DBRS Confirms Noranda Operating Trust Rating at BB (high), Stable Trend

DBRS has today confirmed the BB (high) rating with a Stable trend on the Senior Secured Notes of Noranda Operating Trust (the Trust). The Trust remains a well-established and currently profitable processor of zinc concentrates strategically located to serve North American zinc metal markets, but is highly dependent on a zinc concentrate supply and processing agreement (Supply and Processing Agreement) with Glencore Canada Corporation (Glencore Canada) that ends its initial term in May 2017.

DBRS discontinued the Issuer Rating of the Trust (an exception to our normal rating practice), due to the uncertainty regarding the Trust’s viability post-2017. As well, DBRS has not established a recovery rating for the Trust’s amortizing Senior Secured Notes as their repayment remains intricately tied to assumptions regarding the successful operation under the Supply and Processing Agreement, which extends beyond their maturity in December 2016.

The Trust, under the Supply and Processing Agreement, generates a low-risk stream of earnings largely insulated from volatile zinc prices with its raw material (concentrate) purchase costs linked to its revenue. Although the Trust has invested significant capital to maintain and enhance the operating capabilities of its zinc processing facility (CEZinc), the economic viability of CEZinc post-May 2017 is uncertain as it will need to replace (or continue) the Supply and Processing Agreement in a market that is currently in oversupply and with low zinc processing charges.

Zinc concentrate processing levels returned to normal levels in 2011 following a marked reduction in 2009/2010 due to operating issues, yielding net revenues of about $300 million per year and about a 40% margin before selling, depreciation and other costs in the 2011 to 2013 period. Operating income improved throughout the period, but higher unit costs in the first half of 2014 (H1 2014) shrank margins to 32% and sharply reduced income.

Largely steady operations and reduced distributions have resulted in dramatically reduced indebtedness since 2009, currently standing at $59.6 million, although debt increased in the first half of 2014 due to unexpectedly high costs. The Trust’s coverage credit metrics weakened in H1 2014 despite lower debt although they remain adequate for the rating.

Despite the issues confronted in H1 2014, DBRS expects better earnings and operating cash flow for the Trust in H2 2014, but given the uncertainty around the source of concentrates, earnings and cash flow are expected to be lower and more variable than historically. Higher raw material acquisition costs remain a concern due to variable feed sources. DBRS’s outlook also assumes no processing interruption occurs due to expiration of the current labour contact in the third quarter of 2014.

With steady operating performance, DBRS expects the Trust’s Senior Secured Notes will be fully repaid by the end of 2016. In addition to its indebtedness, the Trust’s remediation liability estimate has increased and legislated security requirements are scheduled to increase by $22.4 million over the next two years. In order to maintain liquidity to fund any potential remediation needs post May 2017, DBRS expects the Trust to be judicious in its distribution levels.

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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodology is Rating Companies in the Mining Industry (September 2014) and Rating Companies in the Industrial Products Industry (July 2014), which can be found on our website under Methodologies.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report or for more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.