DBRS Confirms Xstrata plc and Related Entities at A (low)

DBRS has today confirmed the ratings for Xstrata plc and its related entities (Xstrata or the Company) at A (low), R-1 (low) and Pfd-2 (low) with Stable trends, following an in-depth review of the Company’s business profile and credit metrics.

Important to the confirmation of Xstrata’s ratings has been the Company’s decisive action to strengthen its balance sheet via a $5.9 billion equity offering during the depths of the recession in the spring of 2009, its ongoing and successful efforts to improve the competitiveness of its operating units and the recovery of commodity prices, which have led to a recovery of the Company’s credit metrics throughout 2009 and into 2010.

Xstrata continues to position itself as a competitive producer of a handful of commodities important to the support of Western industrialized economies and to the growth of emerging economies such as China, India and Brazil. Strong operating cash flow underpins the Company’s efforts to increase its copper and coal output by 50% and its nickel output by 100%, by 2014, via the development of its existing resource base and without undue strain on its debt levels.

At the end of 2008, Xstrata, with $16 billion in net debt and a gross leverage ratio of 42%, faced a dramatic collapse of commodity prices and demand in the midst of a global financial crisis. Decisive action by the Company on both the operating and financial fronts led to the suspension or closure of uncompetitive operations, the restructuring of divisions, a restraint on capital spending, a suspension of dividends and a major equity issue. By the end of 2009, leverage had been reduced to 28%, the cost-competitiveness of struggling operations had been greatly improved and operating cash flow had been maintained at $6.0 billion, just 2% below 2008 levels.

The first half of 2010 brought additional improvements in Xstrata’s credit metrics, which are now solid for its current rating. Strong base metal prices and steady shipments of most products increased earnings compared with the first half of 2009. A 70% increase in operating cash flow to $3.4 billion was supplemented by the $2.3 billion disposition of financial assets related to the Prodeco coal operations (acquired in conjunction with the equity issue in the spring of 2009), which resulted in a further reduction in net debt to $8.2 billion at June 30, 2010 – half the level seen at the end of 2008. Lower debt resulted in gross leverage of 21% at the end of June 2010. EBITDA interest coverage in the first half of 2010 was 21.1 times (10.6 times in the first half of 2009) and cash flow-to-total debt was 0.72 times.

The liquidity of the Company remained strong at June 30, 2010, with improving operating cash flow, $1.4 billion in cash on hand, unutilized short-term credit capacity of approximately $7.6 billion and manageable ($3.8 billion) note maturities over the next five years.

Risks remain that the economic recovery that has been proceeding at a slow pace in the Western industrialized world may reverse, and that the plus-10% growth experienced in 2009 by China and other developing countries may moderate. This could lead to a retrenchment of commodity prices, with a consequential negative impact on Xstrata’s earnings and cash flow. Given the Company’s healthy balance sheet and ability to slow its heavy capital investment schedule, DBRS believes that Xstrata is well prepared to weather a double-dip recession.

Xstrata has been an aggressive consolidator in the mining industry for most of the current decade, and this behaviour was partly responsible for its high debt levels at the end of 2008. Although the Company has entered a phase of aggressive organic growth, it remains on the lookout for acquisitions that will enhance its existing businesses or add further diversification to its product portfolio. The nature and financing of any major future acquisition would require a review of the appropriateness of Xstrata’s rating.

Over the longer term, Xstrata, with an expanding diversified portfolio of competitive, high-quality operations, is well positioned to profit from the ongoing demand for basic commodities. DBRS views the long-term outlook for commodities to be favourable. The urbanization and industrialization of emerging economies is expected to support demand and prices for commodities. The severity of the 2008-2009 downturn has led to the slowdown of many output expansion projects, which can be expected to result in supply shortages in the next growth cycle.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The Commercial Paper of Xstrata Finance (Canada) Limited is bank-line supported.

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