DBRS Morningstar Upgrades the Rating on Sherritt International Corporation’s Second Lien Notes to B (low) from CCC (high) and Confirms Its Issuer Rating at B

DBRS Limited (DBRS Morningstar) upgraded the Recovery Rating of Sherritt International Corporation (Sherritt or the Company) to RR5 from RR6, resulting in the rating on the Company’s Second Lien Notes (the Notes) being upgraded to B (low) from CCC (high), and confirmed Sherritt’s Issuer Rating at B. All trends are Stable. The confirmation of the Issuer Rating is mainly due to the support of Sherritt’s financial risk profile, which is within the BB range and continues to improve. The improvement in the financial risk profile is a consequence of nickel and cobalt price realizations increasing by 42% and 63%, respectively, in the last 12 months ended September 30, 2022 (LTM Sep 30 2022) compared with the last 12 months ended September 30, 2021 (LTM Sep 30 2021). The rating confirmation is also supported by Sherritt’s business risk profile, which remains in the BB category and accounts for the Company’s (1) relatively long reserve life and (2) favourable operating cost structure at its nickel operations. DBRS Morningstar notes that the overlay factors for sovereign risk, other financial considerations, and ESG considerations were used to temper the final Issuer Rating.

The upgrade of the Recovery Rating to RR5 is due to Sherritt’s repurchase of $41 million of Notes on June 1, 2022, and a further repurchase of $88 million of Notes on December 1, 2022, resulting in a reduction of approximately 35% in the principal amount currently outstanding on the Notes compared with March 31, 2022. DBRS Morningstar notes that the Recovery Rating of RR5 results in a one-notch differential from Sherritt’s Issuer Rating of B. The trends are Stable due to the steady outlook for nickel and cobalt prices from 2023 to 2025 (based on the Bloomberg consensus as of November 23, 2022).

On October 13, 2022, Sherritt announced a new five-year agreement, commencing January 1, 2023, for settling $362 million of outstanding receivables from its 33%-owned Energas S.A. (Energas) in Cuba. Under the agreement, the Moa Joint Venture (JV) will prioritize paying dividends in finished cobalt up to an annual maximum volume of 2,082 tonnes (100% basis). Essentially, Energas will exchange Sherritt’s U.S. dollar-denominated debt and trade payables for a loan denominated in Cuban pesos. The Moa JV will deliver the Cuban partner’s share of Moa’s cobalt production, up to 1,041 tonnes per year for five years, directly to Sherritt, which then can sell the cobalt, along with its own share from the Moa JV, for U.S. dollars to international customers. Payments from these international customers will then flow back to Sherritt, with the final amount subject to spot market pricing at the time. DBRS Morningstar notes that the transaction converts a stream of receivables to a stream of inventory that when sold can amount to a change in non-cash working capital. This amount would not be included in DBRS Morningstar’s financial risk metrics. Nevertheless, the Company’s liquidity position would improve as a result of an increase in Sherritt’s cash balances.

That said, the Company continues to have significant cash balances and outstanding unpaid receivables associated with its Cuban operations. At the end of Q3 2022, Sherritt reported a cash balance of $137.6 million, including $95.8 million of cash held at the Company’s Power operations in Cuba and USD153.2 million in overdue Power and Oil and Gas receivables held in Cuba. DBRS Morningstar notes that during LTM Sep 30 2022 Sherritt received $43.4 million in dividends from its Moa JV compared with $62.2 million in LTM Sep 30 2021.

The low-risk brownfield expansion at the Moa JV’s nickel and cobalt operations continues to progress. Among the near-term project milestones is the completion of the final draft of the National Instrument 43-101 report expected to be completed by the end of Q1 2023. The expansion project is considered relatively carbon-friendly compared with the riskier and more carbon-intensive oil and gas development that the Company previously pursued in Cuba.

DBRS Morningstar notes that a further significant reduction in the principal amount maturing on the Notes could result in another positive rating action on the Notes. However, a sustained suspension of dividends from the Moa JV or a protracted delay and material cost overruns at the Moa JV expansion project could trigger a potential negative rating action.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Environmental Factors
Emissions, Effluents and Waste – In the past Sherritt has owned and operated coal mines in western Canada and carries a modest provision for monitoring former sites. That said, the Company could be included in any future legal actions, including those related to elevated selenium levels in the local watersheds surrounding their former operations, resulting in this factor being considered relevant to the credit analysis.

There were no Social or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929 (May 17, 2022).

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodologies are the Global Methodology for Rating Companies in the Mining Industry (August 30, 2022; https://www.dbrsmorningstar.com/research/402159) and DBRS Morningstar Global Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (September 1, 2022; https://www.dbrsmorningstar.com/research/402218), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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