Tashkent, Uzbekistan (UzDaily.com) -- S&P Global Ratings today assigned ‘B+’ rating to the Uzbek copper producer Almalyk Mining and Metallurgy Combine.

S&P Global Ratings sees risks related to the execution of Almalyk’s large greenfield project Yoshlik as the main constraining factor for the rating.

The Yoshlik project, at a preliminary cost of Uzbekistan sum (UZS) 42,000 billion, or about $3.6 billion, aims to almost double the company’s production of copper to 290 thousand tons (kt) from 148 kt and gold to 1,050 thousand ounces (koz) from 550 koz. Almalyk plans to launch the greenfield project in three years, managing related capital investments of about UZS14,000 billion annually (about $1.2 billion). Yoshlik represents 3.5x the company’s current EBITDA and we believe its realization could be challenging for Almalyk, given its limited expertise in launching projects of this scale. Although not our base-case scenario, a significant delay in project realization or cost revisions could negatively affect the company’s metrics and postpone expected deleveraging following the Yoshlik launch, especially if this coincides with an industry downturn. Furthermore, the agency notes that financing for the project is still to be secured, since operating cash flow will only cover 35%-40% of total capital investments. The government has committed to provide UZS10,700 billion ($1 billion) in equity, while the rest will be covered by debt, which the company has yet to secure. This includes prepayments from counterparties and public market instruments.

S&P Global Ratings projects FFO to debt will fall to about 20% in 2022, as Almalyk accumulates debt to finance capex, and we incorporate possible credit metrics volatility in our financial risk assessment.

Almalyk plans to realize a massive UZS50,000 billion capital investment program to be evenly spent in the next three years. The program includes operational stabilization and development of close-pit mine Samarchuk, but most capex will be to launch the open-pit Yoshlik and construct a new processing plant. Although we note current favorable market conditions, with copper and gold reaching highs of $10,460 per ton (/ton) and $1,906 per ounce (/oz) respectively as of June 2, 2021, we believe these inflated prices are unsustainable and expect  $7,500/ton for copper and $1,300/oz for gold by 2023. That said, we forecast EBITDA will peak at UZS13,700 billion in 2021, falling to about UZS11,800 billion next year on the back of flat production, no changes in taxes, and price adjustments. Combined with an anticipated increase in debt to fund the investments, FFO to debt will likely decrease to about 20% in 2022 but could fall further if the peak coincides with an industry trough. Like other rated peers in the mining industry, we further adjust our financial risk assessment by one notch to reflect current favorable market conditions.

High country risk in Uzbekistan and the company’s heavy tax burden, limited scale, and reliance on a single mine to produce most ore, further limit our business risk assessment. 

Almalyk is the second largest tax contributor to the Uzbekistani budget, generating about 13% of tax revenue at year-end 2020. Despite good ore quality and overall low costs of production, large mineral extraction taxes increase production costs by almost 2.5x, pushing total cash costs to produce copper to about $2,850/ton. Moreover, Almalyk’s portion of net income, which has an EBITDA margin above 15%, is taxed at 75%, limiting cash flow available to finance capital investments and repay debt. We also note Uzbekistan’s recent decision to pause excessive net income tax rate reductions, to 25% from 75%, to support the country’s budget after being hit by the COVID-19 pandemic. The changing regulatory environment and taxation practices, captured in our high country risk assessment, are among the key risks for Almalyk. Although it is the sole copper producer in Uzbekistan, Almalyk is still smaller in scale compared to international peers with similar business risk profiles. At year-end 2020, Almalyk produced 400 kt of copper equivalent versus 610 kt at Eurasian Resources Group or 888 kt at First Quantum Minerals. Furthermore, while First Quantum Minerals and Eurasian Resource Group are diversified among three main production assets, Almalyk mines about 85% of its ore at open-pit Kalmakir. Although not our base-case scenario, any operational disruption at this mine would significantly affect the company’s ability to generate cash flow. At the same time, we positively note potential improvement in asset diversification and scale when greenfield Yoshlik is fully operational. Successful project ramp-up, if coupled with material deleveraging, should support an upgrade in the future, all else being equal.

Governance practices are evolving and their development is crucial for successful Yoshlik ramp-up and long-term sustainability. 

Almalyk has recently taken measures to introduce best corporate governance practices, gradually transforming from a government-controlled company to a listed metals and mining producer. There is still long way to go, but Almalyk published its January 2020 opening balance for the first time under International Financial Reporting Standards this year, and is preparing to publish its full statement with two-year results (2020-2021) in 2022. The company’s governance setup recently changed again, after the government unexpectedly cancelled an agreement with external trust management, who were in charge of transforming the company from a government-managed enterprise to a public efficient commodity producer. The company claims that the management changes did not affect existing operations or the arrangement of financing for the Yoshlik project. Still, we see a risk that the planned improvement in transparency, disclosure, and incorporation of best governance practices could take more time than previously anticipated. Maintaining solid governance will be particularly important for the realization of a large-scale project like Yoshlik, as timely ramp-up and strong cost control could support improvements in business sustainability, deleveraging, and equity growth.

Almalyk’s key strengths are its large reserve life, good ore quality, taxes linked to commodities prices, and diversification into countercyclical metals to offset copper price volatility. 

Almalyk’s mining and metallurgical complex is the only copper producer in Uzbekistan. The company further produces molybdenium, lead concentrate, and cement and is significantly diversified into gold and silver. We note gold and copper contribute 35%-40% each to Almalyk’s EBITDA. In principal, copper is a very cyclical metal and prices are usually reflective of global GDP growth, while gold is countercyclical. However, in the current extraordinary circumstances, prices for both metals are above mid-cycle levels and we expect correction for both commodities. Despite export operations generating only 30% of revenue, gold, and silver are realized at the Central Bank of Uzbekistan at spot rates, ensuring about 75% of revenue is U.S.-dollar linked, which further reduces exposure to domestic currency volatility. Almalyk’s production is fully concentrated in Uzbekistan, with Kalmakir being the main cash-generating asset. The mine was launched about 70 years ago, but good ore quality and significant reserve size still ensure a reserve life of about 100 years and above-average production profitability. We further positively note recent changes to the tax system, including cancelled cut-off prices, excise taxes, and reduced mineral tax rates. The tax rates are linked to commodity prices, introducing a natural hedge against any price drop, and supporting profitability during downturns.

Our rating on Almalyk benefits from potential extraordinary support from the government of Uzbekistan.

We assess Almalyk as having a high likelihood of extraordinary support from the government of Uzbekistan, its 98.6% owner, resulting in one notch of rating uplift. In our view, Almalyk has a very strong link with, and plays an important role for, Uzbekistan. We positively note a track record of support through loans issued at favorable rates, guaranteed by the government. Although we understand Uzbekistan plans to refrain from providing guarantees in the future, the government recently committed to a capital injection of about UZS10,700 billion and can provide additional support for the Yoshlik project, if needed. In our base case, we don’t forecast the government will reduce its stake in the company to below 75% and expect it will fully control Almalyk’s strategy through its board representation.

The stable outlook reflects our expectation that Almalyk will raise financing for its massive investment program and launch production at the Yoshlik mine with no material cost overruns or delays. In our base case, FFO to debt should remain above 20% at its peak and successful Yoshlik ramp-up should allow the company to start deleveraging in 2024, while diversifying production from Kalmakir.