OREANDA-NEWS. Fitch Ratings has assigned SCF Capital Limited's USD750m 5.375% notes due in 2023 a final senior unsecured rating of 'BB'. The notes are guaranteed by PAO Sovcomflot (BB/Stable).

The proceeds of the notes are planned to be used for refinancing of USD660m of the USD800m Eurobonds due 27 October 2017 as part of Sovcomflot's proactive debt management policy. As a result, we do not expect this transaction to significantly increase the amount of senior unsecured indebtedness. Although the company has high senior secured debt, we rate the senior unsecured notes in line with Sovcomflot's Long-Term Issuer Default Rating (IDR). This is because the ratio of unencumbered assets to unsecured debt is around Fitch's threshold of 2x.

SCF Capital Limited is indirectly a wholly owned subsidiary of Sovcomflot, which unconditionally and irrevocably guarantees the payments under the notes.

Sovcomflot's ratings reflect the steady improvement of its financial profile, mainly driven by the tanker shipping sector's recovery, while the company maintains heavy capex plans. The company continues to benefit from a strong business profile, which is compatible with the high 'BB' rating category. Sovcomflot's 'BB' Long-Term IDR incorporates a one-notch uplift for state support to its standalone rating of 'BB-'.

KEY RATING DRIVERS

Improving Financials

Sovcomflot outperformed Fitch's expectations for 2015 with reported funds from operations (FFO) adjusted net leverage of 3.7x and FFO fixed charge cover of 4.2x. We expect FFO adjusted net leverage to remain well below 5x and FFO fixed charge cover to remain above 3x in 2016-2018. Given the volatile nature of freight rates, we have taken a through-the-cycle approach and assumed 10-year average spot tanker rates for the company's spot operations from 2016. This forecast is driven mainly by sector fundamentals and does not take into account the proceeds from the company's potential IPO.

The improvement in conventional fleet performance, along with the shift in the company's portfolio to higher-margin segments (eg gas and offshore) should support higher profitability and visibility in the medium term.

Improving Tanker Shipping Fundamentals

We continue to expect better supply/demand balance for tanker shipping in 2016 due to moderate supply growth supporting capacity discipline and growing oil consumption, coupled with regional changes in oil demand patterns having a positive tonne-mile effect on tanker demand. While the improving sector fundamentals may lead to higher vessel orders, they are likely to be contained by limited available funding as banks remain cautious with shipping exposure and are therefore unlikely to materially pressure tanker rates over the next two to three years.

Long-term Contracts

Sovcomflot's business profile benefits from a fairly high share of long-term contracts coverage with USD8.1bn of contracted revenue, half of which will be generated over 2015-2022. About two-thirds of the fleet operated on time charters in 2015. Operational strength is also underpinned by a gradual shift towards more profitable segments (eg LNG and offshore), which are expected to account for half of the company's revenue by 2020, from just over a third in 2015. Strong operations are also supported by the company's leading global position as tankers owner and in certain niche markets, a fairly young fleet and diversified customer base.

Sizeable Capex to Continue

We expect Sovcomflot to remain highly capital-intensive in the medium term as the company maintains its modern and technologically advanced fleet, and to support its LNG and offshore business. Sovcomflot plans to take delivery of eight more new vessels (including four Icebreakers, three shuttle tankers and one LNG vessel) over 2016-2017 following the delivery of 1 VLCC and 4 LNG carriers in 2014 and 2015, respectively. All vessels are planned for operation under long-term contracts.

As a result, we do not expect a significant reduction of average annual capex, which will remain around USD500m. Maintenance capex is low at around USD40m annually. As a result of the intensive capex programme, we forecast that Sovcomflot will remain free cash flow (FCF) negative over 2016-2018, despite rather solid cash flow from operations. This implies that a large portion of its capex is debt-funded.

Diversified Customer Base

Sovcomflot has a diversified customer base consisting of large international and Russian oil and gas players. Exposure to any counterparty is limited to about 10% of revenue. The company has purchased all of its LNG vessels for projects which are currently operational, except for one vessel, which is on order now for the Yamal project. According to Sovcomflot, the rate under long-term contracts is set for the duration of the contract and not dependent on oil or gas prices dynamics.

One-Notch Uplift for State Support

Sovcomflot's 'BB' Long-Term IDR incorporates a one-notch uplift to its standalone rating of 'BB-' for state support as Fitch assesses the strategic, operational and, to a lesser extent, legal ties between the group and its 100% parent (the state) to be moderately strong, despite the planned partial privatisation of the company. The strength of the ties is supported by Sovcomflot being integral to the Russian government's energy strategy, Russia's growing oil and gas market, close working relationship with state-owned oil and gas companies and previous tangible financial support.

Senior Unsecured Rating

The rating of the senior unsecured notes remains aligned with the company's Long-Term IDR, given adequate unencumbered assets, the value of which is around 2x of unsecured debt. However, we would consider decoupling the ratings, should the amount of unencumbered assets fall below this level.

KEY ASSUMPTIONS

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

- No proceeds received by the company from potential IPO.

- 10-year average freight rates for spot operations from 2016; contractual rates for time charters.

- Capex and capacity expansion as per management business plan.

RATING SENSITIVITIES

Positive: Future developments that could lead to positive rating action include:

- Material improvement of the company's credit metrics, with FFO adjusted net leverage well below 4.5x and FFO fixed charge cover above 3.5x on a sustained basis, due to, among other things, strong recovery of the tanker industry, significant downsizing of the capex programme and/or reinvestment of IPO proceeds.

- Evidence of stronger state support.

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

- Decline of tanker rates and/or more sizeable capex resulting in deterioration of the company's credit metrics (eg FFO adjusted net leverage above 5.5x and FFO fixed charge coverage below 2.5x on a sustained basis).

- Evidence of weaker state support.

- Unencumbered assets falling below 2x of unsecured debt, which would lead to a downgrade of the senior unsecured rating.

LIQUIDITY

Fitch views Sovcomflot's liquidity as adequate. The company's unrestricted cash position of USD409.8m at end-1Q16, along with its undrawn portion of committed credit lines at USD806m (85% of which is due in 2029), was sufficient to cover its short-term debt of USD285.7m. Its debt repayment schedule is well balanced with a peak in 2017 due to the maturity of its USD800m eurobonds, USD660m of which the management plans to refinance with the USD750m bond issuance. As a global tanker shipping player, the company has demonstrated good access to financial markets, having raised USD1,260m in bank financing during December 2014-December 2015. We expect Sovcomflot to remain FCF negative over 2016-2018.

FX risk is low due to natural hedge as the company generates revenue and cash flow in USD and raises debt in USD. Capex is also USD-denominated, while most of operating costs are in USD.