Fitch Assigns Initial IDR of 'BB' to Magnesita Refratarios S.A.

NEW YORK & SAO PAULO, Brazil--(BUSINESS WIRE)--

Fitch Ratings has assigned a Local and Foreign Currency Issuer Default Rating (IDR) of 'BB' and a long-term National Scale Rating of 'A+(bra)' to Magnesita Refratarios S.A. (Magnesita). The Outlook is Stable.

Magnesita's ratings are supported by its position as the world's third-largest refractory manufacturer with a 5.9% global market share, its low-cost and vertically integrated business model backed by long-life mine reserves, geographical diversification, and sound liquidity. The company's core business is Refractory Solutions, comprising 88% of BRL2.3 billion in revenues during 2011, followed by its Services business line (7%), and its Minerals segment (5%), which has strong growth potential. The company's credit profile remains resilient under Fitch's base case scenario, and is able to generate positive free cash flow (FCF) after capex and dividends.

The company's ratings are constrained by its customer concentration in the cyclical steel industry, which accounted for 85% of revenues in 2011, and acquisition event risk due to the globally fragmented refractory industry. Magnesita is diversifying into cement and petro-chemical refractories to mitigate sector exposure in the medium to long term. The company's cost-per-performance (CPP) business model accounts for 33% of its contracts with global steel companies and 70% with Latin American steel companies in 2011. Under this model, Magnesita is paid by steel volumes produced as opposed to being linked to the price of steel, making its revenue stream less volatile.

Magnesita has deleveraged following its highly leveraging acquisition of European subsidiary LWB Refractories during 2008, with debt ratios trending down through the challenging operating conditions of 2009. The company's total and net adjusted debt to EBITDA ratios in 2008 were 7.0x and 6.0x, compared to 4.6x and 2.7x by year-end 2011, respectively. Deleveraging was aided by the company raising BRL279 million of equity to repay debt during the first quarter of 2011. Coverage ratios for the year were also robust with a funds from operations (FFO) fixed-charge coverage ratio of 3.5x and EBITDA to gross interest expense ratio of 2.4x, an improvement on 3.3x and 2.3x in 2010, respectively.

Magnesita's liquidity position is comfortable for the rating category, ending 2011 with BRL814 million of cash and marketable securities compared to short-term debt of BRL126 million. The company has a manageable debt amortization schedule of just BRL77 million due in 2012, BRL87 million in 2013, BRL166 million in 2014, and BRL 237 million in 2014, in relation to current cash on the balance sheet. The next debt amortization is not until the 2020 bullet repayment of BRL400 million. Liquidity ratios are solid as a result, with Magnesita's cash to short-term debt ratio 6.5x and cash plus cash FFO to short-term debt ratio of 11.3x for 2011.

The company's improved operating performance in 2011 vis-a-vis 2009 should enable it to reduce leverage and improve its debt profile by negotiating better terms and conditions with current or new lenders in the debt and capital markets. Magnesita's proven access to export credit lines could also be an alternative source of future funding if required. However, the company may incur higher financial costs if it takes this approach, due to the recent measures taken by the Brazilian government to increase tax on financial transactions through the Imposto Sobre Operacoes Financeiras tax.

Steel sector cyclical risk is to some extent alleviated by the company's consistent cash flow generation ability. Magnesita has exhibited positive FCF generation consistantly since 2008, ending 2011 with FCF of BRL384 million after capex of BRL216 million and dividends of BRL9.4 million. This was a significant improvement on FCF of BRL290 million in 2009. The company's dividend policy has also remained conservative, with only BRL9.4 million to be paid in 2012, the first time following the LWB acquisition in 2008.

The strong FCF resulted from a robust FFO of BRL444 million in 2011, compared to BRL456 million in 2010. CFFO increased to BRL609 in 2011 due to a large working capital inflow of BRL165 million resulting from an improvement in number of days in the company's cash conversion cycle, compared to CFFO of BRL365 million in 2010.

Magnesita is one of the lowest-cost and most profitable producers of refractory products in the world due to its vertical integration into magnesite and dolomite, along with other minerals. It also owns one of the largest and highest quality reserves of magnesite, graphite and talc in the world. In 2011, the company's operating EBITDA margin was 18.4%, a decline on 20.3% in 2010 due to increased labor and energy costs. This compares very well to the operating EBITDA margins of its peers, the largest of which is Vesuvius with a 10.5% global market share, followed by RHI with 9.2%. The company is currently around 70% vertically integrated with plans to increase internal raw material supply to 90% in 2014.

Magnesita benefits from strong future growth potential through its nascent Minerals segment. China accounts for 80% of world production of graphite and has recently imposed export restrictions. As a result, Magnesita is strategically placed to take advantage in the growing market for graphite driven mostly by the global uptake trajectory for rechargeable batteries. Magnesita is also the leading operator in refractory products in Brazil and South America and maintains long-standing relationships with all the leading steel and cement producers in Brazil, a position developed since 2008.

Foreign exchange risk for the company is mitigated due to its geographic diversification resulting in approximately 46% of its 2011 EBITDA being generated in foreign currency compared to 80% of its debt being denominated in USD. Magnesita's total debt adjusted for post-employment benefits in 2011 was just under BRL2 billion, close to 40% of which is made up of its USD400 million bond due 2020. The company's financial strategy is to diversify its funding base using capital markets, and to seek protection from foreign exchange risk by balancing foreign exchange debt with foreign exchange cash generation.

A downgrade or Negative Outlook could take place following a downturn in the steel and cement markets that hampers production volumes globally. Another potential negative driver would be large debt-funded acquisition, driving leverage up and increasing refinancing risks. A positive rating action could be driven by faster than expected growth in the company's Minerals segment, and sustained improvement in debt and coverage ratios alongside growth in the company's scale.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 12, 2011);

--'National Ratings Criteria' (Jan. 19, 2011).

Applicable Criteria and Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229

National Ratings Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=595885

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