OREANDA-NEWS. Fitch Ratings has affirmed Public Joint Stock Company Aeroflot - Russian Airlines' (Aeroflot) Long-term foreign currency Issuer Default Rating (IDR) at 'B+' and removed it from Rating Watch Negative (RWN). The Outlook is Stable. A full list of rating actions is available at the end of this commentary.

The rating affirmation and removal of RWN reflect the improvement of Aeroflot's credit metrics in 2015, which we expect to be sustained over 2016-2019. The rating action also reflects our forecast of positive free cash flow (FCF) generation over 2016-2019 and Aeroflot's limited involvement in Transaero as opposed to the previously planned but subsequently cancelled acquisition. The Stable Outlook incorporates the balance of risks between financial and Russian air travel market pressures and the company's fairly strong business profile and adaptability to challenging market conditions.

Aeroflot's business profile is supported by the company's fairly diversified route network, favourable hub position, competitive cost structure and its strong market position on the domestic market.

The 'B+' rating incorporates a single-notch uplift for state support.

KEY RATING DRIVERS
Financials Drive RWN Removal
Aeroflot demonstrated significant improvement in its financial performance in 2015, supported by lower oil prices, a rise in passenger traffic, especially on domestic routes, a material increase in yields in rouble terms and a reorganisation of the charter business.

Funds from operations (FFO) adjusted gross leverage dropped to 5.7x in 2015 from 7.5x in 2014 and FFO fixed change cover increased to 2x in 2015 from 1.8x in 2014. We expect the positive momentum to continue over 2016-2019, due to expected low oil prices, heathy growth in passenger traffic on the new routes obtained from Transaero and yield recovery, albeit at a more measured pace than in 2015.

We forecast FFO adjusted gross leverage to slightly exceed 6x in 2016-2017 before falling below this level by 2018, remaining within Fitch's negative rating guideline, and FFO adjusted net leverage of around 5.5x on average over 2016-2019. We expect FFO fixed charge cover to remain above 1.5x over 2016-2019. We forecast FCF to remain positive over 2016-2019.

Limited Involvement in Transaero
Following the cancellation of Aeroflot's acquisition of Transaero at end-2015, we assess the financial impact of Aeroflot's involvement in Transaero's operations in 2015 to be manageable and expect it to be largely neutral in the short-to medium-term. Aeroflot spent RUB17bn over September-December 2015 for transportation of Transaero's passengers both on its own and Transaero's flights.

After Transaero's bankruptcy at end-2015, Aeroflot obtained slots for 56 routes out of 141 international routes previously serviced by Transaero, including new routes to European and Asian markets and Kazakhstan. This should strengthen Aeroflot's market position on international destinations. Its market share increased to 37% in 2015 from 31% in 2014. As Transaero's slots will require additional aircraft capacity and workforce, Aeroflot plans to take up to 34 aircraft from Transaero, comprising 15 new planes from the order book and 19 planes previously operated by Transaero. In addition, Aeroflot considers employing around 6,000 of Transaero's employees. The routes from Transaero will be operated by both Aeroflot and its subsidiary JSC Rossiya Airlines and most of the staff will be employed by Rossiya Airlines.

Yields Remain under Pressure
As we expected, yields in dollar terms fell 25% yoy in 2015, reflecting the full effect of the rouble depreciation. The largest decline was on the domestic and European destinations while Asian and Middle Eastern routes fared better. We expect the yields in dollar terms to remain under pressure in 2016-2017 due to a weak Russian economy, falling fuel surcharge due to low oil prices, an increasing share of domestic traffic and expected further rouble depreciation in 2016. We forecast a gradual recovery from 2018.

High FX Exposure
Almost all of Aeroflot's debt (90% at end-2015) is denominated in USD, as a large portion of its debt (71% at end-2015) represents finance leases for aircraft purchases. In contrast only 38.5% of its revenue in 2015 was earned in USD or EUR. While an additional 32% of revenue was linked to EUR, ticket prices were set in RUB and their increase remained significantly short of mitigating the impact of the rouble deprecation. In addition, over 50% of operating costs are denominated in USD or EUR, further contributing to the currency mismatch and, consequently, weaker financials.

