DBRS Confirms Sherritt International at BB (high), Stable Trend

DBRS has confirmed Sherritt International Corporation’s (Sherritt or the Company) Issuer Rating and Senior Unsecured Debt rating, both at BB (high) with Stable trends. In addition, the recovery rating for Sherritt’s Senior Unsecured Debt under a hypothetical default scenario remains at RR4. Sherritt’s diverse operations allowed it to generate steady operating earnings and cash flow through the 2008-2009 recession in comparison to many other mining companies. Nonetheless, 2011 and 2012 could be challenging years for the Company as it seeks to fund the completion of its 40%-owned Ambatovy project in Madagascar, and as political uncertainties remain heightened in Cuba (a significant source of the Company’s earnings).

The Ambatovy picture remains a key near-term concern. In December 2010, the Company announced an increase in the cost estimate of its Ambatovy project to US$4.8 billion. DBRS expects Ambatovy’s project finance facility will only cover a portion of the costs to complete the project and additional funds will be required from the project owners. Sherritt faces potentially significant capital outlays as it completes the Ambatovy project. Although Sherritt’s partners have been funding a significant portion of the Company’s share of capital costs, they are not required to do so, potentially leaving Sherritt the option of funding the project from its own resources or face dilution of its interests.

It is DBRS’s view that Sherritt will be able to source the funding required to bring Ambatovy to completion such that the project financing will become non-recourse, but that the Company’s flexibility to face any unforeseen demand for funds will be strained. The Company’s short-term liquidity is currently provided by approximately $700 million in cash and short-term investments not dedicated to expansion projects, complemented by annually renewable revolving credit facilities at the corporate level, and a revolving credit facility maturing in 2012 in its Coal unit. The prize of a successful Ambatovy development can be substantial for Sherritt, providing a long-lived, competitive core asset, financed on a non-recourse project basis, although early-years cash flow will be dedicated to debt repayment.

The near-term outlook for Sherritt’s non-Ambatovy operations remains generally positive. At current commodity prices and even lower (20% or more) as is expected, each operating unit is forecast by DBRS to be a solid generator of earnings and cash flow. Sustaining capital expenditures are expected to be low (less than $200 million) and dividends affordable (approximately $45 million) despite a recent increase in the common share dividend.

The positive near-term outlook remains clouded by the Cuban political picture and the ongoing potential for delayed payments for products sold to that country. Although Sherritt’s ratings incorporate the political risks of operating in Cuba and the impact of Cuban/American relations on Sherritt’s operating and financial activities, DBRS believes the ongoing changing leadership in Cuba has the potential to disrupt the Company’s important relationships throughout all levels of government that the Company has enjoyed for many years, creating heightened political risks.

Over the longer term, Sherritt has an expansion project in Power that is underway and one in Metals that remains on hold. DBRS expects the Metals expansion project will be revived as funds become available. In addition, oil production in Cuba is declining and will continue to do so unless added capital is invested (also discretionary). A number of coal supply contracts in the Prairie coal division will reach the end of their initial term over the next several years, and will have to be extended if the historically stable earnings from that unit are to continue. The Company is expected to benefit from the start-up of its activated carbon project in Saskatchewan.

The RR4 recovery rating for Sherritt’s Senior Unsecured Debt corresponds to an estimated 30% to 50% recovery of principal amounts of the senior unsecured 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.

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.