OREANDA-NEWS. Fitch Ratings has revised Russia-based OJSC Holding Company United Confectioners' (UC) Outlook to Stable from Negative while affirming the Long-term Issuer Default Rating (IDR) at 'B'. A full list of rating actions is available at the end of this commentary.

The revision of the Outlook to Stable reflects our expectation that UC's net outflows to related parties and dividends will be moderate over 2016-2019, following a material reduction in 2015. This should enable the company to keep fund from operations (FFO) adjusted gross leverage at 2.5x-3.0x and support adequate access to bank financing.

While we expect UC's business profile and credit metrics to remain consistent with higher-rated peers over the medium term the ratings remain constrained by high corporate governance risk. The ratings factor in our expectation that UC will be able to maintain its sales volumes and pass on some of the raw materials cost increase to customers over 2016-2019. This will protect profits from a material decline in a challenging consumer environment in Russia..

KEY RATING DRIVERS
Leading Market Position
The ratings reflect UC's leading positions in the core confectionery market segments of Russia and a strong portfolio of nationally recognised brands. We believe that the company's focus on the medium price segment and increasing presence in the economy segment, together with high customer loyalty and a wide distribution network across the country, will enable UC to retain its leading position in the Russian confectionery market over the medium term. These strengths should also allow UC to continue to see resilient revenue performance in the current difficult market environment, as demonstrated in 2015.

Subdued Consumer Sentiment
Since 2015, consumer spending in UC's home market of Russia has been contracting, affecting confectionery sales. We expect this weak demand to persist in 2016 and to translate into further declines in sales volumes of confectionery. However, the company's increased focus on the economy segment and on bakery and sugary sweets, which tend to see greater demand when consumers trade down, should allow UC to outperform the market in 2016 and limit sales volumes declines to the low single digits. We also take into account the company's continued efforts to increase direct contracts with retailers, which should provide additional support to sales volumes.

EBITDA Margin under Pressure
We estimate UC's EBITDA margin to have decreased to 12% in 2015 from 14% in 2014 and expect a further reduction to around 10% in 2016 due to continued increases in raw materials costs. These raw material costs remain largely outside the company's control and have increased as a result of swings in prices for major inputs, such as cocoa and sugar, and also because of the depreciation of the rouble as they are USD-linked. UC was, however, able to increase average prices by more than 20% in 2015, which we believe may have enabled it to protect its EBITDA and outperform our expectations.

Further pressure on the EBITDA margin in 2016 will stem from changes in the product mix towards less profitable bakery and sugary sweets. However, we expect this figure to improve to 11% in 2017-2019 on the likely recovery of demand for chocolate sweets.

Loose Corporate Governance Practices
Weak corporate governance remains a key credit risk, in particular with respect to aggressive and variable cash distributions either in the form of dividends or loans to related parties. Lack of management independence and a large portion of UC's cash being held at Guta Bank demonstrate UC's dependence on its shareholder Guta Group.

We view weak corporate governance as potentially adversely affecting unsecured creditors and therefore cap UC's ratings at the current 'B' level, although the company's credit metrics and business profile are commensurate with higher rating.

We assume that outflows to shareholder and related parties would be at manageable levels over 2016-2019, allowing UC to maintain moderate leverage and retain adequate access to bank financing. The Outlook revision also takes into account the material reduction in 2015 of net outflows to related parties and shareholders, enabling the company to reduce its debt burden and increase its headroom under the current rating.

Moderate Leverage
Fitch estimates UC's FFO adjusted gross leverage to have decreased to 2.4x in 2015 (2014: 2.9x) as a result of debt reduction by around RUB2bn following the substantial decrease in net outflows to related parties and the shareholder. We project FFO adjusted gross leverage to rise to 2.5x-3.0x over 2016-2018 due to lower EBITDA margin and a possible resumption of outflows to related parties, dividends or acquisitions of non-core assets. We assume though that total payments and outflows for each year would not exceed prior-year net profit.

Despite the projected increase in leverage, expected credit metrics are strong compared with peers, allowing comfortable headroom under the 'B' rating.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for the issuer include
- 1% decrease in sales volumes in 2016 and 1%-2% growth thereafter
- Revenue up 20% in 2015, followed by mid-single digit growth over 2016-2019
- Decline in EBITDA margin to 12% in 2015 and to around 10% in 2016 as a result of higher raw materials prices. EBITDA margin to improve to 11% in 2017-2019.
- Capex at around 2%-3% of revenue over 2016-2019
- Cash distributions (dividends, loans to related parties and investments in non-core assets) equal to prior-year net profit
- Adequate liquidity

RATING SENSITIVITIES
Positive: An upgrade is unlikely unless there is consistent evidence of improved corporate governance practices.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Sustained material deterioration in free cash flow (FCF) generation, driven by operating underperformance
- Larger-than-expected distribution of funds to Guta Group or material investments in non-core assets not balanced by greater pre-dividend FCF
- Sustained FFO-adjusted gross leverage above 4.0x

LIQUIDITY
As at end-2015 Fitch-adjusted unrestricted cash of RUB0.2bn, available undrawn committed bank lines of RUB4.4bn and expected positive FCF were not sufficient to cover short-term debt of RUB7.6bn. However, we estimate the company's liquidity position to have improved substantially after it signed an agreement for an additional RUB4bn credit facility in March 2016 and refinanced a large portion of its short-term maturities. Liquidity and refinancing risks may increase in case of large and uncontrolled cash leakage to related parties and dividends.

SUMMARY OF FINANCIAL STATEMENTS ADJUSTMENTS
- Operating leases: Fitch adjusted debt by adding 8x of yearly operating lease expense (2014: RUB93m).
- Cash: Fitch adjusted available cash at end-2015 by deducting RUB2.1bn for cash held at related-party bank.

FULL LIST OF RATING ACTIONS

OJSC Holding Company United Confectioners
Long-term IDR: affirmed at 'B'; Outlook revised to Stable from Negative
National Long-term rating: upgraded to 'BBB(rus)' from 'BBB-(rus)', Outlook Stable

OOO United Confectioners-Finance
National senior unsecured rating: affirmed at 'B'/'RR4'