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By John Helmer in Moscow

Evraz, Russia’s largest steelmaker, has received its first rating downgrade from an international ratings agency. It also is the first time Roman Abramovich and Alexander Abramov, who share control of the Evraz group’s Russian and international assets through Mastercroft Limited, a Cyprus registered company, have been downgraded.

According to an announcement and brief report by Fitch Ratings on July 29, both Evraz and Mastercroft, which holds the controlling stake of Evraz shares, were hit with a downgrade of the long-term foreign currency Issuer Default Rating (IDR) and the senior unsecured rating to ‘BB-‘ from ‘BB’. Fitch’s last rating was an upgrade for Evraz, issued in July of 2007. No further action was taken by the agency until three months ago, when Fitch announced it was putting Evraz on a Rating Watch Negative, one step short of the downgrade that was announced yesterday. Fitch’s latest announcement says that the company is still under Rating watch Negative, in the event that fresh news might impact on the group’s revenues.

Fitch’s rating move reflects the assessment that there is a growing probability that Evraz will breach its borrowing covenants because third-quarter and fourth-quarter sales revenues and profitability are no longer judged likely to improve as much as had been hoped. If, as Fitch now expects, the second-half financial results will be flat, the scope for improving earnings and lowering debt will dwindle.

Fitch’s report says: “the downgrade reflects Fitch’s 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. The RWN continues to reflect risks of potential covenant breaches under the company’s various facilities….Management has adjusted production capacity, executed a significant cost reduction programme, extended the duration of the debt portfolio (including financing obtained from Russian state bank VEB), and issued new equity and convertible debt in a total amount of USD965m. Fitch forecasts that the company’s revenue and EBITDAR in 2009 will fall by 40-50% and 55%-65% respectively, and that the EBITDAR margin will decline to 18-22% in 2009 from 28% in FY2008.”

According to Fitch, for Evraz to retain its higher BB rating, it must lift its earnings by more than the rating agency now calculates will be achievable in the steel market conditions prevailing for the remainder of this year. Fitch said it “expects Evraz’s 2009 net debt/EBITDAR to be 2.7x-2.9x, which would exceed guidelines for the ‘BB’ rating category of net debt/EBITDAR at 1.5x. The covenant headroom at the end of 2009 is expected to be low and the company may not be in compliance with financial covenants in certain of its debt instruments at 2009 covenants testing expected in Q110. If this issue is not resolved it could also constitute a cross default under Evraz’s other debt instruments.””

Fitch also reports a gloomier prognosis for next year than has been acknowledged recently, as Russian stock market traders have promoted a rise in Russian share prices. “Fitch expects a weak recovery of the steel industry in 2010 and has concerns that Evraz may not be able to regain a “through-the-cycle” credit profile consistent with the ‘BB’ rating category within 18-24 months of the trough of the current recession.”

In Moscow share trading on Wednesday, Evraz lost 2.4%, but the share price is up 54% in the past three months. Severstal, which Fitch downgraded earlier this month to B+, is up 38% over the past three months. Fitch noted “that the peak of Evraz’s debt maturities (approximately 30% of total debt) is expected in 2010, therefore 2010 liquidity is heavily dependent on the company’s ability to generate enough free cash flow, roll-over the debt and attract new financing to meet its debt obligations.”

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