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Fitch sees tough times for Russian steel industry

Fitch Ratings expects the Russian steel industry to continue to face challenges for the reminder of 2009, such as soft domestic demand and depressed prices, although their impact will vary across companies.

Fitch noted that “The operating and financial performance of Russian steel companies in Q109 generally remained weak despite some revival of steel sales and demand in Q109 compared to Q408. For Q209, the agency expects steel output and prices to remain at Q109 levels. Although domestic sales may continue their recovery, particularly in Q309-Q409, as the government stimulus kicks in and restocking intensifies, there are still risks that Russian steel producers may be affected by protectionist measures and/or weak demand from major markets such as China or Europe.”

It said that “While average utilization of Russian steel production capacities increased to 70%-72% in March 2009 from 55%-60% in January 2009, Fitch attributed the increase in production to restocking and rising exports as domestic demand fundamentals remained weak. According to World Steel Association figures, in Q109 Russian steel companies produced 12,862 thousands of metrics tonnes of steel, down 33% year on year but up 11% quarter on quarter. The share of export sales increased to more than 50% y-o-y from 39%. Q109 average steel prices observed by Russian steel producers decreased 40%-46% from Q408. Export prices are consistently 10%-20% lower than domestic prices. Russian producers have announced significant production cutbacks and cost reduction programs and despite a decrease in input prices, these measures were not enough to offset the decline in sales prices. As a result, Fitch observed a sharp drop in EBITDAR margin of Russian steel companies. For example, in Q109 OJSC Novolipetsk Steel (NLMK) ('BB+'/'B'/Stable) EBITDAR margin decreased to 15% from 25% in Q408 and OAO Severstal (Severstal) ('BB-'/'B'/RWN) EBITDAR margin decreased to -5.7% from 7.4% in Q408.”

Nevertheless, Fitch notes that the outlook for Russian steel producers as NLMK and OJSC Magnitogorsk Iron and Steel Works ('BB'/'B'/Stable) remains stable. Fitch estimates that both companies will be able to sustain EBITDA margin at 15%-20% due to low cost advantage and modest operating leverage. The agency also expects both companies to continue to have adequate liquidity positions due to historically conservative financial policies and significant cash balances. At end-Q109 NLMK had USD1.5bn cash vs. short-term maturities of USD1.0bn In accordance to unconsolidated financial statements prepared to Russian Accounting Standards, at end-Q109 MMK had cash of RUB17.7bn (USD0.5bn) versus short-term maturities of RUB10.9bn (USD0.3bn).

The credit profiles of Evraz Group SA ('BB'/'B'/RWN) and Severstal will continue to be under pressure as these companies have higher leverage than other Fitch-rated Russian steel peers and significant near-term maturities. As of FYE08 near-term maturities as a percentage of total debt were 39% and 24%, respectively, at Evraz and Severstal. Fitch expects to resolve the RWN on both issuers by mid-July 2009 when it has assessed the adequacy of anti-crisis measures announced by management of both companies to reduce financial and operational risks.

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