OREANDA-NEWS. Fitch Ratings has affirmed Polish state-owned railway company Polskie Koleje Panstwowe S.A.'s (PKP) Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB' and 'BBB+', respectively, with Stable Outlooks. A full list of rating actions is available at the end of this commentary.

The rating affirmation reflects PKP's strong legal links with the state, including state guarantees for a substantial part of the company's debt. The credit profile is supported by significant deleveraging since 2012 thanks to completed asset disposals in line with management's expectations as well as by sufficient liquidity for debt repayments in 2016 when EUR180m (PLN0.8bn) eurobonds (rated 'BBB') are due.

KEY RATING DRIVERS

Rating Linkage with the State
Fitch assesses PKP's ratings as two notches below Poland's Long-term foreign and local currency IDRs (A-/A/Stable), due to the strong legal links reflected in state guarantees for a large portion of the company's debt and the financial and operational involvement of PKP's sole shareholder, the State Treasury, in the company's operations.

We assess PKP's strategic links with the state as strong albeit decreasing due to the privatisation of several companies from the PKP group. This includes freight business PKP Cargo largely disposed in 2013-2014 (in which PKP still owns a 33% stake but retains operational control), and 100% stake in PKP Energetyka, the electricity distribution network adjacent to the railway network, and TK Telekom, a telecom operator, sold in 2015. In addition, due to the gradual transfer of PKP's stakes in the national railway infrastructure company PKP PLK to the state, PKP ceased to be a majority owner of this company in 2013.

Forecast Decrease of Guaranteed Debt
Historically, most of the company's debt has been guaranteed by the state. Repayment of PLN1.5bn of guaranteed debt in line with schedule in 2014 reduced the share of state-guaranteed debt to 33% of total debt at end-2014 from 64% at end-2013. The next large maturity is EUR180m Eurobonds (PLN0.8bn) due in October 2016. This debt is not guaranteed by the state. After the Eurobonds repayment the share of guaranteed debt will rise to about 50% at end-2016.

The guaranteed debt includes cross-default clauses to other debt, which captures also the unguaranteed debt. As a result, in our view unguaranteed debt benefits from implicit state support as a default on unguaranteed debt could trigger payments under state guarantees.

Possible Change of Rating Approach
Fitch may change the current top-down rating approach to a bottom-up approach in the next three years, depending on PKP's links with the state. We would consider the decreasing share of state-guaranteed debt and PKP's reduced strategic importance to the state following the completed and planned sale of stakes in several large subsidiaries. This may lead to a downgrade.

Progressive Deleveraging
Completed asset disposals in line with plans enabled the company to reduce its debt to PLN1.8bn (EUR0.4bn) at end-2014 from PLN4.1bn at end-2012. The agency assumes further deleveraging, mainly due to large asset disposals completed in 2015 and more moderate disposals planned for 2016-2018. We expect PKP to reach a net cash position in 2017. The company's ability to repay maturing debt without the need for refinancing, mainly due to the proceeds from the sale of stakes in subsidiaries, supports the standalone credit profile.

Improving Standalone Profile
PKP's standalone credit profile has improved since 2011. This is due to the significant reduction of net debt and FFO adjusted net leverage (to 2x in 2015-2016 from 4x in 2014 and above 10x on average in 2012-2013). An improved medium-term liquidity position due to completed asset disposals in 2015 has also contributed to a stronger standalone credit profile. We now view the standalone profile as commensurate with a rating in the upper end of the 'B' category.

Fitch rates PKP on a deconsolidated basis mainly due to the continued disposals of its major subsidiaries, lack of centralised treasury operations as subsidiaries raise external funding for their capex and operations independently and also no cross-default clauses between PKP and its subsidiaries.

Sale Proceeds Sufficient for Repayment
PKP managed to secure funding for debt repayment of PLN0.8bn in 2016 without having to refinance existing facilities. This was made possible by the disposal of two subsidiaries, PKP Energetyka (PLN1.4bn) and TK Telekom (PLN220m) in 2015. PKP expects to repay debt in 2016-2018 with available cash and further sales of subsidiary stakes (though lower disposal amounts are required for debt repayment than in 2014-2016). PKP has no plans for debt refinancing.

