Fitch Ratings has revised the rating Outlook on coal producer Mongolian Mining Corporation (MMC) to Negative from Stable, and affirmed the Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘B’.

Fitch has also affirmed MMC’s USD440 million 9.25% senior unsecured notes due 2024 at ‘B’ with Recovering Rating ‘RR4’. The notes are co-issued by MMC and its wholly owned subsidiary, Energy Resources LLC (ER), and guaranteed by most of MMC’s operating subsidiaries.

The Negative Outlook reflects the uncertainty about MMC’s business recovery due to periodic restrictions at the border with China to contain the spread of Covid-19. We expect the prolonged border disruptions in 2021 to have caused MMC’s credit metrics to deteriorate from 2020 levels. Border traffic remains restricted at the moment, but the company expects the curb to be lifted soon. However, the credit metrics could remain weak if there is no clear recovery in border traffic.

MMC’s rating is constrained by its small scale, single-product focus on hard coking coal and limited cost competitiveness outside of northern China, its main market. However, MMC has flexibility in capex, which should provide a sufficient buffer to continue generating free cash flow (FCF) during business downturns.

KEY RATING DRIVERS

Capex Flexibility: MMC estimates its minimum sustaining capex, mostly for regular maintenance of its mines, mining fleets and coal-hauling trucks, will be around USD2 million in 2022 and USD5 million in 2023. MMC capitalises some of its stripping cost when stripping of the mine results in long-term benefits. The capitalised stripping capex is likely to be USD18 million-70 million a year in 2022-2023. Stripping cost is related to mining volume, therefore MMC can decrease stripping cost during a business downturn.

Moderate Financial Profile: MMC’s financial and liquidity profile is commensurate with its rating. MMC’s funds from operations (FFO) net leverage and net debt to EBITDA ratios exceeded our negative triggers in 2020 and we expect these ratios to remain higher than the negative triggers in 2021. However, MMC’s credit metrics should improve significantly if the border with China opens up in line with our expectation from 2Q22, while demand remains steady and average selling prices are strong.

We expect MMC to have sufficient liquidity in the short term. MMC has USD15 million of senior notes and USD41 million of coupon payments due in 2022. We expect the company to have enough operating cash to settle these payments. MMC also has USD39 million in committed unused bank facilities available.

Border Disruptions, Operating Uncertainties: Traffic at the border between Mongolia and China was disrupted several times in 2021, which is likely to have reduced MMC’s sales volume for the year. We estimate 2021 washed coking coal sales fell to 1.2 million tonnes, a sharp drop from 3.5 million tonnes in 2020.

Before the Covid-19 outbreak, MMC’s average daily throughput to China was around 700 trucks, but this fell to around 500 trucks in 2020 and around 200 trucks in 2021. Current average daily throughput is capped at around 100 trucks per day. MMC expects the border restrictions to be resolved by end-March 2022 and throughput to rise to 500 trucks in 2Q22, then improve to pre-pandemic levels in 2H22. However, the restrictions may continue or throughput may not increase as quickly as we expect, leading to uncertainty over a business recovery in 2022.

Small Scale, Single Product: MMC is small compared with Fitch-rated coal miners globally in terms of revenue. We expect MMC’s revenue to have decreased by more than 50% in 2021 (2020: USD417 million). Hard coking coal accounted for over 90% of MMC’s total revenue in 2020. The latest coal reserve statements show pro forma total run-of-mine coal reserves of 478 million tonnes, giving MMC a reserve life of 30-35 years. MMC’s small scale and product concentration constrain its business profile to the ‘B’ rating category.

Limited Cost Advantage: MMC’s cash cost is in the 1st quartile of the global coking-coal cost curve, but its cost advantage is only in the northern part of China due to the proximity of its mines to steel mills in that area. MMC’s transportation cost by land to its Chinese customers is around USD25 per tonne on average, which limits its cost competitiveness and puts MMC in the higher quartiles of the global coking-coal cost curve. Delivery beyond northern China would raise costs, leaving MMC with customers that are mainly in northern China.

DERIVATION SUMMARY

Compared to rated coal producers such as Yankuang Energy Group Company Limited (BB+/Stable) and PT Golden Energy Mines Tbk (GEMS, B+/Stable), MMC is much smaller in scale in terms of revenues. Yankuang Energy is around 25 times larger than MMC while GEMS is over 2 times larger. However, MMC has a similar EBITDA margin as Yankuang Energy and a higher margin than GEM.

MMC is a single product coal miner, similar to its peers. MMC’s present operational profile in terms of mine life is strong when compared to Geo Energy Resources Limited (CCC+), which has a mine life of less than 10 years, and similar to that of PT Golden Energy Mines, which has a mine life of over 25 years.

MMC’s leverage and financial flexibility profile is weaker than that of GEMS. GEMS has better FCF generation ability, much lower leverage and well-distributed amortising debt. MMC’s FCF generation has been weakened by the border disruptions, which resulted in higher-than-expected leverage. MMC’s debt structure is less smooth with bullet payments.