Zaporizhstal pursuing loans to finance converter shop construction

Zaporizhstal (ZPST UK), Ukraine’s fourth-largest iron
and steel plant in which a 49.9% stake is owned by Ukraine’s largest steelmaker
Metinvest (METINV), is conducting talks with European bankers on financing a
USD 1 bln three-year project on replacing its open-hearth furnaces with an
oxygen converter shop, according to the plant’s CEO Rostyslav Shurma as
reported by iz.com.ua, a news website.

Shurma said that some creditors already have approved
the loan, but further talks are necessary and progress is expected within
months. The construction of the converter shop will take three years, according
to Shurma. The CEO blamed Ukraine’s domestic political situation for the
caution on creditors’ part.

Dmytro Khoroshun: We think
that Zaporizhstal’s strength as a standalone borrower for a USD 1 bln loan can
be questioned by prudent creditors independently of other factors such as Ukraine’s
political struggles.

We calculate that since January 2016 the plant’s
monthly EBITDA amounted to USD 25 mln on average (USD 300 mln per year), never
exceeding USD 38 mln (USD 456 mln per year). Therefore, we calculate that
Debt/EBITDA would easily exceed 3x even if the plant has no debt other than the
USD 1 bln for financing the converter shop. We also note that the interest
cover ratio (EBITDA/interest) might easily drop below 5x, and even approach 3x,
for realistic interest rates such as 8-10%. These values of credit metrics are
rather weak.

Therefore, we think that this time around, similar to
several times in the past, Zaporizhstal will face difficulties launching this
project due to lack of financing.

We also note that Zaporizhstal faces risks related to
its markets. The plant’s main product, hot-rolled coils, has recently been
pushed out of the EU market by the introduction of an import duty.
Furthermore, the plant has less flexibility than Metinvest’s other plants in
switching to producing semi-finished steel products exactly because its
outdated steelmaking facilities do not allow for producing merchant slab.

Should Zaporizhstal succeed and attract the USD 1 bln,
this would be slightly negative for Metinvest’s Eurobond, despite the debt
being off Metinvest’s consolidated books. This is because the heavy CapEx
spending and substantial debt service payments at at Metinvest’s JV
(Zaporizhstal) would not be positive for the cash flows of the holding. We also
note that the benefits of the project will not materialize during the life of
Metinvest’s Eurobond due to the construction lasting at least three years.

We are keeping our neutral view on METINV
Eurobonds.