LONG READ: Leading Russian chemical and fertiliser concerns Uralkali and Uralchem are facing bankruptcy in the next year

LONG READ: Leading Russian chemical and fertiliser concerns Uralkali and Uralchem are facing bankruptcy in the next year
Leading Russian chemical and fertiliser concerns Uralkali and Uralchem have some $7bn worth of debt coming due in the next 12 months.
By Ben Aris in Berlin October 7, 2019

Leading Russian chemical and fertiliser concerns Uralkali and Uralchem are facing bankruptcy in the coming year, according to a report released in October by the Moscow Centre for Analytics, Research, Strategies and Technologies (ARST).

The two companies are controlled by controversial businessman Dmitry Mazepin, who has allowed them to build up over $11bn of debt that is more than value of the companies' assets and both companies are running at a loss and will struggle meet debt payments. Uralchem is due to pay back $500mn in December and doesn't have the cash, and Uralkali is due to pay back the principal of a loan that runs into billions of dollars in the New Year. Both companies are currently loss-making.

Uralkali is Russia’s biggest producer of potash and accounts for about 20% of the world’s total production. It operates five mines and seven concentrating mills with a total capacity of 13mn tonnes a year. The company’s revenues in 2018 were $2.5bn but it booked a net loss of $77.9mn.

The company has a chequered past. Formerly in partnership with Belarus’ Belarusian Potash Company (BPC), the two companies had an eight-year long cartel on the business, but they fell out with each other in 2013 and now are in direct competition, which has led to a fall in the price of potash and hurt their profitability.

Relations plummeted to an all time low when Uralkali CEO Vladislav Baumgertner was in Minsk on August 26 at the invitation of Belarusian Prime Minister Mikhail Myasnikovich to discuss the crisis in the potash sector, only to be arrested as he tried to leave the same day, causing a major diplomatic scandal. He was eventually released and returned to Russia. There was a half-hearted attempt to re-establish the cartel in 2017, but it came to nothing.

The company has fallen off the radar since its bust up with BPC, but interest amongst investors in the publicly traded company perked up again in July this year when it was reported Mazepin was attempting to take the company private again and may buy out the existing shareholders.

As bne IntelliNews reported, the largest shareholders of Uralkali delisted from the Moscow exchange in December 2017 although the process of squeezing out minorities is not complete and 3.2% of the stock is still listed in Moscow. There were a number of buybacks in this process that were not welcomed by analysts given high costs and the increasingly large treasury stake, as bne IntelliNews reported earlier. The company already delisted in London in 2015

Uralkali is still in the process of squeezing out minorities through a mandatory buy-out, which was due to be completed this summer.

Uralkali and its sister company Uralchem are both controlled by Mazepin, who has been toying with the idea of an IPO on foreign exchanges in the future to lower the debt of the companies. But now it appears time has almost run out for the two companies.

Uralchem is also controlled by Mazepin and is one of the largest producers of nitrogen and phosphorus fertilisers in Russia. It is the biggest producer of ammonia, churning out 2.8mn tonnes a year, as well as 2.5m tonnes of ammonia nitrate, 1.2mn tones of urea and 0.8mn tonnes of phosphorus and complex fertilisers per year. Both companies are export orientated: some 40% of Uralchem’s production is sold domestically with the rest going to export. In 2018 Uralchem had revenues of RUB1.3bn, but made a loss of $638mn.

The fertiliser business is a very profitable one and Russia is a major player. The two companies are giants in the business. Uralkali produced RUB691bn worth of revenues as of 2016, which is over a quarter (28%) of Russia’s entire chemical sector output and equivalent to 1% of Russia’s entire GDP. Uralchem is also the biggest producer of ammonium, a key ingredient in fertilisers, in the world.

However, prices for potash and the chemical based fertilisers that Uralchem produces have been falling in recent years. Now the companies have got into real difficulties as both their debts soar into the billions of dollars that ARST claims they are unable to repay.

