Kazakh Pharmaceutical Company Chimpharm And Proposed Notes Assigned 'B-' Ratings - S&P

Frankfurt. July 25. Kazakhstan Today - Standard & Poor's Ratings Services said July 24 that it had assigned its 'B-' long-term corporate credit rating to Kazakh generic pharmaceuticals manufacturer Chimpharm JSC. The outlook is positive, Kazakhstan Today reports.

At the same time, S&P Rating Services assigned 'B-' issue ratings to Chimpharm's proposed KZT10 billion unsecured notes. The recovery rating on this debt is '4', indicating our expectation of average (30%-50%) recovery for creditors in an event of payment default.

The rating action follows the announcement on July 12, 2012 when S&P assigned its 'kzBB' Kazakhstan national scale rating to Chimpharm and the proposed notes.

"The ratings reflect our assessment of Chimpharm's business risk profile as "vulnerable", mainly due to its relatively small size, and political risk in the Republic of Kazakhstan(BBB+/Stable/A-2), its main market. Other business risks are Chimpharm's lack of geographic diversity and reliance on public funds and distribution capabilities in an evolving domestic health care system", the press release of S&P Rating Services reads.

Positive factors are Chimpharm's position in the Kazakh pharmaceutical market as the leading domestic producer, by volume, of mainly generic drugs and medicines. S&P's view of Chimpharm's credit metrics is another support for the ratings. Leverage was very low at the end of 2011, with the company's debt totaling KZT1.2 billion (about $8 million). Chimpharm's operating margin (EBITDA) was relatively high at 33% in 2011.

"We project margins will decline over the next few years, as selling and marketing expenses will likely outpace the expected strong improvement in the gross margin following the company's planned expansion", noted in the press release. However, the increase in selling and marketing expenses is unlikely to be material and mainly reflects the need to adapt to new business conditions under a recently signed exclusive supply contract between Chimpharm and the domestic market regulator.

To cope with the contract's specifications for production and delivery of guaranteed volumes, Chimpharm has initiated a $65 million facility expansion and modernization program in compliance with the U.S. regulator's Good Manufacturing Practice standards. The resulting need for additional resources will push up expenses from 2012. S&P believes this will offset the projected significant rise in the gross margin on the back of likely sizable price increases and a more profitable product mix after Polpharma took control of Chimpharm in 2011. Consequently, we expect EBITDA margins in our base-case scenario for 2012 and 2013 to temporarily fall to 27% and recover to about 30% thereafter, though still comparing favorably with those of its peers.

S&P assessesChimpharm's financial risk profile as "aggressive" under our criteria. "This mainly reflects view of the company's less-than-adequate liquidity profile, in turn reflecting uncertainties about the successful placement of the proposed notes. The company's credit metrics are a rating support, in view of relatively high operating margins and satisfactory free cash flow generation. We expect leverage in our base-case scenario to rise to more than 2.5x in 2012 and 2013, due to sizable capital spending to construct new facilities and fund the related working capital requirements", the press release reads.

Chimpharm is privately owned by two large shareholders: Poland-based Polpharma (50% plus one vote) and Visor Growth Fund B.V., which is owned by Kazakhstani investors (the remainder). S&P believes there are no significant corporate governance issues. Polpharma exercises operating control as stipulated in the shareholder agreement, with the support of former majority owner Visor Growth Fund B.V., which saw the need for a strong industrial partner for Chimpharm. "We believe Chimpharm's management has a generally measured risk appetite. We understand Chimpharm is to start paying dividends to its shareholders after the notes are repaid. We note that, according to the shareholder agreement, no dividends are paid if cash flows are negative", the press release says.

The positive outlook reflects S&P's view that Chimpharm's liquidity will likely improve if it successfully places the proposed notes, enabling it to carry out its expansion plans. This should result in satisfactory cash flow generation if there are no significant delays in the construction program.

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