DBRS Downgrades Xstrata to BBB (high), Stable; Initiates Glencore Xstrata Issuer Rating at BBB (high), Stable

DBRS has today downgraded the ratings of Xstrata plc and its related entities (collectively, Xstrata or the Company) to BBB (high), R-2 (high) and Pfd-3 (high), with Stable trends. The proposed all-share merger of Xstrata and Glencore International plc (Glencore) has been completed, with Glencore changing its name to Glencore Xstrata plc (Glencore Xstrata). The merger enhances the scale and diversity of the Glencore Xstrata group’s operations, resulting in a group with assets of about $169 billion. However the financial metrics of the combined group will be weaker than that of Xstrata on a stand-alone basis. The resultant impact of the Glencore merger is expected to increase the credit risk of the existing Xstrata debt rated by DBRS.

In addition, it is anticipated that a financial structure will be put in place for the combined group, providing upstream and downstream debt guarantees throughout the Glencore Xstrata group, and DBRS will further consider the impact of the guarantee structure once it is in place.

Following the downgrade of the Issuer Ratings of Xstrata plc and Xstrata (Schweiz) AG, DBRS discontinued the Issuer Ratings of these two companies. DBRS has also initiated an Issuer Rating for Glencore Xstrata at BBB (high) with a Stable trend.

Glencore, on a stand-alone basis, is a major commodities-oriented enterprise with marketing and industrial investment activities in metals and mining, energy products and agricultural products around the world. Glencore reported $5.9 billion in adjusted EBITDA in 2012, equal to the average over the last five years, with Xstrata representing about 24% of this average. Glencore’s historic financial metrics are weaker than Xstrata’s, with gross debt in its capital structure at December 31, 2012, of approximately 50% and weaker coverage metrics. A significant portion of Glencore’s approximately $36 billion gross debt is associated with Glencore’s marketing activities. DBRS has netted Glencore’s approximately $17 billion of debt related to the financing of its readily marketable inventory and its marketing activities when examining Glencore’s financial metrics, which results in a lower debt-to-capitalization (about 35%) and improves its stand-alone financial metrics.

As a stand-alone company, Xstrata’s credit metrics to the end of 2011 improved significantly from the stress they were under due to the negative impacts of the sharp 2008-2009 recession, with operating cash flow reaching a record $9.6 billion in 2011 and debt-to-capitalization under 20% at year-end. The Company had gone from retrenchment in 2009 to aggressive renewal and expansion marked by sharply rising capital expenditures. High capital expenditures and record dividends in 2012 in the face of lower operating cash flow have led to higher debt at the end of 2012 and credit metrics for the Company that are weaker, albeit adequate to support Xstrata’s pre-Glencore merger credit ratings.

Regulatory approvals of the merger transaction by China and the European Union can be expected to dampen some of the market strength and growth opportunities expected for Glencore Xstrata. Specifically, the European Commission has mandated that Glencore (1) sever its agreement with Nyrstar NV (Nyrstar) to purchase commodity-grade zinc metal produced at Nyrstar’s smelters located within the European Union and (2) divest its 7.8% equity interest in Nyrstar. In addition, Chinese regulatory authorities have mandated, among other conditions, that the combined group divest itself of the Las Bambas copper mine project in Peru (or, if not saleable within the prescribed parameters, a sale of another significant copper property held by Xstrata). Although not considered material, these actions will limit the market strength and growth potential of Glencore Xstrata, partially offsetting some of the projected $500 million of synergy benefits of the merger on the business profile of that entity.

With DBRS’s expectation that commodity prices will recover from soft 2012 and year-to-date 2013 levels as added commodity productive capacity, brought on by mining’s organic growth expenditure boom in 2010-2013, is absorbed by growth of developing countries (particularly China), Glencore Xstrata’s earnings for 2014 and forward have significant growth potential as its expansion projects reach capacity. As such, they should contribute to the longer-term improvement of Glencore Xstrata credit metrics, enhancing the strength of the group’s BBB (high) Issuer Rating.

DBRS placed Xstrata’s ratings Under Review with Developing Implications on February 7, 2012, in response to the original Xstrata Glencore merger announcement. These ratings were then placed Under Review with Negative Implications on November 20, 2012, following the Company’s announcement that eligible Xstrata’s shareholders have approved the proposed all-share merger with Glencore, subject to a number of regulatory and court approvals.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

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

The ratings of Xstrata Finance (Canada) Limited and Xstrata Canada Corporation are based on the guarantee of Xstrata plc.

The applicable methodology is Rating Companies in the Mining Industry (June 2011), which can be found on our website under Methodologies.