Fitch Ratings adjusted the Outlook of Uzbek Metallurgical Plant (UZMK) from stable to negative, while maintaining its Long-Term Issuer Default Rating (IDR) at ‘BB-’. The revision in Outlook is attributed to UZMK’s leverage exceeding expectations in 2023-2024, as the company’s expansionary capital expenditure (capex) aligns with weaker market conditions and escalated production costs.
What does 'BB-' rating stands for?
'BB-' grade (junk bond territory). The Standard & Poor's and Fitch credit agencies assign a BB credit rating to a bond issuer, such as a government or corporation, to reflect the issuer's creditworthiness and possibility of bond default.
Bonds with a BB rating are not investment grade, indicating a comparatively high credit risk. It means that there is doubt about the borrower's ability to fulfil its financial obligations, making it appear "junk" or unstable.
Although UZMK’s leverage is anticipated to moderate from 2025-2026, the company’s liquidity remains constrained and its flagship project, the Casting and Rolling Complex, is subject to execution risks. These elements exert pressure on UZMK’s ‘b+’ Standalone Credit Profile (SCP), which also mirrors UZMK’s small but growing scale, corporate governance limitations, robust position in Uzbekistan’s domestic market, and moderate costs.
UZMK’s support score is 25, indicating ‘strong’ expectations for state support, as per Fitch’s recently updated Government Related Entities (GRE) Rating Criteria. UZMK is rated on a bottom-up basis, with a single-notch uplift to the SCP for state support.
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Key rating drivers
UZMK’s decision-making and oversight by the government is viewed as ‘strong’, given the state’s 93% stake in the company and its control over the company’s operating activity and investment programme. Precedents of support are assessed as ‘very strong’ as nearly half of the external funding for the casting and rolling project was provided by the state, despite the government not guaranteeing any of UZMK’s debt.
UZMK’s preservation of government policy role is assessed as ‘strong’ as the company accounts for 80% of all steel products produced in Uzbekistan and more than a third of steel products consumed within the country. This should increase to more than half after the Casting and Rolling project is commissioned. A UZMK default would impact the development of the national steel industry and may obstruct the development of the construction metals and mining sectors. However, UZMK is not given any scores for contagion risk, given its external debt is relatively small.
UZMK’s gross leverage is expected to peak in 2023-2024 at around 5x before it moderates to 3x in 2025 and below 3x in 2026-2027. The expected lower leverage is driven by higher projected EBITDA from 2025-2026 following the commissioning of the Casting and Rolling project and normalising capex, leading to positive projected free cash flow (FCF). The Negative Outlook reflects the risk that deleveraging could be slower than assumed in our rating case.
UZMK has already received waivers for possible leverage covenant breaches with some of its lenders based on its 2023 results. Projections indicate that the covenant might also be breached in 2024, which could necessitate additional waivers.
The Casting and Rolling project is a transformative hot-rolled sheet project for UZMK and the country’s steel industry. The project will increase UZMK’s steel-making capacity to 2.1 mn tons per annum (mtpa) from 0.9 mtpa and double its total capacity for finishing lines to 2.2 mtpa. This provides diversity to its current output of longs (mostly used in the domestic construction sector) and grinding balls (mostly used by the domestic metals and mining sector).
UZMK has limited experience in delivering new projects and is exposed to the risk of cost overruns and delays. UZMK expects the Casting and Rolling project to be commissioned by end-2024, though it is still in the process of obtaining the remaining funding from a syndicate of international commercial banks.
The Casting and Rolling project, estimated to cost around €730 mn, has secured funding from various sources. An equity injection of €140 mn from the state-controlled Uzbekistan Funds for Reconstruction and Development (UFRD) received in 2021, a loan of €110 mn from UFRD received in 2023, approximately €90 mn from local banks received in 2019-2020, €190 mn in project finance facility, and the remaining €200 mn from UZMK’s own resources.
UZMK management plans to sign an inter-creditor agreement with its lenders to arrange for contractual subordination of the €110 mn UFRD loan due in 2031. However, the loan will likely continue to be included in the debt quantum as it bears cash interest.
UZMK’s unit margin (EBITDA/unit) experienced a sharp decline in 2023 to a Fitch-estimated $80 per tonne, after a strong $175 per tonne on average in 2021 and 2022. This was due to compressed margins worldwide, extreme weather conditions in early 2023 leading to electricity blackouts and idle production, increased energy tariffs in Uzbekistan and currency depreciation.
Unit margins are expected to normalise at around $100 per tonne for 2024-2027, which, coupled with almost a doubling in production volumes, should lift EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation) to around $200 mn by 2026, from around $100 mn in 2024. UZMK’s margins will likely continue to be supported by low energy prices relative to international peers and its exclusive right to purchase and set the price for scrap metal in the domestic market. These forecasts, however, are subject to the Casting and Rolling project coming on stream by early 2025.
Steel markets in 2024 are expected to be more robust than a year ago, aided by a recovery in demand ex-China, falling costs, and a slight rise in prices in China, India, and Europe. Producer margins in China will continue recovering from Q3 2023 as supply falls and buoyant manufacturing and green energy infrastructure offset the sluggish property sector.
The Uzbek Metallurgical Plant was assigned an ESG Relevance Score of ‘4’ for Financial Transparency. This is primarily due to the subpar quality of its financial disclosure, such as the absence of interim financials. This factor negatively influences the credit profile and is pertinent to the ratings when considered alongside other factors.
The apex level of ESG credit relevance is a score of ‘3’, unless stated otherwise in this section. A score of ‘3’ implies that ESG issues either have no impact on the credit of the entity or have a negligible impact. This is either due to the inherent nature of these issues or how the entity is managing them.
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