Fitch Affirms Nickel Mines Limited at 'B+'/Stable on Acquisition Announcement

(Fitch Ratings - Sydney/Jakarta - 16 Dec 2021)--Fitch Ratings has affirmed Nickel Mines Limited's (NIC) Long-Term Issuer Default Rating at 'B+' with a Stable Outlook. Fitch has also affirmed NIC's USD325 million senior unsecured notes at 'B+' with a Recovery Rating of 'RR4'.

The affirmation follows our expectation that funds from operations (FFO) leverage will remain below 3.0x through to 2023 - the threshold above which we would consider negative rating action - following NIC's proposed acquisition of Indonesia-based PT Oracle Nickel Industry (ONI). We expect the acquisition to be funded by cash on hand and free cash flow. However, even if it is partly debt funded, we believe the increase in leverage can be contained within the existing rating.

NIC executed a binding definitive agreement with Shanghai Decent Investment (Group) Co., Ltd. (SDI - a Tsingshan group company) on 8 December 2021 to acquire a 70% equity interest in ONI for a total of USD525 million, including USD371 million in consideration and USD154 million in shareholder loans to ONI.

Key Rating Drivers

Available Debt Capacity: FFO leverage will remain below 3.0x in 2022-2023 (2021 estimate: 1.5x), even under the scenario of a partially debt-funded acquisition of ONI. We understand that the funding of the acquisition could comprise a mix of cash reserves, equity raise and debt funding. NIC has debt capacity within its current metrics, but we believe it is more likely that the acquisition will be funded from free cash flow. NIC has a record of utilising equity to fund acquisitions, which enables Tsingshan to participate in the equity raising and maintain interest in the project, albeit indirectly.

Acquisition Payment Schedule Manageable: The acquisition payment schedule provides NIC with a significant runway to finalise the ultimate funding mix of the acquisition. Payments will be made incrementally from 4Q21 until 1Q23, with USD302 million scheduled for late stage 4Q22 and 1Q23; as the bulk of the payment is not until the latter part of 2022, the quantum of debt and equity funding will evolve and be driven by production levels, nickel pig iron (NPI) prices and costs.

New Production to Support Deleveraging: We estimate leverage will reach 2.6x-2.8x in 2022 if the company decides to raise USD300 million-350 million as part of a partially debt-funded acquisition. However, leverage should fall to around 2.0x in 2023 as ANI commences full operation in 4Q22 and ONI starts full production in 3Q23. NIC has stated that it will continue to explore opportunities with SDI. The timing and funding of further acquisitions could reduce the headroom in its credit metrics and concurrently increase its reliance and exposure to Tsingshan group as the sole off-taker for its products.

Larger Scale, Single Commodity: ANI's full production, which NIC expects to commence in October 2022 following the completion of a power plant in September, will improve NIC's asset concentration risk. NIC's current production is located at PT Indonesia Morowali Industrial Park (IMIP), while ANI is based at Indonesia Weda Bay Industrial Park. We expect full production at both ANI and ONI to boost NIC's nameplate capacity to 102,000 tonnes a year by 2024, from 30,000 tonnes currently. Both projects have 36,000 tonnes of annual capacity at full production.

ANI and ONI will position NIC as a globally significant nickel producer, but it will remain highly exposed to Chinese NPI prices.

Robust EBITDA Margin: We expect the EBITDA margin to remain above 30% through to 2023 (2021 estimate: 36%). NIC's solid cash cost position at its NPI facilities should help it weather the impact of commodity price fluctuations on its selling prices and input costs. The purchase of nickel ore accounts for around 30%-40% of its costs and thermal coal purchases for electricity make up 25%-30%. The EBITDA margin remained solid in 1H21 at 36% (2020: 37%), as higher NPI prices compensated for the surge in thermal coal prices.

NIC's two rotary kiln electric furnace (RKEF) processing facilities - PT Hengjaya Nickel Industry (HNI) and PT Ranger Nickel Industry (RNI) -- are strategically located at IMIP, the world's largest integrated stainless-steel production facility. Indonesia is the largest nickel producer globally and the Morowali regency has some of the country's largest nickel ore deposits. A ban on raw ore exports and close proximity to ore supply give NIC the advantages of cheaper raw material prices and low logistic costs.

Positive Free Cash Flow: Free cash flow should stay positive through to 2023, supported by a solid EBITDA margin and steady capex and shareholder returns. We expect free cash flow to comfortably cover a large part of the acquisition amid our forecast for a stable NPI price in 2022. We believe NIC has adequate funding access, given its record of raising funds in the equity and offshore bond markets.

Derivation Summary

We believe NIC has a better credit profile than Guangyang Antai Holdings Limited (B/Stable). Guangyang Antai's larger operational scale and revenue generation, as China's third-largest stainless-steel producer, are offset by NIC's solid cash cost position and credit metrics. Guangyang Antai's business profile and margin are weighed down by its increasing exposure towards the lower-margin trading business. NIC's cash flow generation is significantly better, with an EBITDA margin of above 35%, supported by its strong cash cost position. This compares with Guangyang Antai's EBITDA margin of less than 5%.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

- Stable production at HNI and RNI in 2021-2023

- Full production at ANI to commence in 3Q22 and full production at ONI to commence in 3Q23

- EBITDA margin of around 32%-36% in 2021-2023

- Minimal capex at subsidiaries, as major investment projects were recently completed

- USD525 million acquisition of ONI to be paid incrementally from 4Q21 until 1Q23

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- Successful ramp-up of ANI in line with our expectation, while maintaining FFO leverage at below 2.0x

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- Sustained increase in FFO leverage to above 3.0x

- Material disruption at the HNI and RNI smelter operations

KEY RECOVERY RATING ASSUMPTIONS

The recovery analysis assumes that NIC would be reorganised as a going concern in bankruptcy rather than liquidated. We assume a 10% administrative claim.

Our going-concern EBITDA estimate reflects our view of a sustainable, post-reorganisation EBITDA level upon which we base the enterprise valuation.

Our going-concern EBITDA estimate of USD240 million reflects the mid-cycle nickel price and stable RKEF operations at HNI and RNI. We use a multiple of 5x to estimate a value for NIC because of its geographical concentration in Indonesia and smaller operational scale compared with peers, despite stronger growth prospects following ANI's production commencement.

The going-concern enterprise value corresponds to a 'RR1' Recovery Rating for the senior unsecured notes after adjusting for administrative claims. Nevertheless, we rate the senior unsecured bonds at 'B+' and 'RR4' because NIC's operating assets are located in Indonesia. Under our Country-Specific Treatment of Recovery Ratings Criteria, Indonesia is classified under the Group D of countries in terms of creditor friendliness and Recovery Ratings are subject to a cap at 'RR4'.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Medium-Term Debt Maturity: NIC successfully issued another USD150 million in senior unsecured notes in 3Q21 as a follow up to its USD175 million note issue in 1Q21. Consequently, NIC's closest debt maturity is in 2024, with the maturity of the USD325 million senior unsecured notes. NIC had USD120 million in cash, of which USD75 million was held at the NIC level, at end-September 2021.

Issuer Profile

NIC is an NPI producer that operates in Indonesia's IMIP. It operates four rotary kiln electric furnaces processing facilities with total annual name-plate capacity of 30,000 tonnes.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. (ends)