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

DBRS Limited (DBRS) has today confirmed the Senior Secured Notes rating of Noranda Operating Trust (the Trust) at BB (high) with Stable trend. The Trust is a well-established and currently profitable processor of zinc concentrates strategically located to serve North American zinc metal markets, but it is highly dependent on a zinc concentrate supply and processing agreement (Supply and Processing Agreement) with Glencore Canada Corporation that ends its initial term in May 2017. DBRS has not established a recovery rating for the Trust’s Senior Secured Notes, as their repayment remains intricately tied to assumptions regarding the success of the operation under the Supply and Processing Agreement, which extends beyond their maturity.

The Trust has invested significant capital to maintain and enhance the operating capabilities of its zinc processing facility (CEZinc), but the economic viability of CEZinc post-May 2017 is uncertain, as it will need to replace (or continue) the Supply and Processing Agreement at terms DBRS expects will likely be less favourable than currently. The available supply of zinc concentrates from Canadian sources has diminished over the last few years, and CEZinc has become more dependent on concentrates produced offshore. If concentrates are unavailable, or processing terms uneconomic post-May 2017, CEZinc may be forced to close and incur significant remediation costs. DBRS discontinued the Issuer Rating of the Trust (an exception to its normal rating practice) in 2012 because of the uncertainty regarding the Trust’s viability post-May 2017.

Under the Supply and Processing Agreement, the Trust generates a low-risk stream of earnings largely insulated from volatile zinc prices, with its raw material (concentrate) purchase costs linked to its revenue. Zinc concentrate processing levels and zinc metal production remained steady from 2011 to 2014, with an upturn in both in Q1 2015, following the completion of the cell-house reline project in 2014. Nonetheless, net income before non-recurring items was down in 2014 from strong levels in 2013, but with more normal levels being generated in Q1 2015 (annualized).

Accordingly, the Trust continues to generate positive gross free cash flow, but a $98.1 million increase in working capital since the end of 2013 has resulted in a $73.5 million increase in net debt, bringing total indebtedness to $114.4 million as at March 31, 2015, $37.5 million of which relates to its Senior Secured Notes (less the $7.5 million repaid June 28, 2015). Nonetheless, the Trust’s gross debt remains less than the borrowing base of its asset-based, revolving credit facility ($150.0 million). In addition, the Trust faces a material increase in its legislated remediation security obligations requirements to $23.5 million by January 2017.

Currently, the Trust’s credit metrics remain strong for its rating, and they are expected to remain so with steady, near-capacity operation of the CEZinc facility. Notably, the Senior Secured Notes are amortizing with the last payment due December 2016, before the expiry of the initial term of the Supply and Processing Agreement.

DBRS expects the Trust’s 2015 earnings before non-recurring items will be higher than in 2014, with the restoration of full capacity and improvements made to the facility only being partially offset by higher costs associated with more concentrates being sourced offshore and assuming no processing interruptions. DBRS also expects the Trust’s operating cash flow to increase in 2015 over 2014 and that its credit metrics will continue to improve as term debt and interest costs are reduced and capital expenditures are held in check. A reduction of working capital is also expected in the last three quarters of 2015 as zinc metal inventories built up in Q1 2015 are reduced.

DBRS expects the Trust will generate significantly lower profitability post-May 2017 or even experience a possible shutdown because of competitive pressures in the zinc concentrate processing marketplace. Beyond May 2017, the Trust’s only debt is expected to be for working capital; however, with the uncertainty around the availability of concentrates and the structure of long-term processing fees being subject to competitive market forces, operating cash flow is expected to be materially reduced.

The Trust has continued to restrict distributions to its unitholders in order to provide funds to maintain the operational capability of CEZinc and to build resources to accommodate any transition/remediation/closure costs that may be incurred post-May 2017. DBRS views this as a prudent action given that the viability of the CEZinc facility post-May 2017 remains in doubt.

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 (September 2014) and Rating Companies in the Industrial Products Industry (June 2015), which can be found on our website under Methodologies.

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