OREANDA-NEWS. Fitch Ratings has affirmed Georgian Railway JSC's (GR) Long-term foreign currency Issuer Default Ratings (IDR) at 'BB-' with a Stable Outlook. A full list of rating actions is at the end of this release.

GR's ratings continue to be driven by its standalone creditworthiness, which is higher than that derived from the top-down approach. We assess GR's standalone profile at 'BB-', underpinned by its sound financial profile, strategic and dominant market position, liberal tariff setting policy and importance for the local economy. However, GR's standalone profile is constrained by its small size compared with rated peers and dependence on traffic from other countries with slowing economies.

KEY RATING DRIVERS
Standalone Profile Drives Rating
Fitch assesses the links between GR and Georgia (BB-/Stable), its indirect parent (through JSC Partnership Fund, BB-/Stable) as moderate. Material dividend payments during a high capex period, staff cost increases and our perception of a reduction in government backing for key investment projects, led us to change the rating approach under Fitch's Parent and Subsidiary Rating Linkage criteria in 2013. We apply a top-down one-notch rating approach, reflecting the company's importance to the local economy as the largest taxpayer and employer and its role in Georgia's regional transit corridor. GR's standalone 'BB-' creditworthiness is higher than that derived from the top-down rating approach, which results in a 'BB-' IDR.

GR's standalone credit profile is underpinned by the company's sound financial profile, liberal tariff setting policy and strategic position in the transit corridor in the region. However, the ratings are limited by the company's small size compared with other former Soviet Union railways, and its reliance on the transportation of transit volumes by a single transit route, which heightens event risk.

Volumes Under Pressure
GR's freight transportation volumes and turnover continued to decline in 9M15 by 13.4% and 11.9% yoy, respectively. This was mainly driven by the decrease of crude oil, construction related freight and ores transportation by 47%, 33% and 19.3%, respectively. The company managed to slightly increase more profitable oil products transportation volumes by 4% driven by the increased volumes of heavy black oil from Kazakhstan. We do not expect freight transportation volume and turnover to improve significantly over 2016-2018 on the back of slowing economies in the region. From 2017 freight railway traffic may increase following the commissioning of Baku-Tbilisi-Kars rail link, although the commissioning of this rail link has been already delayed several times.

Lari Depreciation Offset Lower Volumes
In 9M15, GR reported freight transportation revenue of GEL399m, up by 23% yoy. This accounted for over 92% of total revenue, up from 87% in 9M14 and EBITDA of GEL249m, up by about 30% yoy. This was mainly driven by the Georgian lari depreciation by 27% yoy on average as well as 7.8% average revenue per tons-km in US dollars increase. Combined with the fact that the majority of GR's expenses are denominated in local currency, this resulted in the improvement of EBITDA margin to 57% from 51% in 9M14. However, we note that in US dollar terms, GR's freight transportation revenue declined by about 5%.

FX Fluctuations in Debt
GR is subject to FX fluctuations as all of its outstanding debt (GEL1,017m at end-2014) is denominated in US dollars, made up by two unsecured bonds. In July 2015, GR repaid bonds of GEL53m upon maturity, the remaining amount to be repaid in 2022. We expect GR's debt to increase by about GEL277m (using the Fitch expected exchange rate of GEL/USD of 2.4) by end-2015 as a result of lari depreciation. Foreign currency risk is mitigated by its natural hedge as the majority of GR's freight transportation tariffs are denominated in US dollars, and by some foreign cash currency holdings. At end-3Q15, about 45% of total cash and cash equivalents (or GEL130m out of GEL290m) was held in USD and CHF.

Limited Headroom in Credit Metrics
At end-2014 the company reported funds from operations (FFO) adjusted net leverage of 2.3x, down from 4.1x in 2013 and FFO fixed charge coverage of 3.8x, up from 2.3x. We expect GR's FFO adjusted net leverage to deteriorate to around 2.8x and fixed charge coverage to around 3.5x on average over 2015-2018, as a result of the lari depreciation and continued pressure on volumes.

Capex-Driven Negative FCF Expected
Fitch expects GR to continue to generate healthy cash flows from operations of about GEL270m on average over 2015-2018. However, its free cash flow (FCF) may turn negative in 2016 driven by the ambitious capex programme, averaging about USD235m annually (using average 9M15 exchange rate) over 2015-2018. Although GR has some flexibility in capex implementation and could delay some of the projects to moderate credit metrics, there is a risk of assets being left stranded should the Tbilisi Bypass project (GEL354m spent by end-2012) remain unfinished.

Total capex commitments at end-3Q15 were GEL676m (end-3Q14: GEL576m), mainly relating to the mainline connecting Tbilisi to the Black Sea modernisation of GEL450m and Tbilisi Bypass project of GEL220m. The Baku-Tbilisi-Kars project is fully funded by the Azerbaijan government and not executed by GR.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Freight transportation volumes to decline by about 13% in 2015, flat volumes growth in 2016 and low single digit increase thereafter.
- Freight tariffs in local currency equivalent increase following the lari depreciation in 2015 and a single digit increase thereafter.
- Inflation driven cost increase.
- Capex in line with management expectations of USD524m.
-GEL/USD exchange rate of 2.4 at end-2015 and 2.27 average for 2015, 2.37 average and year end for 2016 and 2.35 for 2017 and onwards.

RATING SENSITIVITIES
Positive: We do not anticipate an upgrade as GR's IDR would be above the sovereign's current rating, and cannot be upgraded unless Georgia's sovereign IDR is upgraded. If Georgia's sovereign rating is higher, future developments that could lead to positive rating action include:
- A sustainable improvement in GR's standalone rating to 'BB', including FFO adjusted net leverage to below 2.5x and FFO fixed charge cover greater than 3.5x.
- Stronger links with the government, such as government guarantees for a material portion of GR's debt, which could also result in Fitch aligning GR's rating with the sovereign.

Negative: Future developments that could lead to negative rating action include:
- Negative sovereign rating action.
- A sustained increase of FFO adjusted net leverage above 3x and/or FFO fixed charge cover below 3x that results in a weaker standalone creditworthiness. A downgrade for this reason would be limited to a one-notch differential below the sovereign rating.
- Weakening links with the government, such as privatisation of a majority stake may result in wider notching down from the sovereign rating.

LIQUIDITY
At end-3Q15 GR's gross debt was GEL1,208m, including short-term maturities of GEL20m, which were comfortably covered by cash and cash equivalents of GEL290m together with undrawn credit facilities of GEL43m. Fitch notes that cash and cash equivalents as well as undrawn credit facilities are mostly held by Georgian banks, with non-investment grade ratings. We expect GR's FCF to revert to negative over 2016-2018 following continuation of the suspended Tbilisi bypass project. GR may postpone certain capex projects or delay them where necessary.

FULL LIST OF RATING ACTIONS
Long-term foreign currency IDR affirmed at 'BB-', Outlook Stable
Long-term local currency IDR affirmed at 'BB-'; Outlook Stable
Short-term foreign currency IDR affirmed at 'B'
Short-term local currency IDR affirmed at 'B'
Foreign currency senior unsecured rating affirmed at 'BB-'
Local currency senior unsecured rating affirmed at 'BB-'.