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By John Helmer in Moscow

In the sharpest warning issued to date by an international ratings agency about a major Russian steelmaker, Standard & Poors (S&P) said yesterday there is “significant doubt about the group’s ability to continue as a going concern.”

Evraz is Russia’s largest steel and mining group. It is controlled by the Millhouse holding of Roman Abramovich and Eugene Shvidler (pictured left to right, respectively) , plus the last of the founding shareholders, Alexander Abramov, and his protege Alexander Frolov. Until recently, these men have been considered among the most bankable of Russian metal magnates, and Abramovich the most secure of Russian oligarchs.

The S&P report, authored by analysts Alex Herbert and Andrey Nikolaev, downgrades Evraz’s corporate credit and unsecured debt ratings from BB- to B+. The move, according to S&P, reflects “our opinion that there is heightened uncertainty about the willingness of banks to agree to waive or amend financial covenants, and the ability of Evraz to address its currently very weak liquidity. This follows the announcement by Evraz of operating results for the six months to June 30, 2009, that were even weaker than we had previously anticipated. Evraz faces a difficult combination of very low cash flow generation caused by the severe steel industry downturn and substantial adjusted debt from previous debt-financed acquisitions. In addition, the group has persistently high short-term debt and faces potential financial covenant breaches, which may be more difficult to address than management expects.”

In Thursday trading, following the release of the report, the Evraz share price fell 5%.

S&P’s negative action on Evraz follows the ratings downgrade six weeks ago by Fitch. On July 29, Fitch cut Evraz from BB to BB-, warning the market of its “view that measures undertaken by Evraz’s management to-date have not been sufficient to offset a fall in revenues following the significant decrease in global demand and prices for steel products, especially in the construction and infrastructure industry to which Evraz is most exposed.”

Like Severstal owned by Alexei Mordashov, Evraz paid premium prices to acquire North American steel and pipemills, which are now adversely impacting the group’s better performing Russian mills. According to a statement at the start of September by Evraz CEO Frolov, “in view of the positive pricing trends in recent months in our key export markets, driven primarily by robust demand from the emerging economies of Asia, the Middle East and North Africa, and the growing volumes of our Russian steel production from July 2009, we expect better results in the second half of the current financial year than in the first half.” In its first-half financial report, issued on September 1, Evraz reported a $999 million loss on the net income line, the biggest term loss of a Russian steelmaker ever reported.

The new S&P report conveys skepticism on the part of underwriters, banks, and institutional investors that Frolov’s optimism is warranted. “We anticipate,” the S&P analysts report, “that Evraz’s credit metrics will weaken substantially in the second half of the year. Steel industry conditions will in our view likely remain subdued, adversely affecting the group’s future cash flow generation.” If the cash burn continues to worsen by year’s end, as S&P expects, Evraz “does not in our view have sufficient liquidity to meet short-term debt repayments…. Cash on hand of $678 million and undrawn committed bank lines of $563 million were available as of June 30, 2009. Since then, Evraz has issued a $650 million bond due 2014, raised $315 million of new equity, and repaid $912 million of short-term debt. Even if the short-term debt due to Russian state-owned banks is extended as planned, Evraz is in our view likely to face ongoing material refinancing needs in 2010, as we estimate more than $2.5 billion of debt would mature. We anticipate that Evraz will approach its lenders to seek waivers or amendments to certain financial covenants, which in our view look likely to be breached at year-end 2009.”

Moscow investment banks and their steel analysts have been reluctant to go as far as the ratings agency. In keenness to fire up trading on speculative share price gains, Boris Krasnojenov of Renaissance Capital leads the pack, concluding that “Evraz remains among the most efficient global steelmakers with 1H09 cash cost of $221/tonne for slab; and maintains 100% self-sufficiency in basic raw materials. Evraz is close to finalising negotiations with [Russian state banks] VEB and VTB on loan extensions and refinancing…” In the RenCap score-book, Krasnojenov’s estimated target price for Evraz is 84% higher than its current price — a record of sorts.

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