OREANDA-NEWS. Fitch Ratings has downgraded Far-Eastern Shipping Company Plc's (FESCO) Long-term foreign currency Issuer Default Rating to 'B-' from 'B', and removed it from Rating Watch Negative (RWN). The Outlook is Negative. A full list of ratings actions is at the end of this commentary.

The downgrade reflects our expectation that the company is unlikely to reduce its funds from operations (FFO) adjusted net leverage to below 5x by the end of 2015 as a result of weaker rouble and continued underperformance of its rail division, even if the ongoing Eurobond buyback tender is successfully realised in full, in accordance with the company's plans.

The Negative Outlook incorporates the uncertainty around the operating environment and the company's exposure to the shrinking Russian economy and high volatility of the rouble to US dollar exchange rate.

KEY RATING DRIVERS
Bond Buybacks Not a Distressed Debt Exchange
Fitch does not consider the Eurobond and rouble bond buybacks that FESCO announced on 31 March 2015 as a Distressed Debt Exchange (DDE) under the agency's DDE criteria (dated 30 June 2014 at www.fitchratings.com), as the tender acceptance is not conditional on a minimum aggregate amount being tendered and is not combined with the amendment of restrictive covenants. We also believe that the offer was not made in order to avoid bankruptcy, similar insolvency or intervention proceedings or a traditional payment default as the bonds mature in 2018 and 2020 and do not cause an imminent liquidity squeeze. The bondholders are not obliged to participate in the offer as it is voluntary.

FESCO initially announced it would spend USD85m on a Eurobond buyback for both issues with the possibility of modifying the maximum payment amount. On 20 April 2014, the company announced an increase in the amount it would spend on the Eurobonds buyback to USD130m. FESCO proposed to bondholders a discount of 49%-65% on the bonds' nominal value depending on the application submission date and the particular Eurobond.

FESCO expects to fund the Eurobonds buyback with external funds which are mostly local currency denominated. If fully realised, the tender could improve FESCO's net debt-based credit metrics and its FX risk exposure, although interest coverage ratios may weaken as the cost of new debt is likely to be higher than the coupons on Eurobonds.

FESCO has also offered to buyback rouble bonds as well for the nominal value of RUB4bn (80% of outstanding rouble bonds) with a 20% discount. The application period for local bonds has closed and FESCO received applications for RUB2.992bn bonds with a nominal value of RUB1,000 each at a fixed price of 80% of the nominal value. FESCO spent RUB2.5bn on buying back rouble bonds covering the discounted bonds value (RUB2.4bn) and accrued interest expense. The rouble bonds buyback was funded with own funds.

FX Risks Are Still High
FESCO remains exposed to foreign currency fluctuations as about 86% of its total debt at end-2014 was denominated in US dollars. In contrast, only around 47% of revenues are dollar-linked or dollar-denominated. The company is improving the natural hedge of its earnings through renegotiation of contracts in the port division, converting certain port tariffs to US dollars from roubles. In addition, FESCO has made an offer to buy back a portion of its US dollar-denominated Eurobonds due in 2018 and 2020. The company expects the buyback to be funded mostly by rouble-denominated external funds. If successful, this should result in narrowing the currency mismatch between FESCO's debt and revenue.

Low Capex, Positive FCF Expected
We expect FESCO to revise its investment plans down to a maintenance level of around USD22m annually on average over 2015-2018. Together with its policy of zero dividend payments as long as the fixed charge coverage ratio is below 2.0x and consolidated total leverage ratio is above 3.25x, this may allow management to keep FCF positive over 2015-2018.

Continued Rail Division Underperformance
In 2014, FESCO's rail division reported revenue of USD165m and EBITDA of USD45m, a 34% and 50% year-over-year (yoy) decline respectively, driven by the decline of gondola rates, single-digit decline in rail cargo load as well as rouble devaluation. Freight rail volumes and prices continued to decline in 2014 driven by the slowdown of the Russian economy. In the medium term, we expect freight volumes to decline following a GDP contraction, which we currently forecast at 4.5% in 2015 and at 1% in 2016. We do not expect gondola rates to increase as falling demand for the transportation of commodities intensifies the competition between freight rail operators.

