DBRS Assigns Issuer Rating of BB (high) to Sherritt International, Recovery Rating of RR4 to Senior Unsecured Debt, Trend Stable

DBRS has today established an Issuer Rating of BB (high) for Sherritt International Corporation (Sherritt or the Company), with a Stable trend. The new Issuer Rating has been assigned in tandem with a recovery rating of RR4 for Sherritt’s Senior Unsecured Debt, which corresponds to an estimated 30%-50% recovery of principal amounts of the debentures under a hypothetical default scenario. The RR4 rating, in turn, results in no change (notching) to the rating of Sherritt’s Senior Unsecured Debt, and as such, the instrument rating of BB (high) with a Stable trend has been confirmed.

Issuer ratings represent solely the likelihood of default, without consideration of the relative priority of claims of various debt issues to the Company’s assets in a default scenario. The recovery rating determines the degree to which the instrument rating (i.e., the BB (high) rating on Sherritt’s Senior Unsecured Debt) is notched (up or down) relative to the Issuer Rating based upon the range of recovery (expressed as a percent of principal outstanding) that could be anticipated under a hypothetical default scenario analyzed. The resulting instrument rating may not exceed BBB (low) for instruments rated RR1 and RR2 and may not exceed BB (high) for those rated RR3; junior issues may be notched down from those levels.

Pursuant to its rating methodology for leveraged finance, DBRS has created a default scenario for Sherritt in order to analyze when and under what circumstances a default could hypothetically occur and the potential recovery of the Company’s debt in the event of a default (even though currently there is a relatively low probability of default implied by the Company’s Issuer Rating of BB (high)). The scenario assumes a deterioration in nickel, oil, cobalt and export thermal coal prices in 2010, 2011 and 2012, rendering net cash generation from Sherritt’s Metal, Oil and Gas and Mountain Coal units to zero or below. A general turmoil in commodity markets results in severe economic strain on Cuban state finances and various Cuban entities important to Sherritt are assumed to fail to meet their payment obligations. It is assumed that the collection of receivables from the Power unit and payments on Cuban government securities held by Sherritt are not achieved. The financial crisis in Cuba, combined with Cuban political instability, is assumed to lead to a halt of production from all of Sherritt’s Cuba-related assets in 2012. Operating cash shortfalls and continued capital and financing requirements would lead Sherritt to exhaust its cash resources and fully draw down its revolving credit facilities. These issues would impair the Company’s ability to access additional capital and existing borrowers would choose in 2012 to not extend short-term credit facilities – leading to calls on the Company’s outstanding letters of credit and default in the second half of 2012. With low nickel and cobalt prices, the net economic value to the Company of its Ambatovy project is reduced to nil, although it is also assumed that financing arrangements for the project relieve Sherritt of the need for any additional cash injections or debt repayment.

DBRS has determined Sherritt’s estimated value at default using an EBITDA multiple valuation approach, consistent with a view that default would likely result in the restructuring and/or recapitalization of the assets with value as a going concern versus the sale of its individual assets. EBITDA multiples utilized are applied to cyclically normalized EBITDA at default as opposed to the actual low EBITDA values expected at the time of default, reflecting the forward-looking nature of the valuation. The valuation further reflects the differing risks in Sherritt’s various operations, applying multiples appropriate to each business segment that reflect the political risk, sustainability of the business and other factors. Critically important to the recovery analysis is the assumption that the suspension of cash flow from Cuba-related entities (due to assumed Cuban fiscal troubles, political instability in the country and matters related to the Helms-Burton Act) render the value of certain assets to zero. Cuban project-related debt or debt secured by Cuban-related assets is assumed to incur no recovery.

The valuation considers the issuer and/or the guarantor of specific debt instruments, allocating value proceeds accordingly – that is, debt recovery in Sherritt’s Coal unit benefits from the assumed valuation of that unit to the extent that Coal-specific debt is assumed fully funded before any residual proceeds can be used to recover other Sherritt debt obligations. Sherritt’s main revolving credit facilities ($235 million in the Coal unit and $140 million at the corporate level) are secured and assumed to rank ahead of unsecured obligations within each of the related entities. Capital leases and other equipment financing obligations are assumed to rank ahead of unsecured debt. Ambatovy-related debt is assumed to be non-recourse and without call on Sherritt’s non-Ambatovy-related assets.

DBRS has forecast the economic value of the components of the enterprise at approximately $754 million using a 5.0 times (x) multiple of normalized EBITDA for Sherritt’s Prairie Coal and an EBITDA multiple of 3.0x for the short-lived/volatile Mountain Coal operations and other oil and gas assets. Cuba-related Metals, Oil and Gas, and Power units are deemed to have no value.

Based on the default scenario above, the estimated amount of non-Ambatovy-related debt outstanding ($1.2 billion) and the ranking of Sherritt’s debt instruments at the time of default, DBRS has assigned a recovery rating of RR4 to Sherritt’s Senior Unsecured Debt, which corresponds to a forecast recovery of between 30% and 50% of principal amounts. This results in no notching of the instrument rating, which remains BB (high) with a Stable trend.

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

The applicable methodologies are Rating Mining and DBRS Rating Methodology for Leveraged Finance, which can be found on our website under Methodologies.

This is a Corporate rating.