Fitch Assigns Nickel Mines Limited and Notes First-Time 'B+'; Outlook Stable

(Fitch Ratings - Sydney - 18 Mar 2021)-- Fitch Ratings has assigned a Long-Term Issuer Default Rating (IDR) of 'B+' to Nickel Mines Limited (NIC), a nickel pig iron (NPI) producer. The Outlook is Stable. At the same time, Fitch has also assigned a rating of 'B+' with Recovery Rating of 'RR4' to the company's proposed US dollar senior unsecured notes.

The proposed notes will be issued by NIC. They are rated at the same level as the IDR as they constitute unconditional, unsecured and unsubordinated obligations of NIC.

NIC's rating reflects its solid financial profile, with strong EBITDA margin above 35% and positive free cash flows. Both of the company's rotary kiln electric furnace (RKEF) processing facilities at PT Hengjaya Nickel Industry (HNI) and PT Ranger Nickel Industry (RNI) are in Indonesia, and they sit in the first quartile of the cost curve and drive strong profitability. Both assets have consistently exceeded their name plate capacities by 35%-45% since their commissioning in 2019.

NIC's financial strength is weighed down by its asset concentration, with the two RKEFs in PT Indonesia Morowali Industrial Park (IMIP). NIC's asset diversification will improve with its investment in PT Angel Nickel Industry (ANI), another RKEF facility at PT Indonesia Weda Bay Industrial Park, which is being developed by Tsingshan Group and expected to start production in 2022. The Tsingshan Group, a China-based group focused on stainless steel production that owns 18% of NIC, has a record of delivering RKEF facilities on time and within budget.

KEY RATING DRIVERS

Proven Commissioning and Production Record: NIC's credit profile is supported by its robust RKEF operations in Indonesia. It first produced NPI in January 2019, less than 12 months after breaking ground at HNI and RNI, and now has attributable nameplate capacity of 24,000 tonnes per annum (tpa). We expect these operations to account for more than 95% of NIC's EBITDA in 2021, and more than 80% in 2022 after ANI starts operation. NIC has transformed from being exclusively an upstream miner of nickel ore from its PT Hengjaya Mine (HM) operation, to a significant producer of NPI.

Low-Cost Position: NIC's NPI production benefits from low-cash cost positions. HNI and RNI are strategically located in IMIP, the world's largest integrated stainless-steel production facility. Indonesia is the largest nickel producer globally and Morowali regency has some of the largest nickel ore deposits in the country. A ban on raw ore exports and close proximity to ore supply give NIC the advantages of cheaper raw material prices and lower logistic costs.

Accordingly, the company's operations are located within the first quartile of global nickel producers' cost curves, based on data from Wood Mackenzie. NIC's actual cash costs were around USD7,300/tonne in 2020, against the average nickel price of USD13,200. In addition, the vertical integration of operations within the IMIP provides numerous cost and efficiency benefits to NIC.

Improving Asset Diversification: NIC now operates only four RKEF lines at HNI and RNI with total nameplate capacity of 30,000 tpa. The start of production at ANI, due in late 2022, will add 38,000 tpa of nameplate capacity and improve asset diversification. ANI will also provide structural cost advantages, as it has a 380MW captive power plant that will reduce power costs relative to current operations and offer more margin advantage over other producers.

Bonds to Finance Acquisition: NIC plans to issue USD300 million of bonds to fund part of its acquisition of 50% of ANI for USD350 million. NIC already owns 30% of ANI and the additional stake will give it 80% ownership for a total consideration of USD560 million.

Minimal Risk of Overruns: Fitch views the risks of cost-overruns and delays from the ANI acquisition to be manageable for NIC. In accordance with the agreement between NIC and Shanghai Decent (a Tsinghan group company that owns 18% of NIC), the latter will be in charge in designing and constructing facilities at ANI. In addition, ANI will be indemnified for any construction cost exceeding USD700 million. Shanghai Decent has a record of building and ramping up NIC's RKEF lines at HNI and RNI on time and within budget.

NIC's leverage profile will not be materially altered by any delay in the start of ANI's operations, as the additional debt of USD300 million is manageable relative to the company's annual EBITDA of around USD200 million from RKEF production. We also expect the free cash flow at HNI and RNI to provide an additional cash cushion.

Positive Free Cash Flows: We estimate NIC's free cash flow will remain positive due to its solid cost position, assuming there are no major capex and significant increase in shareholder returns. NIC's EBITDA margin will remain solid above 35% in 2021 and 2022 under our assumptions of stable cash cost per tonne at around USD7,300. Positive free cash flow will be supported by minimal capex from its young-age RKEF lines. However, a material increase in dividends can reduce free cash flows and erode its current strong cash buffer.

Solid Credit Metrics: NIC's leverage, as measured by funds from operations to gross leverage (FFO leverage), will remain strong below 2.0x in 2021-22, including debt funding of the ANI acquisition. Deleveraging from 2023 will be supported by the start of production at ANI. FFO interest coverage will also remain high at above 5.0x during those years.

DERIVATION SUMMARY

We believe that NIC has a better credit profile than Guangyang Antai Holdings Limited (GYAT, B/Stable). The latter's larger operational scale and revenue generation, as the third-largest stainless-steel producer in China, is offset by NIC's solid cash cost position and credit metrics. GYAT'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 EBITDA margin of above 35%, supported by its strong cash cost position. In comparison, GYAT's EBITDA margin is far thinner at less than 5%. We expect NIC's FFO leverage to remain conservative below 2.0x, lower than GYAT's above 2.0x.

KEY ASSUMPTIONS

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

- Stable production at HNI and RNI at a level similar to that in 2020. Production at ANI will commence in late 2022.

- Nickel price of USD15,000/tonne in 2021 and USD14,000/tonne thereafter, in line with Fitch's price deck.

- Stable cash cost at HNI and RNI of around USD7,300/tonne. Cash cost at HM to improve to USD26 per wet metric tonne from 2021 following the full mining at central pit.

- Minimal capex at HNI, RNI and HM as major investment projects were recently completed.

RECOVERY RATING ASSUMPTIONS

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

Going-Concern (GC) Approach

The GC EBITDA estimate reflects Fitch's view of a sustainable, post-reorganisation EBITDA level upon which we base the enterprise valuation.

Our GC EBITDA estimate of USD170 million reflects the mid-cycle nickel price and stable RKEF operations at HNI and RNI.

An enterprise value multiple of 5x EBITDA is applied to the GC EBITDA to calculate a post-reorganisation enterprise value. We use a multiple of 5x to estimate a value for NIC because of its asset concentration in Indonesia and its smaller operational scale compared to peers, despite its stronger growth prospects following the ANI acquisition.

The going-concern enterprise value covers 100% of NIC's unsecured debt, corresponding to a 'RR1' Recovery Rating for the senior unsecured notes after adjusting for administrative claims. Nevertheless, Fitch has rated the senior unsecured bonds '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'.

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 below 2.0x

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

- Sustained increase in FFO leverage above 3.0x

- Material disruption in its smelter operations at HNI and RNI

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

Adequate Liquidity: NIC had USD351 million of cash at end December 2020 against USD45 million debt from related parties. We expect NIC to generate free cash flow of around USD70 million in 2021 and finance the USD524 million payment for ANI shares through bond issuance. We believe funding risk to be manageable given NIC's solid credit profile and relationship with Tsingshan Group.

DATE OF RELEVANT COMMITTEE

03 March 2021

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.