Stake disposals as well as development and sales of investment properties are the main source of cash flow for PKP, so any unexpected delays may result in the company having to refinance part of its maturities. This risk has been substantially reduced thanks to the large disposals completed in 2015. If PKP refinances its guaranteed debt with an unguaranteed debt issue we may consider changing our rating approach.

Large Capex
We assume capex of around PLN1.3bn in 2015-2019 to be funded largely from grants. PKP has been successful in funding a large share of its capex with government and EU subsidies. We also expect that PKP will continue to dispose its large pool of properties, which should generate around PLN0.2bn of inflows annually (similar to 2013-2014).

Foreign Currency Risk
PKP's total debt remains largely denominated in foreign currencies (77% at end-2014), mainly EUR and JPY, while PKP's revenue is mainly denominated in PLN. Foreign currency risk is hedged against a substantial portion of interest payments. In addition, part of PKP's foreign currency debt is guaranteed by the state.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Stable lease and properties management business
- Capex of around PLN1.3bn in 2015-2019, funded largely from grants
- Privatisation inflows in 2016-2018 at PLN1bn; continuation of real estate disposals
- Repayment of outstanding debt facilities in line with the schedule and no new debt financing

RATING SENSITIVITIES

Positive: Future developments that could lead to positive rating actions include:
-Rating upside is limited due to the decrease in the share of state-guaranteed debt and lower strategic links. The limited upside is also due to the company's standalone credit profile, which despite improvement is significantly lower than the rating reflecting state support. However, an upgrade of Poland's sovereign ratings could result in positive rating action for PKP depending on our view on the links with the state.

Negative: Future developments that could lead to negative rating actions include:
- A downgrade of Poland's sovereign ratings
- Evidence of weakened state support for PKP, a much smaller share of state-guaranteed debt triggered, for instance, by an unguaranteed debt issue if stake sale proceeds are insufficient to repay maturing debt in 2016-2018.

For the sovereign rating of Poland, PKP's parent, Fitch outlined the following sensitivities in its rating action commentary of 31 July 2015:

The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. Nonetheless, the following risk factors could, individually or collectively, trigger positive rating action:
- Continued reduction in external debt ratios.
- Favourable GDP growth that supports income convergence towards EU and 'A' category medians.
- Greater confidence that a track record of low budget deficits and declining government debt ratios is being established.

The following risk factors could individually or collectively, trigger negative rating action:
- Fiscal loosening that endangers the achievement of a medium-term budget deficit and debt reduction targets.
- Weakening of policy credibility or economic performance, resulting either from external or from domestic shocks, that halts income convergence or endangers the stability of public finances.

LIQUIDITY

PKP's liquidity is adequate. At end-September, short-term debt amounted to PLN583m, which was covered by PLN1.1bn of unrestricted cash. The next three significant debt repayments are scheduled for 2016 (PLN0.8bn), 2017 (PLN0.4bn) and 2018 (PLN0.5bn).

PKP is in a position to fully repay its whole debt (PLN1.8bn) owing to the disposal of its 100% stake in PKP Energetyka in September (net proceeds of PLN1.2bn after obligatory payments to an employee fund). The company has decided to use some of its cash surplus to increase the share capital of passenger transportation company PKP Intercity S.A. (rated BBB/BBB+/Stable) by PLN1bn (earmarked for capex) instead of repaying its debt prior to maturities. As a result, we assume that some further asset disposals, but substantially lower than in 2014-2015, will be needed to repay debt due in 2017-2018 without debt refinancing.

FULL LIST OF RATING ACTIONS

The rating actions are as follows:
Long-term foreign currency IDR: affirmed at 'BBB'; Stable Outlook
Long-term local currency IDR: affirmed at 'BBB+'; Stable Outlook
National Long-term rating: affirmed at 'A+(pol)'; Stable Outlook
Foreign currency senior unsecured rating: affirmed at 'BBB'.