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S&P takes Essar Steel Algoma off watch, affirms 'CCC+' rating
September 26, 2012 / 2:56 PM / 5 years ago

S&P takes Essar Steel Algoma off watch, affirms 'CCC+' rating

Overview
     -- We are removing our ratings on Sault Ste. Marie, Ont.-based  Essar 
Steel Algoma Inc. (ESA) from CreditWatch, where they had been placed with 
developing implications April 5, 2012.
     -- At the same time, we are affirming all our ratings on ESA, including 
our 'CCC+' long-term corporate credit rating. The outlook is developing.
     -- The removal from CreditWatch reflects our view of the completion of 
ESA's two-year US$350 senior secured term loan, with the proceeds subsequently 
being used to repay and terminate the company's US$300 million senior secured 
revolving credit facility. 
     -- The developing outlook indicates that we could raise the ratings if a 
sustained rally in the steel market in the next 6-12 months were to support an 
expedited refinancing process on ESA's current debt obligations. 
Alternatively, we could lower the ratings if a mediocre steel environment 
limits the company's progress in refinancing debt maturities due after 
mid-2014.

Rating Action
On Sept. 26, 2012, Standard & Poor's Ratings Services removed its ratings on 
Sault Ste. Marie, Ont.-based Essar Steel Algoma Inc. (ESA) from CreditWatch, 
where they had been placed with developing implications April 5, 2012. 

At the same time, Standard & Poor's affirmed its ratings on ESA, including its 
'CCC+' long-term corporate credit rating. The outlook is developing.

Our removal of the ratings from CreditWatch reflects our view of the 
completion of ESA's two-year US$350 senior secured term loan, with the 
proceeds subsequently being used to repay and terminate its US$300 million 
senior secured revolving credit facility. 

Rationale
The ratings on ESA reflect what Standard & Poor's views as the company's 
highly leveraged financial risk profile, featuring a less-than-adequate 
liquidity position, a large debt burden, and thin coverage ratios; coupled 
with a vulnerable business risk profile that features an exposure to volatile 
end markets and limited operating diversity. These risks, in our opinion, are 
somewhat counterbalanced by the company's better-than-average cost profile.

We believe that the corporate credit rating on ESA depends heavily on two 
largely uncontrollable external factors--steel prices and debt markets. While 
the outlook for North American steel appears to have recovered modestly from 
recent trough levels, ESA's profitability and leverage depend almost entirely 
on further upswings in steel prices to support its heavy debt burden. 
Secondly, we expect that working-capital funding and long-term cash flow 
predictability will be overshadowed by challenges associated with the 
company's reliance on volatile capital markets to refinance several tranches 
of debt beginning in September 2014.

Our base operating assessment for ESA through fiscal 2014 (the company's 
fiscal year-end is March 31) incorporates the following assumptions:
     -- Our economists' latest expectations for global growth;
     -- ESA's fiscal 2013 steel production is largely similar to the steel 
production it achieved in fiscal 2012, with somewhat tighter operating margins;
     -- Large steel producers manage output in a manner that would 
progressively cut steel supply to counter any downward pricing momentum; and
     -- The above operating expectation would lead to ESA generating a 
debt-to-EBITDA leverage ratio above 7.0x and a funds from operations interest 
coverage of about 1.0x through fiscal 2014.

We view the company's business risk profile as vulnerable. ESA manufactures 
primarily commodity flat-rolled carbon steel, which makes up about 80% of 
total shipments and competes in cyclical and capital-intensive end markets. 
Nearly all of ESA's production is sold at spot prices, which increases its 
margins relative to its peers in periods of strong steel prices, but exposes 
it to rapid declines in volume, operating rate, and profitability during 
periods of weak demand.

ESA's business risk profile is constrained, in our view, by its limited 
operating diversity as a single-site producer of commodity sheet and plate 
products in the volatile North American steel market. The company has been 
operating only one of its blast furnaces, blast furnace No. 7, since a sharp 
drop in steel prices in 2009. Operating one blast furnace--the key facility of 
an integrated steel mill--exposes ESA to some operating risk, which was 
highlighted by two outages at this blast furnace in the past few years. 
Although the company used insurance proceeds to offset the lost production, 
any prolonged breakdowns can strain cash flow to the extent that management 
restarts its dormant blast furnace No. 6 to offset the lost production time.

Liquidity
Standard & Poor's views ESA's overall liquidity as less than adequate despite 
a sources-to-uses liquidity ratio that is above 1.2x in the next 12 months. 
Our assessment of the company's liquidity incorporates the following 
assumptions:
     -- The company's 1.2x sources-to-uses ratio is not likely sustainable 
beyond 12 months. We expect the ratio to decline well below 1.0x by September 
2013, as we incorporate the maturity of the US$350 million senior secured term 
loan in September 2014 as a source of cash;
     -- Refinancing pressures could escalate further in 2014 as close to 
US$785 million in senior notes (due in the first half of 2015) joins the 
aforementioned senior secured term loan in the near-term maturity horizon;
     -- ESA's relatively weak standing in the credit markets means it must 
rely on favorable capital market conditions to address its refinancing needs;
     -- An inability to absorb high-impact, low probably events (such as a 
weak capital markets environment); and
     -- We do not incorporate any parental support from Essar Steel Holdings 
Ltd.

Although the newly established senior secured term loan has a borrowing base, 
it contains no financial covenants that would directly restrict access to the 
cash balances that are now on ESA's balance sheet.

Recovery analysis
Standard & Poor's rates ESA's US$750 million senior secured notes 'B' (two 
notches above the corporate credit rating on the company), with a recovery 
rating of '1', indicating our expectations of very high (90%-100%) recovery in 
the event of default. 

We rate the company's US$384.7 million senior unsecured notes 'CCC' (one notch 
below the corporate credit rating on ESA), with a recovery rating of '5', 
indicating our expectations of modest (10%-30%) recovery in a default scenario.


Outlook
The developing outlook on ESA indicates that Standard & Poor's could raise or 
lower the ratings over a period of up to two years depending on the progress 
the company makes in addressing its upcoming debt maturities.

We could raise the ratings if the company performs much stronger than our base 
case operating expectations in the next several quarters with its 
debt-to-EBITDA leverage ratio declining to about 5x with positive free 
operating cash flows that supplement its liquidity position. In our view, this 
could improve ESA's reception in the capital markets with refinancing 
transactions occurring well ahead of mid-2014.

Alternatively, we could lower the ratings on ESA if its weak profitability 
restricts the company's access to capital markets. We believe that ESA will 
have a limited opportunity to refinance upcoming debt maturities, the success 
of which will depend heavily on contemporary steel prices and capital markets 
conditions.

Related Criteria And Research
     -- Methodology and Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
     -- General Criteria: How Standard & Poor's Uses Its 'CCC' Rating, Dec. 
12, 2008

Ratings List
Essar Steel Algoma Inc.

Ratings Removed From CreditWatch And Affirmed/Recovery Ratings Unchanged
                        To                  From
Corporate credit rating CCC+/Developing/--  CCC+/Watch Dev/--
Senior secured          B                   B/Watch Dev   
  Recovery rating       1                   1
Senior unsecured        CCC                 CCC/Watch Dev
  Recovery rating       5                   5


Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.

Our Standards:The Thomson Reuters Trust Principles.
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