Fitch Affirms UCL Rail at 'BB+', Revises Outlook to Stable
November 22, 2013 Fitch Ratings
Fitch Ratings has affirmed UCL Rail B.V.'s (UCLR) Long-term foreign currency Issuer Default Rating (IDR) at 'BB+'. The Outlook has been revised to Stable from Positive. Fitch has also assigned JSC Freight One, UCLR's key 100% subsidiary, a Long-term foreign currency IDR of 'BB+' with a Stable Outlook and its proposed domestic bonds an expected local currency senior unsecured rating of 'BB+(EXP)' and an expected National rating of 'AA(rus)(EXP)'. The final ratings are contingent on documentation conforming with the information already received. A full list of rating actions is below.
The affirmation reflects UCLR's position as the leading rolling stock owner and operator in Russia's rail freight market. The sizeable asset base provides UCLR with a strong ability to execute customer demand and a diversified fleet and customer base. This supports its robust profitability and operating cash flows. However, UCLR's business is exposed to volatile economic drivers affecting both transported volumes and freight rates.
The Outlook revision reflects a weaker than expected market environment in 2013 and 2014 resulting in weaker cash flow and higher leverage. Fitch expects UCLR to report leverage around 2.6x (net adjusted debt to funds from operations; FFO) at YE13, up on 2.1x at YE12. We expect leverage to reduce from 2014, helped by debt repayment, low capex (focused on maintenance and asset life extension) and zero dividend policy.
Freight One's ratings are in line with these of UCLR, reflecting its key contribution to the group - it represents bulk of revenues, earnings and debt.
KEY RATING DRIVERS
Although UCLR reduced its debt by RUB39bn at end-September 2013 compared with end-2012, FFO net adjusted leverage at YE13 is likely to be significantly weaker (2.6x) than our previous expectations (1.7x). This is due to weaker cash flows as a result of lower freight rates. As debt continues to be repaid (possibly at a slower pace), we expect leverage to gradually decrease to around 2x in 2014 and below, assuming only a modest improvement in market conditions. The revised Outlook reflects our expectation that leverage may not be comfortably below upgrade guidance before YE15.
Weak Market Conditions
Freight rail volumes and prices have declined in 2013, mostly due to intensifying competition from smaller players and overall stagnation of the economy and especially industrial production. We believe that some consolidation in the sector will take place, but we do not expect any major growth in freight volumes (demand). We therefore expect freight rates to grow slowly at around the inflation level in short to medium term.
Strong Competitive Position
UCLR is the leading nationwide commercial rolling stock operator in Russia by fleet size (around 18% of the market), transportation volumes (around 20%), and turnover (20%). The company has a diversified fleet and customer base, which along with a broad network of regional branches secure its competitive advantage and efficiency over smaller market players. Long-term contracts with industrial customers are becoming a feature of the market, but it remains to be seen if this will translate into a significant improvement in cash flow visibility.
Elevated Volume Risks
UCLR's strengths are partially offset by the company's exposure to cyclical commodity industries (coal, oil and building materials account for approximately three-quarters of total volume transported) and above-average exposure to lower tariff cargoes (e.g. coal). Fitch assesses UCLR's volume risk as elevated, although this is mitigated by a comparatively low share of fixed costs in the company's cost structure. In addition, regulatory changes or higher tariffs for empty runs may affect cash flows.
Freight One Core to the Group
We view Freight One and UCL Rail as having the same credit profile due to their strong links, with structural subordination of UCL's creditors mitigated by the level of upstream guarantees from Freight One. Fitch believes that the relationship will be strengthened by the planned consolidation of all operating companies into one legal entity in 2014.
Proposed Domestic Bonds
Freight One intends to refinance part of the existing debt by a domestic senior unsecured bond. Although all debt within UCLR is formally secured, only around 6% of total wagon fleet is encumbered, leaving significant asset value for the senior unsecured creditors. In addition, we expect net debt to EBITDA to be below 2x from 2014. As a result, the expected bond rating is aligned with Freight One's IDR.
Positive: Future developments that could lead to positive rating action include:
- FFO adjusted net leverage falling below 2.0x and FFO fixed charge coverage rising above 4.5x on a sustained basis.
Negative: Future developments that could lead to negative rating action include:
- FFO adjusted net leverage rising above 2.5x and FFO fixed charge coverage falling below 3.0x on a sustained basis due to weaker-than-expected operating results, larger capex or dividend payments.
The rating actions are as follows:
Long-term foreign currency IDR affirmed at: 'BB+', Outlook revised to Stable from Positive
Short-term foreign currency IDR affirmed at: 'B'
Senior unsecured rating affirmed at: 'BB+'
Long-term local currency IDR affirmed at: 'BB+', Outlook revised to Stable from Positive
Short-term local currency IDR affirmed at: 'B'
Local currency senior unsecured rating affirmed at: 'BB+'
National Long-term rating affirmed at: 'AA(rus)', Outlook revised to Stable from Positive
Long-term foreign currency IDR assigned at: 'BB+', Stable Outlook
Short-term foreign currency IDR assigned at: 'B'
Senior unsecured rating assigned at: 'BB+'
Long-term local currency IDR assigned at: 'BB+', Stable Outlook
Short-term local currency IDR assigned at: 'B'
Proposed local currency senior unsecured bond rating assigned at: 'BB+(EXP)'
National Long-term rating assigned at: 'AA(rus)', Stable Outlook
Proposed National local currency senior unsecured bond rating assigned at: 'AA(rus) (EXP)'
Company — Freight One
Full nameJSC Freight One