DBRS Limited (DBRS Morningstar) upgraded Sherritt International Corporation’s (Sherritt or the Company) Issuer Rating to B with a Stable trend from Selective Default (SD) and removed the Under Review/Positive Implications status following the release of the Company’s Q3 2020 results and discussions with management. DBRS Morningstar also assigned a Recovery Rating of RR6 and a rating of CCC (high) (or two notches below the Issuer Rating), also with a Stable trend, to Sherritt’s new Second Lien Notes. Despite the pending expiry of the Puerto Escondido/Yumurí production sharing contract (PSC), the upgrade to B is because Sherritt’s business risk profile is in the BB category, supported by its relatively long reserve life and lower operating cost structure at its nickel operations, partially offset by its pending smaller size. The Stable trend reflects expectations that nickel prices will remain at approximately USD 7 per pound over the next three years, based on Bloomberg consensus nickel price forecasts (as of November 23, 2020), underpinned by the ongoing shift to electric vehicles in many economies, especially in China. DBRS Morningstar’s Recovery Rating analysis was based on an enterprise valuation that included a portion of the Company’s reclamation obligations and both Sherritt’s forecast EBITDA and expected dividend stream from its Moa nickel joint-venture (JV) and that resulted in assigning the RR6 recovery rating. Please refer to “DBRS Morningstar Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers” for the full details of this approach.
On August 31, 2020, Sherritt completed its Balance Sheet Initiative (the Transaction), which resulted in the Company exchanging its outstanding unsecured debt for a total of $433 million of new Second Lien Notes and Junior Notes (please refer to the DBRS Morningstar press release published on September 1, 2020, for full details of the Transaction). While the Transaction reduced the Company’s debt, the pending expiry at the end of Q1 2021 of the Puerto Escondido/Yumurí PSC will effectively leave Sherritt with no oil production, which will put further pressure on EBITDA and operating cash flow because the oil operations are fully consolidated into Sherritt’s financials. While both the current spot nickel prices and Bloomberg consensus nickel price forecast should result in attractive operating margins, Sherritt’s investment in the Moa JV is equity-accounted and the Company only receives dividends. DBRS Morningstar notes that in Q3 2020, Sherritt and its Cuban partner, General Nickel Company (GNC), agreed to convert the Moa Expansion loans into equity, meaning that while the 50/50 JV ownership structure is unchanged but all future distributions will be in the form of dividends.
The Company continues to have significant cash balances and outstanding receivables at its Cuban operations. The cash balance of $165.1 million at the end of Q3 2020 included $82.1 million of cash held at the Company’s Power operations; the total outstanding Oil and Gas and Power receivables were $159.1 million at the end of Q3 2020. That said, Sherritt continues to receive both dividends from its Moa JV and receivables despite the negative impact of the Coronavirus Disease (COVID-19) pandemic on Cuba’s foreign currency reserves. In Q3 2020, Sherritt received USD 16.3 million in overdue energy payments, USD 14.0 million of which was received in Canada. USD 2.3 million was used to fund its oil operations. Also in Q3 2020, the Moa JV declared USD 15 million in dividends that were subsequently paid in Q4 2020 with Sherritt receiving its USD 7.5 million share of the dividend plus GNC’s USD 7.5 million share due to the lag in the receipt of the Power receivables under the enhanced June 2019 agreement with Energas S.A.. DBRS Morningstar notes that the sustained payment of outstanding receivables and Moa dividends would mitigate the risk of a potential default in 2026 of the Second Lien Notes and could result in a positive rating action. Conversely, the sustained suspension of either the repayment of the outstanding energy receivables or ongoing Moa dividends could lead to a negative rating action.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Rating Companies in the Mining Industry (August 17, 2020), DBRS Morningstar Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (August 24, 2020), DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 22, 2020), and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2, 2020), which can be found on dbrsmorningstar.com under Methodologies & Criteria.
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
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The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.
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