OREANDA-NEWS. Fitch Ratings has downgraded Russia-based Far-Eastern Shipping Company Plc's (FESCO) Long-Term Issuer Default Rating (IDR) to 'RD' (Restricted Default) from 'C'. This follows the uncured expiry of a 30-day grace period for coupon payments initially due on 4 May 2016 under FESCO's two Eurobonds issues maturing in 2018 and 2020. A full list of rating actions is provided at the end of this commentary.

Under Fitch's criteria, uncured expiry of any applicable grace period following a payment default on capital markets security or other material financial obligation indicates 'RD' ratings.

KEY RATING DRIVERS

Debt Restructuring Expected

FESCO has failed to pay a coupon on its two Eurobonds following the expiry of a 30-day grace period. The company is in the process of negotiating standstill agreements with bondholders. FESCO expects to present its business plan to creditors in June 2016 and intends to negotiate a restructuring of the Eurobonds.

FESCO has also entered a seven-day grace period on one of its local bonds after it failed to pay the coupon and amortising principal on 31 May 2016. On 6 June 2016 FESCO transferred RUB120m to National Settlement Depository for the six coupon payments due under its local bonds series BO-02. However, the company intends to negotiate with local bondholders a six-month postponement of amortising principal repayment to November 2016 as well as a waiver of their rights to claim early redemption of the bonds (to the extent such right arises) for a period of three months.

Insufficient Liquidity

Fitch assessed FESCO's liquidity position at end-1Q16 as insufficient. The company's cash and cash equivalents of USD40m at end-1Q16 and Fitch-projected 2016 negative free cash flows (FCF) will not cover expected maturities of USD130m and coupon/interest payments over 1Q6-1Q17. Financial covenants in the Eurobond documentation (ie fixed charge coverage ratio of 2.0x or higher and consolidated total leverage ratio of less than 3.25x) limit FESCO's ability to incur additional debt over certain limits but their breach does not constitute an event of default.

Low Coverage, High Leverage

At end-1Q16 FESCO's debt was USD912m. Fitch has included in its adjusted debt calculation USD220m Eurobonds that were bought back in May 2015 as these Eurobonds were pledged as collateral under a USD44m loan agreement provided by an international bank for funding the Eurobond buyback and should be released back to FESCO upon the final fulfilment of obligations under this loan in February 2018.

We expect FESCO's funds from operations (FFO) net adjusted leverage to increase to above 10x over 2016-2018, from slightly above 6x at end-2014 on the back of deteriorating operational performance. We expect FESCO to report negative FFO over 2016-2018 due to lower operational cash flows, resulting in FFO interest coverage falling to below 1x over 2016-2018, from slightly above 1x at end-2014.

Earnings Pressure Continues

The Russian transportation market remained under pressure in 2015 from a contracting domestic economy and rouble depreciation, which affected import and transit transportation volumes and consumer purchasing power. The container throughput in the Far Eastern ports and rail container transportation in Russia declined 24% and 8% yoy, respectively, in 2015. This had negatively affected FESCO's operational performance across all business segments in 2015 and 1Q16.

In 1Q16 FESCO's VMTP container throughput, inter-modal transportation volumes and rail cargo turnover fell 22%, 28% and 27%, respectively. FESCO reported a 38% yoy drop in revenue in US dollar-equivalent in 1Q16. We expect 2016 to be another challenging year for container transportation as we forecast Russian GDP to decline by a further 0.7% and the rouble to remain weak.

FX Risks Still High

Despite the buyback of foreign-denominated debt in May 2015 and conversion of certain port tariffs to US dollars from rouble at end-2014, FESCO remains exposed to foreign currency fluctuations as 84% of its total debt at end-1Q16 was denominated in foreign currencies, mainly US dollars. About 60% of revenue in 1Q16 was US dollar-linked or US dollar denominated.

Expected Negative FCF

Despite significant reduction in capex to a maintenance level of about USD20m annually versus USD62m on average over 2012-2014 we expect FESCO to generate negative FCF. This is mainly due to weaker cash generation from operations on the back of falling volumes, continued pressure on rates and high interest/coupon payments on debt. We do not expect operating cash flows to improve in 2016.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Russian GDP decline of 0.7% in 2016 and growth of 1.3%-2% in 2017-2018; Chinese GDP growth of 5.8%-6.9% over 2016-2018

- Russian CPI of 6%-8.2% over 2016-2018

- No dividends payments

- Capex of about USD20m annually over 2016-2018

- USD/RUB exchange rate of 70-73 over 2016-2018

RATING SENSITIVITIES

Negative: Future developments that could lead to negative rating action include:

- FESCO entering into bankruptcy filings, administration, receivership, liquidation or other formal winding-up procedure.

Positive: The 'RD' rating will be revised to reflect the appropriate IDR for the issuer's post-restructuring capital structure, risk profile and prospects in accordance with relevant criteria.

FULL LIST OF RATING ACTIONS

Far-Eastern Shipping Company Plc

- Long-Term Foreign Currency IDR downgraded to 'RD' from 'C'

- Long-Term Local Currency IDR downgraded to 'RD' from 'C'

- National Long-Term Rating downgraded to 'RD(rus)' from 'C(rus)'

- Local currency senior unsecured rating affirmed at 'C'/Recovery Rating 'RR6'

Far East Capital Limited S. A. (Luxembourg)

- Foreign currency senior unsecured rating affirmed at 'C'/Recovery Rating 'RR6'.