Rating Action Overview

• Magnetic Infrastructure Group Pty Ltd. (MIG) acquired One Rail Australia Holdings Ltd. (OneRail) in February 2023 for A$435 million. MIG took on additional subordinated debt of A$200 million to fund the transaction.
• On a stand-alone basis, we expect OneRail's ratio of funds from operations (FFO) to debt to remain subdued at 20%-26% over the next two years, before recovering to more than 30% in fiscal 2025 (year ending June 30). The consolidated FFO-to-debt ratio for MIG will be weaker, leaving minimum headroom at the current rating level.
• We have lowered our rating on OneRail to 'BB' from 'BBB-'. We removed the rating from CreditWatch, where we had placed it with negative implications on Dec. 19, 2022. At the same time, we affirmed our issue rating on the above-rail coal hauling company's rated senior secured debt at 'BBB-' with a recovery rating of '1' (i.e., "very high recovery").
• The stable outlook reflects our view that OneRail's steady cash flow from its contract with Glencore PLC and its scheduled debt amortization will support an improved financial profile over the next two to three years. We also expect the deferred purchase consideration for the acquisition will be equity funded.

Rating Action Rationale

The downgrade follows the new joint-venture, MIG, taking over OneRail. We believe OneRail's credit profile has been primarily hit by the additional A$200 million subordinated debt that MIG took on (via its wholly owned subsidiary Magnetic Rail Group) to fund the acquisition. Management has represented that the remaining proceeds of the A$435 million acquisition (including a deferred consideration of A$125 million) will be paid via equity.

OneRail's long-term contract will continue to support its business position. The company will continue to benefit from the exclusivity of its coal haulage contract with Glencore in the Hunter Valley region of New South Wales. This contract, valid until 2036, has significant take-or-pay obligations till 2026 and a higher tariff path until 2030. Nonetheless, OneRail's small size of operations compared to local peers', and its geographic and commodity concentration, will weigh on its credit profile.

OneRail's EBITDA will remain subdued at A$130million-A$140 million in fiscal 2023 before recovering to A$140 million-A$160 million over the next two to three years. The company's earnings are likely to improve as the effect of severe weather conditions and mine-specific production issues in the past six to 12 months subside. We expect total coal haulage of about 7.5-8.0 billion net ton kilometers per annum over the next two years. About 90% of this is under various take-or-pay contracts. Subsequently, OneRail may be more exposed to variation in haulage volumes, although it will remain the exclusive hauler for Glencore in New South Wales.

OneRail's ambition of expanding haulage services particularly in Queensland would require additional capital investment.  We therefore factor in an additional investment of A$55 million-A$60 million over the next 24-36 months. This spending could see the company's near-term metrics, particularly at the consolidated level, to dip slightly below our downgrade triggers until fiscal 2024; incremental earnings from which will accrue from fiscal 2025 onward.

We believe management of costs and dividends, along with expected debt reduction through cash sweeps would be critical until fiscal 2025. This is given the lack of headroom to handle variations in coal volumes until the FFO-to-debt ratio recovers to more than 30% on a stand-alone basis and over 14% on a consolidated basis by fiscal 2025.

We expect OneRail's stand-alone FFO-to-debt ratio to trend at 20%-26% in fiscals 2023 and 2024, before improving to more than 30% from fiscal 2025 onward.  This is slightly below our previous expectation wherein the ratio was expected to improve to more than 30% by the end of calendar year 2024. We believe the amortizing nature of the company's debt, along with the cash sweep mechanism under the bank loan, will support the improvement in financial metrics. In addition, the metrics will benefit from the initial cash injection of A$24.1 million and high cash balance of about A$38 million as of March 31, 2023. Furthermore, at the stand-alone level, we believe dividends over the next two to three years will be only to meet the interest payment of the subordinate debt and ongoing expenses of MIG. No further cash outflow to the shareholders are likely, with all excess cash balances retained at OneRail.

Our view of the MIG group drives our ratings on OneRail; we expect consolidated FFO-to-debt at the MIG level to fall to 11.5%-13.5% for the next two fiscals, before improving to over 14%.  This ratio is toward the lower end of our assessment of a 'bb' group credit profile. We would expect the ratio to improve to above 13% with some buffer to maintain the group credit profile assessment. The consolidated metrics factor in the A$200 million subordinate debt as well as the management fee payable by MIG. For our analysis, we have assumed all interest is paid out continuously (i.e., no payment-in-kind capitalization of interest for the first 12 months). We believe MIG is jointly controlled by the two joint venture partners and that OneRail forms a core part of this group, being the sole operating entity. Consequently, we equalize our rating on OneRail with our view of the group credit profile.

