Fitch Ratings - Hong Kong/Tokyo - 02 Mar 2021: Fitch Ratings has affirmed Mongolia-based coal producer Mongolian Mining Corporation's (MMC) Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'B'. The Outlook is Stable. Fitch has also affirmed MMC's senior unsecured rating of 'B' with a Recovery Rating of 'RR4'.

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 give it a sufficient buffer to continue generating free cash flow (FCF) during coal price downturns.

KEY RATING DRIVERS

Robust Market Fundamentals: The affirmation of MMC's ratings and Stable Outlook reflect our view that MMC's business and credit profiles remain solid. Fitch estimates MMC's leverage exceeded our negative guidance and FCF was mildly negative in 2020 due to Covid-19-related disruption of border throughput. The disruptions have been mostly resolved, and we expect earnings and cash flow to improve significantly in 2021 on strong market fundamentals driven by stable demand from China's steel sector and robust coking coal prices.

We believe MMC can achieve sales volume of around 4.9Mt as border throughput normalises, with potential to increase sales volumes by using inventory stockpiles if border traffic improves further.

Covid-19 Impact Manageable: Some tail risks from the pandemic remain as potential outbreaks in Mongolia could disrupt border throughput. However, preventive measures seem to be effective as evident from the uptick in border throughput. MMC expects throughput to recover to about 700 trucks per day, broadly in line with 2019, with room for further improvement as logistical bottlenecks have been removed. Therefore, we do not expect any major disruption of MMC's operations and export sales comparable to the instability in 2020.

Small Scale, Single Product: MMC is small compared with Fitch's global rated coal-mining companies in terms of revenue, which we estimate was down by more than 30% yoy in 2020 (2019: USD627 million). Hard coking coal accounted for over 90% of MMC's total revenue in 2019. The latest coal reserve statements show pro forma total run-of-mine coal reserves of 499 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.

Cost Competitive in Limited Markets: MMC is cost competitive only in the northern parts of China due to the proximity of its mines to steel mills in that area. MMC's mine gate-cash cost is low compared with that of global peers at roughly USD30 per tonne, but MMC's transportation cost by land to its Chinese customers is around USD20 per tonne, which limits its cost competitiveness. Delivery beyond northern China would further increase costs, leaving MMC with customers that are mainly in northern China.

Neutral Regulatory Environment: The Mongolian tax and royalty stabilisation certificate granted to MMC for 24 years in 2015 outlines the tax and royalty rates that apply to the company. The certificate helps mitigate risks of sudden shifts in Mongolia's royalty and tax policies. Management said previous bottleneck issues at the China-Mongolia border have been mostly resolved with newly installed gates and systems that will enable MMC to increase its sales to Chinese customers over the next few years.

Capex Flexibility: The company estimates its minimum sustaining capex, most of which is for regular maintenance of its mines, mining fleets and coal-hauling trucks, will be around USD5 million per year. MMC capitalises some of its stripping cost, where stripping of the mine results in long-term benefits. The capitalised stripping cost and minimum sustaining capex are likely to be between USD60 million-83 million per annum in 2021-2023. MMC can decrease its capitalised stripping cost and reduce capex should there be a significant coal price decline.

Moderate Financial Profile: MMC's financial and liquidity profile is in line with that of peers with similar ratings. MMC's funds from operations (FFO) net leverage likely exceeded our negative guidance in 2020. However, increasing export sales against the backdrop of the strong recovery in China, MMC's main market, should lead to a notable improvement in leverage.

MMC's credit profile is also supported by positive FCF due to sustained profit generation based on a stable metallurgical coal-price environment and steady levels of capex. In addition, MMC benefits from ample maturity headroom, with the USD440 million notes only coming due in 2024. We also expect MMC to be able to maintain its FFO fixed-charge coverage above 3x in the near future.

DERIVATION SUMMARY

MMC has a much smaller scale in terms of revenue and EBITDA than other rated coal producers, such as Yanzhou Coal Mining Company Limited (BB-/Rating Watch Positive) and PT Golden Energy Mines Tbk (B+/Stable).

MMC has a single product, similar to its peers. MMC has slightly better margins than PT Golden Energy Mines. MMC's operational profile in terms of mine life is strong compared with that of Geo Energy Resources (CCC), which has a mining life of less than five years, and at a similar level as that of PT Golden Energy Mines, which has a mining life of over 25 years.

MMC's financial and liquidity profile is similar to its 'B' rated peers, with FFO net leverage expected to be less than 3.5x by 2022 and FFO fixed charge cover of above 3x from 2021. MMC's rating however remains constrained by its lack of geographical diversification and scale.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

- Hard coking coal average selling price of USD121/tonne from 2021-2023;

- Capex of up to USD83 million per annum from 2021-2023.

Key Recovery Rating Assumptions

The recovery analysis for MMC is on a going-concern basis in case of bankruptcy and assumes that the company would be reorganised and not liquidated. We have assumed a 10% discount to enterprise value to account for bankruptcy-related administrative claims.

Going-Concern (GC) Approach

The GC EBITDA estimate of USD160 million (2019: USD242 million) reflects Fitch's view of a sustainable, post-reorganisation EBITDA level upon which we base the enterprise valuation. We have taken a lower sustainable EBITDA because a restructuring would most likely be a result of a coal-market downturn.

An enterprise value (EV) multiple of 4x EBITDA is applied to the GC EBITDA to calculate a post-reorganisation EV. The choice of this multiple considers the EV/EBITDA multiple that we use for several rated Indonesian coal company peers that also adopt the GC approach for recovery analysis.

The recovery waterfall results in a 100% recovery estimate corresponding to a 'RR1' Recovery Rating for offshore senior unsecured debt. However, MMC's Recovery Rating is capped at 'RR4' because Mongolia is subject to a soft cap of 'RR4', as it falls under the Group D of countries in terms of creditor-friendliness under Fitch's Country-Specific Treatment of Recovery Ratings Criteria.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- Positive rating action is not envisaged in light of MMC's small scale and lack of cost competitiveness beyond northern China.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- Generation of negative FCF;

- FFO net leverage sustained above 3.5x;

- Any negative regulatory changes.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Liquidity Dependent on FCF: MMC has no liquidity issues for now as it does not rely on bank loans, but rather on notes financing with the nearest upcoming US dollar notes due in 2022 of around USD15 million as of 31 December 2019. MMC had no short-term debt as of 31 December 2019, with cash on hand of USD41 million. It also has limited undrawn committed bank facilities. However, failure to continually accumulate FCF may lead to a liquidity crunch in a downturn. In addition, the company will likely need to refinance at least part of its notes maturing in 2024, as we do not expect cumulative FCF generation to be sufficient to redeem the full amount.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg