OREANDA-NEWS. Fitch Ratings has downgrades Ukraine-based transport company Lemtrans LLC's (Lemtrans) Long-term local currency Issuer Default Rating (IDR) to 'CCC' and affirmed its Long-term foreign currency IDR at 'CCC'.

The downgrade of Lemtrans' Long-term local currency IDR reflects the company's exposure to Ukraine's protracted political and economic instability and uncertainty, which is likely to adversely affect its credit metrics, refinancing risk and FX risk. Lemtrans' ratings are assessed on a standalone basis.

KEY RATING DRIVERS
Customers' Operations Disruptions
The political and economic environment in Ukraine continues to be unstable with military conflicts in the Donetsk and Lugansk regions, which may result in the disruption of operations in these regions. Although Lemtrans does not have any significant fixed assets in the conflict area, its two major customers have fairly significant assets in these regions, which could undermine the operational and financial stability of Lemtrans. The company estimates transportation volumes in the affected regions were 10%-15% of its total in 2013.

Increased Customer Concentration
Lemtrans' customer base remains highly concentrated in two main clients, DTEK Holdings B.V. (DTEK, rated CCC) and METINVEST B.V. (Metinvest, rated CCC), both part of the same holding company as Lemtrans - System Capital Management Limited (SCM). Together they accounted for 88% of Lemtrans' revenue (adjusted for the pass-through infrastructure component) in 2013, up from 75% in 2012.
High customer concentration is explained by their related status and by the fact that DTEK and Metinvest are two largest industrial companies in Ukraine that transport tens of millions of tons of coal, ore and metal products every year by rail. Non SCM group companies - ArcelorMitall Kriviy Rih and YuGok - each accounted for 5% of adjusted revenue in 2013. Although Lemtrans plans to further expand revenue from non-SCM companies Fitch believes that at least over the medium term, DTEK and Metinvest will continue to dominate Lemtrans' revenues and volumes. It should be noted that Lemtrans receives 100% prepayment from its customers and therefore does not typically face non-payment risk.
3-year Agreement on Strategic Partnership

The increased customer concentration also reflects the signing of three-year agreements on strategic partnership with DTEK and Metinvest in 2013, under which Lemtrans acts as a sole expeditor of the cargo of these companies. In 2013 Lemtrans covered around 70% of DTEK's and 50% of Metinvest's volumes with its own rail fleet and received a small fee for its expediting services for the remaining cargo transportation volumes. The terms of the contract envisage a daily yield that the sender has to pay if the cargo is transported by Lemtrans. This daily yield is paid in UAH, but is linked to the USD/UAH exchange rate.
Weaker Credit Metrics

At end-2013 Lemtrans reported funds from operations (FFO)-adjusted leverage of 4.2x, up from 2.2x at end-2012, and FFO interest coverage of 1.4x, down from 3.8x in 2012. This was mainly due to decreased volumes and, subsequently, weaker EBITDA and a larger cash tax prepayment in 2013, which the company will utilise in the coming year. Fitch expects Lemtrans to continue generating positive cash flow from operations over 2014-2017 but negative free cash flow (FCF) due to its ambitious UAH5.7bn capex programme to modernise and expand its rail fleet. This is likely to keep FFO-adjusted leverage elevated at 4.0x-4.5x over 2014-2017, and FFO interest coverage at around 2x. However, Lemtrans' capex programme is fairly flexible and could be scaled back, if needed. In 1H14 Lemtrans spent UAH373m on capex, which was less than originally expected.

FX Linked Debt
At end-2013 Lemtrans reported debt of UAH2.1bn, including finance lease (98%) and loan (2%) from a related party bank - First Ukrainian International Bank (FUIB). Lemtrans is subject to foreign currency risk as all of its debt is either linked to RUB or USD exchange rates (finance lease) or denominated in USD (bank loan). However, foreign currency risk is partly mitigated by natural hedge as the majority of Lemtrans' tariffs are linked to the USD/UAH exchange rate, and by some foreign currency cash holdings. At end-1H14 53% of the total cash and cash equivalents (or UAH338m) was kept in USD and RUB. However, with leases denominated in foreign currencies a steep, sustained UAH weakening against the USD and RUB could weaken Lemtrans' credit metrics and put its ratings under pressure.

1H14 Volumes Increased
In 1H14, Lemtrans' transportation volume increased dramatically by 64% yoy, but only 5% on 2H13. Revenue from transportation service, as a result, was up 57% yoy and 8% on 2H13. The yoy transportation volume increase was explained by Lemtrans' lower volumes in 1H13, partly due to an oversupply of rail fleet in Ukraine, while a 55% volume increase in 2H13-vs-1H13 was mainly driven by the newly-signed strategic partnership agreements with DTEK and Metinvest. Nevertheless, Fitch believe that 2H14 volumes may considerably suffer due to the ongoing instability in the south-east region of Ukraine.

Coal transportation volume declined 12% in 1H14-vs-2H13, which can be partly attributable to the fact that a large portion of coal comes from the conflict area.

RATING SENSITIVITIES
Negative: Future developments that could lead to negative rating action include:
- Further deterioration of the liquidity position resulting in difficulties for the company to service its debt
- Disruption of the company's or its main customers' operations undermining the company's operational and financial stability or customer's credit profile
- Further significant UAH depreciation resulting in material weakening of Lemtrans' credit metrics

Positive: Future developments that could lead to positive rating action include:
- Improvement of the macro-economic environment and of the company's liquidity position
- Improved customer diversification and cargo mix and stronger credit profile of key customers. However, given Ukraine's dependence on coal mining and steel production these changes are not likely over the medium term.