OneRail's medium-to-long term strategy, financial policies, and commitment to the rating, remain key rating drivers.  The managements of OneRail and its new owners continue to work closely to define the company's longer-term growth and diversification strategy. The policies and medium-to-long term expansion plans are likely to evolve over the next six-12 months. Furthermore, the commitment of management as well as the new shareholder to the credit rating and discipline of operating with some headroom above the rating triggers, will remain critical over the medium to longer term. This will be tested further particularly from mid-fiscal 2026 onward, when the take-or-pay limits under the marquee Glencore haulage contract drop to about 65% of the current levels.

Outlook

The stable outlook on OneRail reflects our view that the company's steady cash flow from its contract with Glencore along with protections under its senior secured debt facilitates will support an improved financial profile over the next two to three years. The outlook also factors in the expectation that the remaining A$125 million acquisition payment will not increase debt or reduce cash balances at OneRail.

On a stand-alone basis, we expect the FFO-to-debt ratio to remain subdued at 20%-22% in fiscal 2023, before recovering toward 24%-32% over the next one to two years. The step improvement in metrics will benefit from the amortizing debt profile and cash sweeps.

On a consolidated basis, we expect the ratio to remain at 11.5%-13.5% in fiscals 2023 and 2024. This range is at the lower end of our threshold. Improvement in the stand-alone profile is likely to see the consolidated metrics increase to above 14% in subsequent years.

Downside scenario

The rating on OneRail could come under pressure if MIG group's consolidated FFO-to-debt ratio remains below 13% beyond the next two years. Outside of the group undertaking any additional debt or paying out dividends, this could likely happen with weakness in OneRail's stand-alone business.

Our assessment of OneRail's stand-alone credit profile could deteriorate if the FFO-to-debt ratio remains below 23% beyond the next one to two years with no clear and timely response to restore it with reasonable headroom. This could happen if:

• There is a major disruption or operating performance is below our expectations, leading to a reduction in above-rail coal volumes.
• Capital expenditure (capex) or dividend outflows are materially higher than we expect, indicating a higher risk appetite.
• There is material change in the capital structure, or if amortization of debt/cash flow sweeps are lower than we expect.

Upside scenario

We believe an upgrade over the next two to three years is unlikely. This is because we expect OneRail as well as the group to have growth ambitions and relatively low rating headroom over the next two to three years.

Nonetheless, we could raise the rating if the group sustains its consolidated FFO-to-debt ratio above 23% with supportive policies for maintaining the same.

We could raise our assessment of OneRail's stand-alone credit profile if the company maintains an FFO-to-debt ratio above 30%. The company may need to maintain higher metric thresholds as its business profile weakens, for example with reduction of take-or-pay obligations and pricing resets under the marquee Glencore contract.

Company Description

OneRail provides coal haulage services primarily to Glencore-managed mines in the Hunter Valley. The company's contract with Glencore is exclusive for most of Glencore's Hunter Valley coal volumes until 2036. This includes take-or-pay obligations, which step down in 2026 and 2030, and end in 2034. OneRail owns and operates the youngest fleet in the Hunter Valley. In February 2020, it started services on a contract to haul coal in Queensland.

In February 2023, OneRail was acquired by MIG, a 50-50 joint venture between M Resources Trading Pty Ltd. and PT Asian Bulk Logistics (ABL). M Resources, part of the Matt Latimore group, is based in Australia and is engaged in coal trading and consulting, with primary focus on metallurgical coal products. ABL is an Indonesian based integrated sea logistics and infrastructure solutions provider founded in 2010.

Our Base-Case Scenario

Assumptions

• OneRail's coal haulage volume to be 52-55 mtpa over the next two to three years, including 46-48 mtpa under the exclusive Glencore contract.
• Favorably priced contracts to see EBTDA margins at 50%-53% over the period.
• Total capex, including for growth projects, to remain high at A$25 million-A$30 million a year over the period. This includes spending of about A$20 million in fiscal 2023 to purchase a second train set for the Queensland operation.
• Average interest cost to be 8.0%-8.5%.
• Scheduled repayments will be about A$40 million a year, with an additional A$10 million-A$15 million paid out a year under cash sweeps for the next two years.
• Dividends at OneRail to be sufficient to cover the interest payment at the MIG level, with no additional outflows to shareholders over the next two to three years.

Key metrics

Liquidity

We assess OneRail's liquidity as adequate. We expect liquidity sources will exceed uses by more than 1.2x over the 12 months ending March 31, 2024, and that sources will remain adequate even if EBITDA were to drop by 15% from our base case.