Bank debts

ARST claims that the two interconnected firms have built up a total debt of $11bn that was largely provided by Russia’s two leading state-owned banks Sberbank and VTB. Uralchem owes $4.5bn to VTB, while Sberbank has lent Uralkali a total of $6.5bn, which they can’t repay.

The shareholding structure is typically opaque as most of the shares are controlled by offshore companies. Moreover, their exports are also channelled through trading companies registered in Latvia, putting the Russian companies among the biggest taxpayers in the country last year. However, Mazepin is estimated to control 74.7% of Uralkali, via his control of the quasi-treasury shares in the company that account for 54.8% of the stock (held on the balance sheet of holding company Uralkali-Tekhnologiya) and another 19.9% of shares that are held on the balance sheet of Uralchem.

The other major shareholder is Mazepin's childhood friend, Belarusian businessman Dmitry Lobyak, who controls the Cyprus registered company Rinsoco Trading Co. Limited. Russia's Sberbank acquired a 10.18% stake in Uralkali in December 2018, but in June 2019 it accepted an offer from Rinsoco Trading Co to repurchase those shares as part of the efforts to take the companies private again. Lobyak's stake in Uralkali is reportedly 20.29%, according to the ARST report.

The Russian bank loans were secured against the shares of the two companies but that has left them with very high debt to Ebitda ratios. At the end of 2018 the debt/Ebitda ratio of Uralkali was 4.44 and for JSC UCC Uralchem this ratio was 7.47.

For comparison the debt/Ebitda ratios of rival Russian fertiliser producers Eurochem and Phosagro were 0.7 and 1.9 and the sector average was 1.6 in 2018. Analysts say that when this ratio gets over three a company is usually considered to be in trouble.

And currently neither company is profitable. Uralkali lost RUB4.91bn ($76mn) as of the end of 2018 while Uralchem lost a whopping RUB40.2bn ($622mn) over the same period, according to ARST.

Given the current market cap of Uralkali was circa $4.8bn as of the end of 2018, which has to be set against its debt of $6.5bn to Sberbank, then the firm is clearly in trouble.

At the same time the debt burden of Uralchem exceeds its assets by more than 64% and more imminently it is due to make a $500mn debt redemption payment on December 18, but doesn't have the cash on its balance sheets to cover this amount and so is facing a crisis.

Transfer pricing and debt

The two companies also operate traditional “transfer pricing” schemes where their product is sold to offshore trading firms, two Latvian companies SIA Uralchem Trading and SIA Uralkali Trading .

Theses schemes were common in the 90s: the producer in Russia sells its product to an offshore trading company at well below market prices and the trading company sells on the product on the international market at market prices. The profit gets booked at the trading company, while the loss-making parent reduces its taxes in Russia. The debt-laden parent company is also hard to take over by rivals as it will immediately collapse.

On top of the dodgy trading set up, the head offices of the group’s Latvian structures are housed in Riga in the building of Rietumu Banka, which is one of three banks that has been at the centre of a huge money-laundering scandal. (ABLV and Norvik Banka were the other two and both have gone bust in the meantime.) As bne IntelliNews reported, Rietumu Bank, one of Latvia's largest lenders, was fined €80mn by a Paris court in July for its role in a tax evasion scheme run by a French company.

The two companies shouldn't be in trouble as they collectively generate several billion dollars of revenues. But instead of taking the income to pay down debt, the shareholders have drained the companies of cash through dividend payments as well as launching new ventures in Africa.

Between 2014 and 2018 Uralchem's revenue grew steadily, more than doubling from RUB26.64bn in 2014 to RUB81.1bn in 2018. However, due to high operating costs Uralchem was losing money for much of that period. At the end of 2018, the company announced a net loss of RUB40.17bn, although this was significantly lower than the losses booked in 2017. “One of the reasons for the decrease is the effect of mandatory revaluation of the group's foreign currency assets and liabilities at the official ruble exchange rate at the end of the reporting year,” ARST said in its report.