Port Division Is Key
FESCO's port business continues to remain the key contributor to the company's earnings responsible for about 46% of group's 2014 EBITDA given its higher margins. Intensified international trade between Russia and Asian countries benefit FESCO's volumes in the port segment. Total container and non-container volumes demonstrated strong growth of around 7.7% and 16.7%, respectively, while the revenue and EBITDA of this division declined by 7.4% and 1.3% yoy in 2014. This was mostly due to rouble depreciation as in rouble terms revenue and EBITDA increased by 11.1% and 26.8%, respectively. We expect the port division to continue to outperform the company's rail division due to the high margin container business, implementation of a cost-optimisation programme and tariff dollarisation, which the company implemented at end October 2014.

Buyback Driven Deleveraging Expected
From 2014, Fitch has incorporated a repo loan in its leverage and coverage metrics calculations as margin calls payment last year were partially funded by cash from within the restricted group, although the loan of EUR73m at end-2014 with a pledge over FESCO's 24.1% stake in TransContainer (BB+/Stable) is outside the restricted group and ring-fenced. We expect FESCO's outstanding loans and borrowings to decrease by up to 24% yoy at end-2015 (assuming current exchange rates are unchanged by end-2015) mainly as a result of the expected buyback process, if fully realised. This would improve the company's FFO adjusted leverage metrics. However, Fitch does not anticipate FESCO to reduce its FFO net adjusted leverage to below 5.0x by end-2015, primarily as a result of weak performance of the rail division and rouble depreciation.

Manageable Liquidity
We assess FESCO's liquidity position as manageable. At end-2014, FESCO had cash and cash equivalents of USD66m compared to short-term debt of USD48m including a repo loan. Also the company had unused local currency credit facilities.

FESCO's debt repayment profile is spread with the remaining RUB2bn local bonds to be repaid over 2016-2017 in four half-year instalments and Eurobonds of USD550m and USD325m due in 2018 and 2020, respectively. Financial covenants (i.e. fixed charge coverage ratio at 2.0x or higher and consolidated total leverage ratio of less than 3.25x) in the Eurobonds documentation limit the ability to incur additional debt over certain limits but their breach does not constitute an event of default as they are not maintenance covenants.

RATING SENSITIVITIES
Positive: Future developments that could lead to a revision of the Outlook to Stable include:
- A sustained decrease in FFO lease-adjusted net leverage below 5.5x and FFO fixed charge coverage above 1.5x on a sustained basis.

Negative: Future developments that could lead to a downgrade include:
- Sustained slowdown of the Russian economy, rouble depreciation or weaker than expected operational performance, leading to projected FFO lease-adjusted net leverage above 5.5x and FFO fixed charge cover below 1.5x on a sustained basis.
-Weaker liquidity position.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Russian GDP of -4.5%-0% over 2015-2017; Chinese GDP of 6.5%-6.8% over 2015-2017
- Russian CPI 7.3-15% over 2015-2017
- No dividends payments
- Capex of around USD20-23m over 2015-2017
- USD/RUB exchange rate of 50-60 over 2015-2017

FULL LIST OF RATINGS
Far-Eastern Shipping Company Plc
- Long-term foreign currency IDR downgraded to 'B-' from 'B'; removed from RWN, Outlook Negative
- Long-term local currency IDR downgraded to 'B-' from 'B'; removed from RWN, Outlook Negative
- National Long-term rating downgraded to 'BB-(rus)' from 'BBB+(rus)'; removed from RWN, Outlook Negative
- Local currency senior unsecured rating downgraded to 'B-' from 'B'; removed from RWN, Recovery Rating 'RR4'

Far East Capital Limited S.A. (Luxembourg)
- Foreign currency senior unsecured rating downgraded to 'B-' from 'B'; removed from RWN, Recovery Rating 'RR4'.