Strong Passenger Traffic Growth
We expect Aeroflot to deliver a healthy revenue-passenger-kilometres (RPK) growth over 2016-2019 supported by the new slots obtained from Transaero and organic capacity expansion. As a result, we forecast growth across all destinations, especially on the domestic, Asian and European routes. RPK increased 8.4% yoy in 2015. Although Aeroflot's international RPK fell 3.9% yoy, it was much lower than the 17% decline for the Russian market (based on passenger numbers). Growth on domestic routes was strong with an RPK increase of 27.8% yoy.

Diversified Network and Well-Developed Hub
Aeroflot's business profile is commensurate with the 'BB' rating category, due to a fairly diversified route network, high frequency of international flights, a favourable hub position and the company's position as Russia's largest airline and flagship carrier and a medium-sized airline among European peers.

The implementation of a multi-brand strategy within Aeroflot Group in co-operation with regional subsidiaries provides the group with greater operational flexibility without diluting Aeroflot's brand and enables the group to target multiple customer and geographic segments, adapt more quickly to customer demands and utilise feeder traffic from regional airline subsidiaries.

Rating Uplift for State Support
Aeroflot's rating of 'B+' continues to incorporate a single-notch uplift to its standalone 'B' rating for state support. Fitch considers the strategic, operational and, to a lesser extent, legal ties between Aeroflot and its parent, the Russian Federation (51.2% direct ownership and 8.4% indirect ownership) as fairly strong under the agency's parent and subsidiary rating linkage methodology.

There are no formal legal ties, such as guarantees or cross default provisions, but Aeroflot remains on the list of Russia's strategic enterprises. Its operational and financial strategies are overseen by the government and it is viewed as a means of promoting and developing Russia's aviation market. To date, there has been little evidence of tangible financial support, except for royalties.

A reduction of the state's stake to below 50% coupled with evidence of diminishing state support, may lead to the withdrawal of the one-notch uplift for state support. Although the government has resumed discussions of Aeroflot's privatisation, this is unlikely to lead to state ownership falling below 50% in the short term due to a change-of-control clause in the company's debt documentation.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Russian GDP decline of 2.5% in 2016 and growth of 1.2% in 2017
- Capex in line with the company's forecast
- RPK growth of 9% CAGR over 2015-2019
- Decline of yields in dollar terms in 2016-2017 and a slow recovery from 2018

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-Evidence of stronger state support.
-Improvement of the financial profile (eg FFO adjusted gross leverage below 5.0x and FFO fixed charge cover above 1.5x on a sustained basis) due to yield recovery, successful integration of the received slots, personnel and fleet assets, moderation of investments in the fleet and/or a drop in fuel prices.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-Further material deterioration of the credit metrics (eg FFO adjusted gross leverage well above 6.0x and FFO fixed charge cover below 1.25x on a sustained basis) due to further rouble depreciation, a protracted downturn in the Russian economy, drop in yields or overly ambitious fleet expansion.
-Weakening of state support.

LIQUIDITY AND DEBT STRUCTURE
Adequate Liquidity
We view Aeroflot's liquidity as adequate. Its cash of RUB36.6bn and available credit lines of RUB37bn were sufficient to cover short-term debt obligations of RUB73.6bn at end-2015. The company's debt repayment schedule is generally well-balanced, except for a spike in 2016. The company has RUB5bn domestic bonds falling due in 2016. We expect Aeroflot to generate positive FCF over 2016-2019 despite sizeable capex (including finance leases). Eighteen per cent of Aeroflot's cash position at end-2015 was held in USD and EUR and most of the cash was held at Sberbank (BBB-/Negative).

Senior Unsecured Rating
Although the company's prior-ranking debt is above Fitch's threshold of 2x-2.5x of EBITDA, our recovery analysis resulting in a Recovery Rating of 'RR4' supports the senior unsecured rating at the same level as Long-term IDR.

FULL LIST OF RATING ACTIONS
Long-term foreign and local currency IDR: affirmed at 'B+', off RWN; Outlook Stable
National Long-term rating: affirmed at 'A-(rus)', off RWN; Outlook Stable
Short-term foreign and local currency IDR: affirmed at 'B'
National Short-term rating: affirmed at 'F2(rus)', off RWN
Foreign and local currency senior unsecured ratings: affirmed at 'B+/RR4', off RWN
National senior unsecured rating: affirmed at 'A-(rus)', off RWN