(The following statement was released by the rating agency)
Oct 09 - =============================================================================== Summary analysis -- Mongolian Resources Corp. --------------------- 09-Oct-2012 =============================================================================== CREDIT RATING: B-/Stable/-- Country: Mongolia =============================================================================== Credit Rating History: Local currency Foreign currency 08-Oct-2012 B-/-- B-/-- =============================================================================== Rationale
The rating on Mongolia-based iron ore miner Mongolian Resources Corp. (MRC) reflects the company's production and sales ramp-up risks, its high customer and mineral oncentration, and high debt. MRC's second-quartile cost position and positive demand prospects in the northwest Chinese iron ore market partly offset thse limitations. The rating factors in the company's proposed issue of up to US$300 million in senior secured notes.
We assess MRC's business risk profile to be "vulnerable," as our criteria define the term, to reflect the high risk associated with a ramp-up in the company's production and sales volumes over the next 12-18 months. MRC's target of doubling annual production and sales to 3.7 million tons in 2013, from the 1.8 million tons it expects in 2012, is aggressive, in our opinion. We view the company's record of growing production and sales at such a pace and scale as mostly untested.
MRC's high customer concentration heightens its sales ramp-up risk, in our view. We believe the company may find it difficult to rapidly redirect its production to other customers or outside the region if demand temporarily slows down. In addition, MRC's clients have strong bargaining power and this could disrupt the company's cash flows if commercial disputes are prolonged. We expect customer concentration to remain high over the next two years, despite MRC's stated strategy to broaden its customer base. The company's two largest clients ccounted for about 95% of its revenues for the six months ended June 30, 2012.
We view MRC's risk tolerance as high. As of June 30, 2012, more than 50% of the company's debt stems from a 2011 debt-funded buy-out of the shares held by Deutsche Bank AG (A+/Negative/A-1) in Euro 7 Investment, MRC's major shareholder, and in Altain Khuder LLC (not rated), MRC's main operating subsidiary. Some of these shares were subsequently granted to business partners of Mr. Bazar Radnaabazar, who owns Euro 7 Investment. MRC failed to pay its working capital loans from Golomt Bank of Mongolia (B+/Positive/B) when they fell due in March and May 2012, although it fully repaid these loans in September 2012. In our view, these events highlight the limitations of the company's internal controls and its lack of established financial discipline.
MRC's good second-quartile cost position and low mining costs partially mitigate its high mineral concentration to iron ore. We estimate that a 5% decline in iron ore concentrate prices would result in about 10% decline in EBITDA. Nevertheless, we expect the company's gross profit per ton before depreciation and amortization at about US$34-US$38 over the next three years. This should keep EBITDA positive even if iron ore prices fall 25% from current levels.
In our base-case scenario, we expect MRC's financial risk profile to remain "highly leveraged," as defined in our criteria, over the next 12 months. We forecast a debt-to-EBITDA ratio of 4.5x-5.0x in 2013, with a ratio of funds from operations (FFO) to debt at about 10% following the company's proposed notes issuance. We expect MRC's debt-to-EBITDA ratio to improve to less than 4.5x in 2014 to reflect the growth in sales. We assume MRC's iron ore concentrate sales to be about 2.5 million tons in 2013 and 2.9 million tons in 2014.
MRC intends to uses the proceeds of the proposed notes to repay existing indebtedness and for capital spending and general corporate purposes. Because the company plans to use the proceeds to repay all existing secured indebtedness, we expect its ratio of priority debt to total assets to be less than 15% over the next two years. MRC's major cash-generative subsidiaries Altain Khuder LLC and Million Vision Group Ltd. will guarantee the notes. We expect the notes to be secured over the capital stock of all of MRC's restricted subsidiaries, mining and exploration licenses, cash accounts and receivables, existing mining equipment, and existing processing plants, including processing plant no. 6--if and when it is completed. MRC will be able to incur additional indebtedness subject to a number of incurrence covenants.