OREANDA-NEWS. Fitch Ratings has revised the Outlook on OJSC LSR Group's (LSR) Long-term foreign currency Issuer Default Rating (IDR) to Stable from Negative and affirmed the IDR at 'B'. Fitch has simultaneously affirmed the senior unsecured rating of the outstanding bond issues at 'B'. A full list of rating actions is at the end of this commentary.

The revision of the Outlook reflects the company's solid recent performance and the on-going stable operational dynamics. Although the Russian macroeconomic environment is still challenging, it seems to have stabilised, as the Central Bank's refinancing rate has decreased to 11% from 17% in December 2014 and real estate prices have remained stable.

LSR's ratings incorporate its high geographical concentration in north-western Russia, inherent industry cyclicality and capital intensity, high execution risk should the company develop too many projects at the same time, lack of medium-term certainty over the projects development, and higher than average risks associated with the Russian business and jurisdictional environment. This is partly mitigated by LSR's relatively low leverage (funds from operations (FFO) adjusted leverage of 1.4x expected for FY15).

KEY RATING DRIVERS
Weak Market Conditions Expected
Fitch expects the Russian real estate market to enter negative growth in 2016 on lower disposable income and revised real GDP dynamics, taking into account the sector's particularly high sensitivity to the interest rate and macroeconomic environment. We expect a high single-digit sales volume and price decline as well as large working capital outflow due to reduced prepayments from customers, which will result in free cash flow (FCF) turning negative in 2015-2017.

These risks are somewhat mitigated by LSR's positioning in the key market in Russia as well as the ability to cut dividend outflows, providing more comfort compared with the 2008/09 crisis given its moderate debt level and minimal capex requirements. However, the extent of possible medium-term negative market pressure remains highly uncertain at present.

Reasonable 2015 Results
Despite the worsening economic environment, LSR continues to perform according to our expectations in 2015. However, we expect a decrease in both prices and volumes if the economic situation does not improve.

Top-Five Developer in Russia
LSR retains its position as one of the top-five real estate developers in the highly fragmented Russian residential construction market. The company is the leading elite real estate player and is also one of the leading mass market real estate players in St. Petersburg and Moscow. LSR is also the leading building materials producer in north-western Russia.

Limited Geographical Diversification
LSR generates over 70% of revenues in its domestic market of St. Petersburg and the surrounding Leningrad region. LSR's acquisition of the ZiL and Luchi projects with 2.5 million sq. m. of gross buildable area in Moscow in mid-2014 was another positive step in LSR's strategy to diversify towards Moscow region. At end-2014, Moscow region accounted for 24% of net sellable area and 37% of the company's real estate market value, an increase from 13% and 21% at end-2013, respectively. We believe that these projects will significantly reduce LSR's high regional concentration over the medium term.

Large Land Bank
Over the past years, LSR has increased its land bank from around 8 million sq. m to 10 million sq. m. with the purchase of the Moscow projects, although most of the land bank is concentrated in north-western Russia (around 70% of total). The land bank is sufficient to cover over 10 years of construction at the current levels. However, it poses high execution risk should the company enter into too many projects at the same time. LSR is currently in the process of construction of the first phase of the ZILART project, which is due to be completed in 2017, with the other phases of the project to be implemented later.

Integrated Business Model
LSR is vertically integrated into building materials, which contribute 24% and 25% to sales and EBITDA in 2014, a decrease from 36% and 37% contribution a year earlier. Vertical integration supports the ratings due to the issuer's better input cost control and its exposure to the less volatile infrastructure construction segment, which in turn is supported by the government. We expect the share of building materials to decrease further, as the company is currently planning to sell its ready-mix concrete business.

Operating Environment Discount
Fitch applies a one-notch discount for the company's exposure to the Russian operating environment from the standalone rating level of the company of 'B+'.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- 20%-25% cut of prepayments received by the company in 2016-2017 from the normal rate
- High single-digit drop in prices
- Single-digit drop of volumes in building materials and real estate, high single-digit drop in construction and bricks
- Average annual capex of RUB1.2bn in 2015-2018
- Average cost of new borrowings of 15%
- Increase of the dividend payments

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating action include:
- Improved visibility on the medium-term direction of the Russian real estate market.
- Sustainable improvement in the financial metrics leading to EBIT margin above 15%.
- FFO adjusted gross leverage sustainably below 3x.
- Positive FCF generation on a sustained basis.

Negative: Future developments that could lead to negative rating action include:
- Market deterioration leading to EBIT margin below 10% and/or worsened liquidity.
- Leveraging with FFO adjusted gross leverage sustainably above 4x

LIQUIDITY
The company continues to reduce its debt burden, which decreased to RUB30bn at end-2014 from RUB35bn at 1H14 . LSR has also repaid most of its outstanding local bonds early. Overall, the liquidity position is adequate in our view, with short-term debt standing at RUB8.6bn at end-2014, while the company's cash position stood at RUB25bn. Coupled with the available undrawn credit facilities major Russian banks, this should be sufficient to cover immediate liquidity risks. The company is not exposed to FX risk, as all of the debt is raised in roubles.

FULL LIST OF RATING ACTIONS
-Long-term foreign currency IDR affirmed at 'B'; Outlook revised to Stable from Negative
-Local currency senior unsecured rating affirmed at 'B' for the RUB3.0bn (series 03), RUB2.8bn (series 04) and RUB3bn (BO-04 series) bond issues, Recovery Rating 'RR4'.