The ‘A’ rating indicates that the Company qualifies as a highly reliable borrower. Risk of a delay in meeting liabilities is relatively low, restructuring risk for a loan / part of a loan is minimal.

The reason for the outlook revision is the combined effect of a considerable increase in debt liabilities, weaker financial performance in 2012 and net loss in Q1 2013.

As a result of a downward trend in the global coal prices last year, the company's revenue for 2012 dropped by 27% from RUB 43.4 billion to RUB 31.6 billion, although its physical sales decreased insignificantly. That was enough for the Company’s net profit to plummet 5 times from RUB 14.0 billion to RUB 2.8 billion. In the first quarter of 2013, Southern Kuzbass Coal Company OAO generated a net loss of RUB 202 million, mainly due to revaluation of foreign exchange liabilities and forex losses in the amount of RUB 594 million (for reference, the Company’s net profit for the same period in 2012 was RUB 1,672 million).

While the Company’s financial performance weakened, its debt liabilities increased. The loan debt went up from RUB 52.0 billion to RUB 62.5 billion (i.e. by 20%) in 2012 and further increased by 13% in Q1 2013 reaching RUB 70.5 billion at the end of the quarter. As a result, the net debt / EBITDA multiple climbed to 8.3x on April 1, 2013 against 1.8x at the start of 2012. Therefore, the debt burden on Southern Kuzbass Coal Company OAO increased more than 4.5 times in just 15 months, exceeding all the applicable financial covenants. We tend to regard the Company’s debt burden issue as the main indicator of its lower financial viability exerting heavy pressure on its credit rating. Furthermore, loans denominated in foreign exchange (USD) account for about 50% of the total debt liabilities, which, given the growing US dollar to ruble exchange rate, implies additional loan servicing difficulties.

The Company’s considerable financial investments (RUB 68.6 billion as of April 1, 2013, most of them made for short periods of time) are technically offsetting the high debt burden. These investments are mainly intra-corporate loans provided by the company to Mechel Group’s enterprises. These can hardly be regarded as perfectly liquid assets, seeing as most of these enterprises are facing certain financial difficulties.

After the Company paid dividends for 2012 in the amount of RUB 21.9 billion, its equity to total assets ratio decreased from 0.43 to 0.27, net working capital to current assets ratio from 0.3 to 0.04. However, even after this dramatic decline, these ratios are at least matching the average values in the sector (primarily indicating the performance of the Company’s principal competitors), which can be regarded as one of the positive rating drivers.

The rating of the enterprise is essentially supported by its industrial capacity and firm positions on the Russian coal mining market.

Since 2010, the Company has been annually producing about 12 million tonnes of coal (production holding steady, with a minor upward trend). For 6 months this year, the miners and colliers of Southern Kuzbass Coal Company OAO produced 7.148 million tonnes of coal exceeding last year’s result by almost 12%.

The enterprise is constantly looking for production upgrade and renovation opportunities. In 2012 alone, it added RUB 3.4 billion in new fixed assets to its balance sheet (against RUB 2.4 billion the year before), machinery, equipment and vehicles covering almost 70% of that amount. In early June 2013, the Company concluded a lease contract amounting to RUB 778 million for the delivery of a Harnischfeger (USA) shovel with a 25 m3 dipper and an integrated computer management system for basic operations. As a whole, we estimate the Company’s production risks as extremely low.

The key risk factors for the Company’s operations arise from the situation in the domestic and global markets of metallurgical and power-generating coals, with prices changing both under the influence of macroeconomic and macrosocial factors and in the wake of natural and man-triggered disasters. If the coal prices continue to fall, the enterprise may come across even greater difficulties affecting the issuer’s credit capacity.

Southern Kuzbass Coal Company OAO is one of the principal structural units of OJSC Mechel-Mining, Mechel Group’s coal-mining holding. The enterprise is one of the leading coal producers in the region (the Kuznetsk Basin) and in Russia. In 2012, it accounted for about 4% of all the total coal output in the Russian Federation. More than 60% of its final products output are metallurgical coals which are most in-demand in domestic and foreign markets. Apart from coal-mining capacities, the company has coal-processing (coal preparation) enterprises. About 45% of its goods are exported.

As of April 1, 2013, the Company’s assets totaled RUB 110.8 billion, equity capital amounted to RUB 26.9 billion.

This press release is based on the statement of assigning a credit rating to Southern Kuzbass Coal Company OAO.

The credit rating, along with any information and conclusions provided in this press release, only conveys our opinion on the Company’s credit standing and shall not be considered as advice on the purchase and sale of securities or the provision of loan facilities.

AK&M Rating Agency will not incur any responsibility for any interpretations, inferences and consequences related to the application of results of the rating estimation procedure by any third parties.

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CJSC Analysis, Consulting and Marketing Rating Agency
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Moscow, Russia
www.akmrating.ru
Press release by: A.V. Khibukhin
Phone no. (495) 916-70-30, fax no.: (499) 132-69-18.