DBRS Confirms Codelco at “A” with a Stable Trend

DBRS has today confirmed the Senior Unsecured Debt rating of the Corporación Nacional del Cobre de Chile (Codelco or the Company) at “A” with a Stable trend. Codelco is the premier copper producer in the world, with a large resource base; cost-competitive, long-lived operations; and ample development opportunities. That said, Codelco, in the normal course, faces higher payments to the Government of Chile than a normal, non-government company. Accordingly, Codelco’s rating also incorporates the support of the Republic of Chile (Chile: rated A (high) by DBRS), its 100% owner. Codelco’s Stable trend is based on the Company’s very strong, albeit cyclically high, credit metrics, which are expected to remain in line with DBRS’s current rating in less prosperous copper markets and with the ongoing support of the Chilean government.

Codelco is the largest copper producer in the world; its proven and probable reserves are expected to support copper production for many years. The Company is also one of the lowest-cost producers, allowing it to cope with low price environments better than most of its peers. But unlike other mining companies, 100% of Codelco’s net income “after a deduction of the amounts authorized for capitalization and reserve” is transferred to the Chilean Treasury under an agreement with the government. As a result, the Company, on average, pays about 82% of its EBITDA (before income and export taxes) to the Chilean state, leaving little in the way of retained earnings to fund growth programs. This results in a thin capitalization for the Company, which inhibits its ability to fund the development of its extensive resource base without government support.

The rating of Codelco is tied to the support of the Chilean government, which has the power to define the Company’s dividend distribution policy. The support of the government was evident in 2009 when Codelco’s earnings were negatively affected by the global economic downturn. Codelco received $1 billion from the government through lower taxes and reduced dividend distributions to the state, which was used to support Codelco’s liquidity and capital requirements during the global recession. This happened again in the first half of 2011, with dividends reduced by almost 40% compared with the 2010 level in order to, in DBRS’s view, accommodate Codelco’s capital expenditure needs. This cooperative support with the Chilean government has enabled Codelco to support its expansion efforts. In addition, government support helps to mitigate the impact of lack of access to the equity markets, given that Codelco is wholly owned by the state.

Codelco’s debt is not guaranteed by the Chilean government; however, Codelco remains a strategic asset for the Chilean economy and DBRS expects that the Company will continue to receive strong support from the government. Furthermore, Codelco remains a key contributor to the Chilean government’s budget, contributing on average 16% of state revenues from 2006 to 2010. Accordingly, DBRS rating of Codelco reflects the A (high) long-term foreign sovereign rating of Chile, in addition to its position as a leading copper producer.

Codelco has benefited significantly from high copper prices (due to surging demand from Asia, particularly China), and has generated strong earnings cash flow since the 2009 economic down turn. EBITDA rose by approximately 50% in the first half of 2011 to $4.5 billion. As a result, EBITDA-to-interest coverage (increased to 64.0 times (x) from 28.4x) and cash flow-to-debt (increased to 55.5% from 43.8%) ratios remained strong and within DBRS’s current rating category given the buoyant copper prices in the first half of 2011.

Codelco remains focused on growing its copper production with a 2011-2015 investment plan (approved by the government). Annual capital investment is expected to be $3.5 billion for the period, which is higher than historic levels (just over $2 billion per year over 2006-2010). External funds are expected to be required. However, DBRS expects that the Chilean government would continue to support Codelco’s investment plan by limiting its withdrawal of cash from the Company. In addition, if copper prices retreat significantly such that internally generated cash flow would not support Codelco’s expansion plan, the Company could either slow its expansion or appeal to the Government of Chile for additional support. In either case, DBRS expects Codelco to be able to maintain liquidity and credit metrics in line with DBRS’s current rating. The recent $6.75 billion financing arrangement with Mitsui & Co, which would provide financing if Codelco decides to exercise its January 2012 option to acquire a 49% interest in Anglo America Sur (a copper producer in Chile) from Anglo America plc, is an example of a further mechanism that could reduce Codelco’s direct needs for government support.

Over the longer term, Codelco’s large reserve and resource bases and competitive operating assets can be expected to maintain the Company as a leading player in the copper markets. The ongoing industrialization and urbanization of China, India and other lesser-developed economies should provide ready markets for this widely used commodity.

DBRS expects that Codelco will have to seek additional funding in order to expand the productive capacity of its asset base due to its current funding formulae. This will require additional support from the Government of Chile or from other sources. Although DBRS believes Codelco has the capacity to support additional debt at its current rating, a significant escalation of leverage at Codelco or a protracted period of impairment of coverage metrics of the Company without support from the Chilean government could lead to a downgrade of the rating.

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

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