Stable outlook for Xstrata's and Glencore's ratings
London, 23 November 2012 -- Moody's Investors Service has today confirmed the Baa2/Prime-2 (P-2) senior unsecured ratings of Glencore International AG and Xstrata plc and their guaranteed subsidiaries.
The outlook on Xstrata's and Glencore's ratings is stable.
The confirmation follows the decision of Xstrata's shareholders to support the last merger offer received from Glencore. Moody's considers it highly likely that the merger will be closed in due course, subject to receipt of the still pending authorisations from the Chinese and South African Antitrust authorities.
These rating announcements conclude the review of Glencore's and Xstrata's ratings initiated by Moody's on 7 February 2012.
- CONFIRMATION OF BAA2 RATINGS OF GLENCORE AND XSTRATA
"Our confirmation of the Baa2 senior unsecured ratings of Glencore and Xstrata reflects our expectation that their merger will be finalised in the next few months," says Gianmarco Migliavacca, a Moody's Vice President - Senior Analyst and lead analyst for both Glencore and Xstrata. "Subject to the customary antitrust clearances still pending, the Glencore/Xstrata merger will result in the world's largest combined commodity trading and mining group, supported by an enhanced business profile and solid financial and liquidity profile."
The merger will increase the diversification of both companies, with Glencore achieving stronger control over the high-quality mining resources of its currently 34%-owned associate Xstrata, and the latter gaining full access to the trading and logistics platform of Glencore. In addition, Xstrata will gain access to Glencore's smaller portfolio of mining, oil fields and agricultural assets, with Moody's expecting the latter to become more substantial following Glencore's announced acquisition of the Australian and Canadian grain-handling assets of Viterra Inc. (Ba1 rating under review for upgrade), still to be completed.
Furthermore, Glencore and Xstrata will contribute their respective pipelines of large mining projects, which Moody's would expect to result in a substantial increase in the volumes of both companies. Glencore will provide its portfolio of near-term brownfield mining and oil projects, which are mostly located in Africa (Zambia, Democratic Republic of Congo), Kazakhstan, Colombia and Equatorial Guinea. Meanwhile, Xstrata will contribute its larger pipeline of both short- and long-term brownfield and greenfield mining projects, which are mainly located in more established mining jurisdictions such as Australia, Canada and Peru. Moody's positively notes that the substantial diversification of the new enlarged group by geography, commodity (metal, oil and agricultural) and type of business (mining and trading) would represent an important mitigating factor against the risk of ongoing weakness in metal prices and a protracted downturn in Europe.
In addition, the merger will enable the newly formed group to achieve stronger credit metrics than Glencore on a standalone basis, which has weakly positioned credit metrics for its current rating, due to the much lower debt and stronger operational cash flows of the mining company. However, Moody's notes that the company's free cash flows will remain negative over the next 12-18 months, given the large capital expenditure (capex) plan of the combined group, mainly attributable to Xstrata's organic growth projects.
Despite the positive credit developments noted above, Moody's does not currently envisage any positive pressure being exerted on the ratings of either Glencore or Xstrata, given the significant uncertainty surrounding (1) the post-merger integration process, especially in light of the rejection by Xstrata's shareholders of the retention packages for its senior managers and employees, which the company's independent directors had recommended for approval as an important condition for a smoother integration phase; (2) the actual implementation of a robust and balanced governance structure, which partly depends on the identification of a new Chairman of the combined group; and (3) the new strategy and financial policy of the enlarged group, which needs to be articulated.
Moody's notes that the risk of Xstrata's senior managers leaving the combined group, as a result of the rejection of the retention package, could have a negative impact on the successful execution of the combined group's business plan, given that the management teams of both Xstrata and Glencore are expected to deliver on ambitious targets, including (1) achieving $500 million of synergies within the first year of the completion of the merger; (2) delivering more than 20 large mining projects between 2012 and 2014, most of them under Xstrata's management direct responsibility; and (3) integrating into the new group several acquisitions nearing completion or recently completed by Glencore.
Moody's will monitor GlencoreXstrata's future financial policy, given that this needs to be tested in practice, as the two companies establish a track record as a new combined group. While both companies have publicly committed themselves to maintaining an investment-grade rating, Moody's needs to assess whether the much larger size of the new group could lead to the formulation of a new and more aggressive financial policy. In particular, Moody's notes that Glencore has employed an aggressive financial policy recently, having announced several debt-funded acquisitions, including that of Viterra.
Moody's expects the liquidity profile of the combined group to be solid. This is despite the large cash outflows for the execution of the capex plan, the working capital needs of the expanding trading business, the acquisitions already announced but not yet finalised (Viterra), and dividend payments. Moody's also positively notes that last April Glencore signed new revolving credit facilities totalling $12.8 billion with a total of 91 banks, allowing the company to renew and extend the maturities of its previous revolving credit facilities. Separately, Glencore has also signed a $1.5 billion two-year term loan to cover part of the $3.5 billion that is required to complete the acquisition of Viterra, and another $2.6 billion backstop facility to support the merger with Xstrata. In addition, Glencore has indicated that it expects to realise cash proceeds from the disposal of non-core assets of Viterra after the close of the acquisition. Xstrata, on the other hand, has further improved its good liquidity position in the last month by launching close to $7.5 billion of new senior unsecured notes for general corporate purposes, including the reduction of its utilisations under its $6.0 billion committed revolving credit facility. Moody's understands that this facility is currently mainly undrawn and will remain available following the close of the merger, as the change-of-control clause triggering its mandatory repayment has been already waived by its lenders.
