At the same time, Standard & Poor's assigned its 'B+' senior unsecured debt rating to the planned offering of loan participation notes by Citigroup Global Markets Deutschland AG, which will be used to finance a loan to Severstal.

The ratings reflect Severstal's position as a volume manufacturer in the difficult global steel industry, and the uncertainties caused by the company's aggressive investment strategy and complex structure of its parent, the Severstal group (not rated). The ratings are supported, however, by Severstal's low cost base; moderately growing domestic steel market; and currently strong financial profile with little net debt, high profitability, and cash flow. At Dec. 31, 2003, the company had total debt of $515 million.

Severstal is Russia's second-largest integrated steel manufacturer, with 2002 sales of $2.3 billion on 8.6 million metric tons of steel products. Although in January 2004, the company acquired the assets of the bankrupt U.S.-based steel maker Rouge Industries Inc.--which produced 2.5 million metric tons in 2002--Severstal's key cash generating assets are in the Russian Federation (foreign currency BB+/Stable/B; local currency BBB-/Stable/A-3).

Severstal's key advantage is its low cost position, underpinned by access to cheap labor and energy resources in Russia. This translates into high profitability and cash flow. Supplies are secured by vertical integration into iron ore and coal mining at the shareholder level. Because Severstal has a somewhat higher value-added product mix and higher share of domestic sales compared with peers, the company is best placed to take advantage of the gradual growth of the domestic market. Severstal has strong positions on the domestic market and access to exports, which provides sales diversification and access to foreign currency revenues. The company's net debt is expected to remain moderate even when including the Rouge acquisition.

The ratings are constrained by the company's position of a commodity-biased producer and the difficult steel industry fundamentals, such as cyclicality, competitiveness, and capital intensity. The key risk is the gradual cost erosion caused by Russian ruble appreciation and even faster growth in resource prices in Russia.

Russian steel market growth is moderate and volatile. Its higher value-added commodity segments (which are targeted by Severstal) are small, competitive, and largely depend on the pace of restructuring in the country's auto and capital goods sectors. Although strong positions in these segments are strategically important for Severstal's long-term competitiveness, currently this increases volatility in margins and cash flows.

Severstal's position as the core of the nontransparent and closely held Severstal group implies potential corporate governance uncertainties and, in Standard & Poor's opinion, could lead to large unexpected transactions. Historically, Severstal has financed acquisitions of, and provided limited support to, other (smaller and weaker) group businesses such as auto and mining companies, which have absorbed most of the company's free cash flow.

03 Febrary 2004