DBRS Confirms Sherritt International at BB (high), Trend Changed to Negative

DBRS has today confirmed both the Issuer Rating and Senior Unsecured Debt rating of Sherritt International Corporation (Sherritt or the Company) at BB (high) but has changed the trends to Negative from Stable. In addition, the recovery rating for Sherritt’s Senior Unsecured Debt under a hypothetical default scenario remains at RR4.

The change in the trend to Negative from Stable on Sherritt’s ratings reflects the growing stress of funding the Company’s 40%-owned Ambatovy project to completion, declining oil production and upcoming contract renewals at its Prairie Coal unit, all in the face of weakening and volatile commodity prices. Failure to stem rising debt levels, due to a significant delay in the end of cash input requirements to fund Ambatovy, or due to the expected reduction in operating cash flow from declining commodity prices and reduced oil and coal output over the next year, can be expected to lead to a rating downgrade. Successful completion of the Ambatovy project could offset the weakening of the Company’s business profile due to lower oil and coal production.

The RR4 recovery rating for Sherritt’s Senior Unsecured Debt corresponds to an estimated 30% to 60% recovery of principal amounts of its Senior Unsecured Debentures as a result of examining two hypothetical default scenarios for the Company. The RR4 rating, in turn, results in no change (notching) to the rating of Sherritt’s Senior Unsecured Debt.

Sherritt’s diverse operations have allowed it to generate steady operating earnings and cash flow in comparison with many other mining companies, but earnings in 2012 declined significantly and 2013 is expected to be an even more challenging year.

Sherritt operating income has been volatile since 2008, showing a solid recovery from the 2008/2009 recession only to lose momentum in 2012 and into early 2013. Good growth in nickel and cobalt production from Cuban-related operations helped to offset the impact of declining oil and Prairie Coal production. Combined with ever-changing nickel, cobalt, oil and export coal prices, earnings volatility has been exaggerated. Sherritt faces some step changes in 2013 with the end of the 10.6 million tonne Highvale mine coal contract (about a third of Prairie production) and potential achievement of commercial production at its 40%-owned Ambatovy nickel project.

The Company’s net non-Ambatovy debt has increased to $905 million at the end of Q1 2013 from $577 million at the end of 2011, even though debt was reduced by about $100 million in Q1 2013 due to the deconsolidation of the Moa joint venture.

Accordingly, Sherritt’s credit metrics have weakened in 2012 and to date in 2013 with declining commodity prices, lower output of coal and oil and gas and higher debt levels as the Company continues to fund the completion of the Ambatovy project with its own financial resources. The move of the Moa joint venture to an equity accounted status reduced DBRS-calculated EBITDA, interest costs and debt levels in Q1 2013 and restated Q1 2012.

Net income in 2013 is expected to be much lower than in 2012 due to lower nickel, cobalt and export coal prices, as well as lower coal and oil sales volumes. In addition, exploration costs are expected to rise as are interest costs. Equity accounting for the Moa joint venture will reduce comparability of results.

DBRS expects Sherritt’s credit metrics will also weaken further in 2013 as the Company seeks to complete the Ambatovy project in the face of deteriorating operating cash flow from Coal, Metals and Oil and Gas businesses. Lower coal and oil production, combined with weak nickel, cobalt and export coal prices are expected to contribute to the squeeze.

Sherritt faces high ongoing cash outlays in a period of constrained financial flexibility as it completes the Ambatovy project. The bulk of the Company’s short-term liquidity is in its $442 million cash and short-term investments and its revolving credit facilities. Any unforeseen events that would strain liquidity or utilize or restrict cash flow could be significantly challenging to the Company.

Notes:
All figures are in Canadian 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 applicable methodologies are Rating Companies in the Mining Industry (June 2011) and Rating Oil and Gas Companies (April 2011), which can be found on our website under Methodologies.