- STABLE OUTLOOK FOR XSTRATA
The stable outlook on Xstrata's ratings and the current lack of positive rating pressure primarily reflects (1) the rapidly deteriorating operating environment for most of the commodities mined by the company; (2) the rating agency's expectation that metal prices will remain weak over a protracted period of time; and (3) the more leveraged financial profile of the newly formed group. These factors, combined with Xstrata's high capex scheduled over the coming quarters, will likely affect the company's credit metrics going forward and somewhat reduce its overall financial flexibility. However, the stable outlook assumes that this deterioration in Xstrata's metrics, and especially in its free cash flow, which Moody's expects to remain negative, will be balanced by the company's ability to maintain a good liquidity profile.
- STABLE OUTLOOK FOR GLENCORE
The Baa2 rating and stable outlook on the debt instruments issued by Glencore assumes that, following the close of the merger, GlencoreXstrata will address the degree of structural subordination in the combined group -- which is a result of the weaker credit metrics and lower asset base of Glencore on a standalone basis -- through an equalisation of bondholders' rights with guarantees. This would be achieved by Glencore (and certain of its subsidiaries) guaranteeing Xstrata's notes, and Xstrata (and certain of its subsidiaries) providing guarantees for Glencore's notes, as a result of which Moody's would expect all the senior unsecured debt instruments in the final capital structure of the combined group to have substantially equal rights on operating assets and cash flows.
OUTLOOK CONSIDERATIONS FOR THE GROUP
The stable outlook on the ratings of both Glencore and Xstrata is based on the merger being successfully completed without the companies being forced to undertake remedies that will penalise them significantly in securing the still pending antitrust authorisations. The outlook also assumes a smooth post-merger integration process, with Glencore being able to retain most of the key Xstrata managers. Furthermore, the outlook assumes that the combined entity would maintain good liquidity at all times, thereby enabling it to comfortably execute its large pipeline of capex and the still pending acquisition of Viterra, even in the event of modest delays or cost overruns. The stable outlook also factors in that Glencore and Xstrata have corporate governance structures and financial policies that are consistent with a public commitment towards investment-grade rating status.
WHAT COULD CHANGE THE RATING UP/DOWN
If the merger goes ahead, positive rating pressure would build over time as Glencore and Xstrata establish a track record as a successful combined entity, achieving targeted synergies and further improving their credit metrics, with (1) a combined leverage ratio (Moody's adjusted gross debt/EBITDA) trending towards 2.5x; (2) Moody's adjusted (cash flow from operations (CFO)-dividends)/gross debt in the mid-twenties in percentage terms on a sustained basis; and (3) free cash flow turning positive.
Conversely, negative pressure would build if the integration process post-merger was characterised by severe disruptions, which could be caused by several key Xstrata's managers leaving the group or, more generally, by a governance framework not providing the expected stability and effectiveness. Negative pressure on the rating of the combined entity would also develop if it undertook a more aggressive financial policy than those currently employed by the two companies, leading to large debt-funded acquisitions and to a weaker liquidity profile. Moreover, a downgrade of the combined entity's rating would be triggered if there was a material deterioration in its credit metrics, with a combined leverage ratio (Moody's adjusted gross debt/EBITDA) above 3.5x, a Moody's adjusted (CFO after dividends)/gross debt below the high teens in percentage terms, and free cash flow turning negative on average through the cycle. Downward pressure would also be exerted on the ratings of both Glencore and Xstrata in the event that the closing of the merger was subject to new and materially less favourable terms due to regulatory or antitrust decisions.
Furthermore, if possible structural debt subordination issues were not addressed after the close of the merger, we would reassess the rating on specific debt instruments, where appropriate, to reflect their different asset and cash-flow coverage in the final capital structure.
The principal methodology used in rating Glencore International AG and Xstrata plc was the Global Mining Industry Methodology published in May 2009 and Global Commodity Merchandising & Processing Companies Industry Methodology published in December 2011. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.
Headquartered in Baar, Switzerland, Glencore International AG (Glencore) is a leading publicly listed diversified natural resources group. Its activities are organised around three main business groups (Metals & Minerals, Energy Products and Agricultural Products) that are sub-divided into six commodity departments. These departments are responsible for managing the marketing, sourcing, hedging, logistics and industrial investment activities relating to their respective commodities. In the 12 months to June 2012, the company reported EBITDA of $6.1 billion on revenues of approximately $202 billion.
Headquartered in Zug, Switzerland, Xstrata plc is a global mining company with major operations in base metals, coal and alloys located in the Americas, Australia, South Africa and Europe. In the 12 months to June 2012, the company reported consolidated revenues of $32.6 billion and unadjusted EBITDA of $9.7 billion.
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