Revenues from Uralkali's sales were also increasing and ended 2018 up by RUB21bn y/y, or 15.5%, to a total of RUB156.7bn, including RUB125.7bn from foreign economic activity, which makes up 80% of its total revenue. However, the company booked a small loss of RUB4.9bn in 2018, although in the first quarter of this year it is reporting a modest profit of RUB26.9bn.

Uralchem financials show the company is loss-making

Uralkali financials show the company made a modest profit in the first quarter of this year

The profits are important as the whole empire was built on debt, which has been refinanced several times. Mazepin acquired the first assets in 2007 with the acquisition of 71% of the shares of Voskresensk Mineral Fertilizers, which was paid for with a non-renewable credit line of $700mn from Sberbank, secured by large stakes in the underlying assets in the group – nominally large and profitable fertiliser and chemical factories.

Over the next six years Mazepin borrowed repeatedly from Sberbank to expand the company and refinance previous borrowing, but in 2014 the companies started to run into trouble and twice violated their covenants with Sberbank and VTB, which by this time had also become a creditor.

In 2012 the Russian banks decided to start spreading the risk and Sberbank organised the first in a series of international syndicated loans to keep refinancing the debt. The last syndicated loan deal in 2014 was with 13 international banks in tranches of $725mn and €650mn to refinancing its debt obligations that included a lot of big international names. In 2016 Uralkali raised its biggest ever loan of $1.2bn and remains reliant on the debt markets to service its obligations.

And now the bill is about to come due. At the end of this year Uralkali will have to pay $500mn to Sberbank against its obligations as well as a second payment to Sberbank of $133mn next year.

The situation with Uralkali is even worse as the principal debt of RUB237bn is due next year, but the company has no financial reserves and the total amount borrowed exceeds the value of its assets by 64%, according to ARST calculations.

Africa to the rescue

The companies’ problems have been caused by the falling price of fertilisers in recent years in their core export markets of India and China, partly caused by the increased competition in the business from Belarus and other producers, including the companies' Russian rivals Eurochem and Phosagro that have been ramping up production. The group’s answer to this problem has been to focus on the biggest new market of Africa in the hope of growing its way out of its debt hole.

Africa is the last big emerging market development story and is staring to come into its own as China and Russia, among others, pour investment into the continent. A recent International Monetary Fund (IMF) report said that the African countries made up four of the five fastest growing. 

As bne IntelliNews reported, Uralchem announced plans to built a nitrogen fertiliser plant in Angola for $0.6bn-$0.7bn in March with annual output capacity of carbamide and ammonia of 1mn-1.2mn tonnes, the company said on March 26 following a visit by Mazepin to Angola.

"Currently about 90% of fertilisers and food products are imported to Angola," Mazepin commented, noting that the country is interested in cutting its dependency on imports.

Previously in December 2018 Mazepin told the press that his company would reorient its supplies from the largest markets such as India and China due to low prices, and focus on African market that proposes perspective for growth and higher prices.

Uralchem and Uralkali have made the countries of the Berd transport corridor – Mozambique, Malawi, Zimbabwe and Zambia – their priority. A second area on which the companies are working is the Northern corridor (Mombasa corridor), which includes Kenya, Uganda, Rwanda and Burundi. The point of targeting these corridors is that if a company enters one of these markets then interregional trade means they will sell to the others automatically.

According to the memorandum of understanding that Uralchem signed with the Republic of Zimbabwe on January 15, in addition to establishing the supply of mineral fertilisers to African countries through its trading companies, Uralchem and Uralkali are going to invest in Zimbabwean enterprises in the agricultural sector, in particular, in the largest state-owned company of the Chemplex group.

But it will take several years for these investments to make a return and in the meantime the group has some $7bn of debt to refinance in the next year, which is nine times more than the biggest syndicated loan that Uralkali has ever managed to raise in the recent past. Either the two companies will have to under go a major debt restructuring or they faces bankruptcy and the group will be broken up.