On a stand-alone basis, OneRail has senior debt facilities of A$494.4 million and A$15 million of working capital. The facilities are subject to minimum debt service coverage ratios and maximum leverage. We expect the company to maintain a reasonable buffer against any covenants over the next two to three years.

Principal Liquidity Sources:

• Cash balance of A$38 million as of March 31, 2023.
• Cash FFO of about A$90 million (net of any working capital adjustments) over the 12 months ending March 31, 2024.

Principal Liquidity Uses:

• Scheduled debt maturities of about A$40 million over the 12 months ending March 31, 2024.
• Capex of A$25 million-A$30 million over the period.
• Dividend payments of about A$25 million over the period.

Group Influence

We consider OneRail to be a core subsidiary of MIG, primarily because it is the only operating subsidiary and contributes 100% of group's consolidated EBITDA. MIG is ultimate holding company of the joint venture and the head entity for this group. The joint venture is owned and run jointly by the two partners, and control is split evenly with no one entity having any special influence over the venture. There are no other businesses, debt, or liabilities in MIG apart from the A$200 million subordinate debt. Also, we believe OneRail has reasonable medium-term prospects and is highly unlikely to be sold.

We have assessed the consolidated entity to arrive at the 'bb' group credit profile. Consequently, our view on the group caps the issuer credit rating on OneRail at 'BB'. To that extent, any additional businesses or liabilities that form part of the MIG group would be a consideration in our rating analysis.

Environmental, Social, And Governance

ESG credit indicators: E-4, S-2, G-2

Environmental factors are a negative consideration in our credit rating analysis of OneRail because the entity solely hauls coal. Haulage of thermal coal makes up 85%-90% of its volumes and revenue. As a coal rail freight operator, OneRail remains exposed to long-term demand prospects for thermal as well as metallurgical coal. However, the take-or-pay nature of the key contract tempers the near-term risks. In addition, as a rail operator, OneRail's emissions relate primarily to the operation of its locomotives.

Over the longer term, environmental concerns and global energy policies that reduce demand for miners' products, particularly thermal coal, could dent transport volumes through OneRail's rail network. This may also affect the company's borrowing costs and investor base.

We assess the social and governance factors for OneRail as neutral.

Issue Ratings - Recovery Analysis

Key analytical factors

Our recovery analysis for OneRail contemplates a hypothetical simulated default in the first half of 2028. The issue rating on the A$250 million senior secured tranche B bank loan (current outstanding A$154.8 million) and the US$242 million U.S. private placement (equivalent to A$339.6 million) is 'BBB-'. This is based upon the issuer credit rating of 'BB' and recovery rating of '1'. This reflects our expectation of a very high recovery (95%) should a default event occur.

At the time of the hypothetical default, we assume adverse macroeconomic conditions will cause global end-market demand and pricing for commodities to deteriorate materially. This will lead to a steep decline in coal haulage through OneRail, along with payment issues from contract counterparties. As a result, OneRail will see a significant revenue decline that will impair its ability to meet its scheduled principal or cash interest repayments.

We believe that, following a payment default, OneRail is likely to be reorganized as a going concern. This is due to the long-term nature of contracts with its customers and the applicability of take-or-pay as well as exclusivity obligations. We applied a 4.5x valuation multiple to our estimated distressed emergence EBITDA of about A$81 million to arrive at a gross enterprise value of about A$366 million. The net enterprise value after administrative costs is A$348 million.

Simulated default assumptions

• Simulated year of default: 2028
• Jurisdiction: Australia
• EBITDA at emergence: A$81 million
• EBITDA multiple (railroad and packaging): 4.5x
• Gross enterprise value: A$366 million
• Senior secured working capital facilities of A$15 million (85% drawn at default) and senior secured debt of A$494.4 million (60% outstanding at default)

Simplified waterfall

• Net enterprise value at emergence (after 5% administrative costs): A$348 million
• Estimated net enterprise value available to secured first-lien debt: about A$348 million
• Estimated secured first-lien claims (working capital facilities 85% drawn and including six months of prepetition interest): approximately A$324 million
• Recovery expectations: 90%-100% (rounded estimate: 95%).
• Recovery rating: '1'

Ratings Score Snapshot

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings , Oct. 10, 2021
• General Criteria: Group Rating Methodology , July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments , April 1, 2019
• Criteria | Corporates | General: Recovery Rating Criteria For Speculative-Grade Corporate Issuers , Dec. 7, 2016
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers , Dec. 16, 2014
• Criteria | Corporates | General: Corporate Methodology , Nov. 19, 2013
• General Criteria: Methodology: Industry Risk , Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions , Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities , Nov. 13, 2012
• General Criteria: Principles Of Credit Ratings , Feb. 16, 2011
• General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating , Oct. 1, 2010

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