the Coal and Power units. Profitability from Sherritt’s Mountain coal operations (largely export-oriented) is expected to shrink as significantly lower 2009-2010 coal contract year prices come into effect, but Prairie coal operations are expected to maintain earning levels achieved in the first quarter of 2009. On the whole, DBRS expects that Sherritt will generate positive net cash flow from its existing operations in 2009. With no additional net debt to be incurred other than that related to the Ambatovy project, the Company’s liquidity is adequate and its financial metrics are expected to remain commensurate with the rating.

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.