Fitch Affirms Emeco at 'B+'; Outlook Stable

(The following statement was released by the rating agency) Fitch Ratings-Sydney-02 March 2021: Fitch Ratings has affirmed Emeco Holdings Limited's Long-Term Issuer Default Rating at 'B+' with a Stable Outlook, following the company's stable performance during the coronavirus pandemic. Emeco's revenue improved by around 21% in the first half of the financial year ended December 2020 (1HFY21), with earnings from its Pit N Portal and west coast-based business offset most of the losses from its east coast-based businesses. However, EBITDA declined by about 4% after the EBITDA margin narrowed to around 40% due to an increased revenue contribution from lower-margin long-term service contracts and lower utilisation of its east-coast rental fleet due to weak coal prices, which have now recovered. Fitch believes Emeco is well positioned to capitalise on increasing capex and mining activity in Australia, especially in the western region. Fitch-adjusted net debt/EBITDA was 0.8x following its equity-funded debt reduction in 1HFY21. This was better than its target leverage metric of 1.0x and provides the company with the financial flexibility to manage its capital, including dividends and share-buybacks. Key Rating Drivers Strong Financial Profile: Emeco repaid USD140 million of its senior secured notes through equity raising in 1H21 and extended the notes' maturity by two years to FY24. This left its gross debt and leverage metrics at their lowest point ever - demonstrating Emeco's determination to maintain a strong balance sheet to manage its business through the cycle. Fitch expects leverage, measured by FFO net leverage, to be below 1.0x in FY21 and to remain steady over the next four years. The leverage metric is strong for Emeco's rating, even with our assumption of a modest dividend payout in FY22. Strengthened Business Profile: Emeco has diversified its revenue stream by offering underground equipment, rebuild and repair services as well as long-term mining services contracts, following various bolt-on acquisitions. As such, it has gradually increased its contract tenure with customers and thus improved its earnings visibility through the cycle. The longer-term contracts have a lower EBITDA margin than its fleet-rental business, but the margin remains similar to that of other local mining services companies. However, despite the above, Emeco's rating continues to reflect the EBITDA contribution from its equipment rental business, which is exposed to cyclical downturns versus peers that focus on production-related services. This was highlighted by the profit impact from the lower utilisation of its fleet as coal producers reduced the scope of mining activity in a lower-price environment. This constrains Emeco's business profile, despite its diversified service offerings, increased contract tenures and better commodity diversity. Supportive Industry Conditions: Fitch expects capex in the Australian mining industry to increase over the next few years. Emeco is well positioned to capitalise on this trend, especially in hard-rock commodities. We also believe the company's utilisation rate in Western Australia has room for growth, while its operation on Australia's east coast is likely to stabilise with the recovery in coal prices. We expect mining companies to maintain financial discipline, supporting Emeco's value proposition over a direct-fleet investment. We also expect mining equipment supply to remain adequate and rational compared with the peak in 2012, which should limit pressure on Emeco's fleet utilisation and rental rates over the next few years Derivation Summary Emeco's rating can be compared with that of Indonesia-based PT Bukit Makmur Mandiri Utama (BUMA, BB-/Negative). BUMA has better revenue visibility and a stable operating profile that stems from its long-term contracts with miners and diversified service offerings at various production stages. BUMA also benefits from the long transition time of around three years to switch mining contractors, which results in high switching costs for coal miners. This results in a more stable operating profile with better earnings visibility during the previous downturn than Emeco, but BUMA's weak financial profile is reflected in the Negative Outlook. Fitch expects BUMA to improve its FFO net leverage to around 1.7x by 2023; its ratings could be downgraded if it fails to deleverage in a timely manner. However, Emeco has a better diversified customer base and commodity exposure and a stronger financial profile, which somewhat offsets its relatively weak business profile. These factors underscore the one-notch rating differential between the two entities. Key Assumptions - Operating utilisation rate to remain at around 64% due to tight rental-equipment market conditions and strong activity in the mining sector - Net capex at around 25% of revenue from FY21-FY24 - Cash flow after capex to be paid out as dividends or used for buy-backs from FY22 RATING SENSITIVITIES Factors that could, individually or collectively, lead to positive rating action/upgrade: - Improvements in contract terms, scale or service type that increase switching cost for customers and revenue visibility during cyclical downturns, while maintaining FFO net leverage below 1.0x. Factors that could, individually or collectively, lead to negative rating action/downgrade: -Deterioration of operating performance, including shrinkage of the operating utilisation rate and loss of major contracts. -FFO net leverage exceeding 2.0x for a sustained period. 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 Adequate Liquidity: Emeco's next significant debt maturity is in March 2024, consisting of USD180 million of 9.25% senior secured notes issued by its wholly owned subsidiary, Emeco Pty Ltd. The company had a committed undrawn revolving facility of AUD97 million and cash in hand of AUD72 million at end-2020. We also expect Emeco to generate positive cash flow before dividends over the next four years. 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 Emeco Holdings Limited; Long Term Issuer Default Rating; Affirmed; B+; Rating Outlook Stable Contacts: Primary Rating Analyst Leo Park, Associate Director +61 2 8256 0323 Fitch Australia Pty Ltd Suite 15.01, Level 15 135 King Street Sydney 2000 Secondary Rating Analyst Kelly Amato, CFA Director +61 2 8256 0348 Committee Chairperson Vicky Melbourne, Senior Director +61 2 8256 0325 Media Relations: Peter Hoflich, Singapore, Tel: +65 6796 7229, Email: peter.hoflich@thefitchgroup.com Leslie Tan, Singapore, Tel: +65 6796 7234, Email: leslie.tan@thefitchgroup.com Additional information is available on www.fitchratings.com The following issuer(s) did not participate in the rating process, or provide additional information, beyond the issuer's available public disclosure: Emeco Holdings Limited Applicable Model Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s). 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