Fitch Places Georgian Railway JSC on Rating Watch Negative
The RWN reflects the company's under-performing transportation volumes and turnover, which have already been under pressure from slowing economies in the region, leading to significantly weaker forecast credit metrics than our rating guidance. The RWN will be resolved once we have assessed GR's updated business plan, including capex and expected dividends, as well as the strength of the government links in the view of the general elections in October 2016.
We would downgrade the ratings if we expect funds from operations (FFO) adjusted net leverage to be sustainably above 3x and FFO fixed charge cover below 3x. The downgrade would be limited to one notch below the sovereign rating (BB-/Stable) provided the company's links with the state through JSC Partnership Fund (BB-/Stable) do not weaken.
KEY RATING DRIVERS
Supply Disruptions Exacerbate Volume Drop
Volumes and turnover from transportation of oil products, the most profitable and significant part of GR's business, have been significantly hit by the political tensions between Azerbaijan and Armenia during which Azerbaijani government restricted the country's exports. GR's oil product transportation volume and turnover in 1H16 decreased 39% and 46% yoy, respectively. This emphasises the high event risk GR is exposed to, due to its reliance on the transportation of transit volumes by a single transit route. Overall volumes fell 22% yoy during 1H16.
Weaker Standalone Profile
GR's standalone creditworthiness is likely to weaken below the current level of 'BB-' on the back of the reduction in transportation activities, especially if we see them as largely structural and if it is not offset by cash flow conservation.
Parent Links to Support Rating
The ratings may be supported at 'B+', a one notch below the sovereign's, by GR's links with the state, including factors such as the company's importance to the local economy as the largest taxpayer and employer and the company's role in Georgia's regional transit corridor.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for GR include:
- Freight transportation volumes to decline 12% in 2016, before growing in low single digits thereafter
- Freight tariffs to decline in low single digits
- Inflation-driven cost increase
- Capex in line with management expectations of USD316m for 2016-2019
- GEL/USD exchange rate of 2.37 on average in 2016 and 2.35 thereafter
RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- A negative sovereign rating action.
- A sustained increase of FFO adjusted net leverage above 3x or FFO fixed charge cover falling below 3x that results in weaker standalone creditworthiness. A downgrade for this reason would be limited to a one-notch differential below the sovereign rating if the links between GR and its parent do not weaken.
- Weakening links with the government, such as privatisation of a majority stake, which may result in a wider differential from the sovereign rating
Positive: As the ratings are on RWN we do not anticipate an upgrade. Future developments that may, individually or collectively, lead to a rating affirmation:
- A sustained improvement in FFO adjusted net leverage to below 3x and FFO fixed charge cover greater than 3x.
- Stronger links with the government, such as government guarantees for a material portion of GR's debt, which could result in Fitch aligning GR's rating with the sovereign.
LIQUIDITY
As of 30 June 2016, GR had a USD500m bond (or GEL1,211m), due 2022. Cash and cash equivalents stood at GEL254m and undrawn credit facilities at GEL145m. We expect GR's free cash flow to remain negative during 2016-2019 on the back of an ambitious capex programme. GR may postpone certain capex if necessary.
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