OREANDA-NEWS. Fitch Ratings has affirmed PKP Intercity S.A.'s (PKP IC) Long-term foreign currency Issuer Default Rating (IDR) at 'BBB', Long-term local currency IDR at 'BBB+' and National Long-term rating at 'A+(pol)'. The Outlook on the ratings is Stable.

The affirmation of the ratings reflects the continued strong links of PKP IC with the Polish state, evidenced in particular by state guarantees on a majority of its debt and its distinct position in the government's railway policy. PKP IC's ratings are notched down by two notches from the Polish state's Long-term foreign and local currency IDRs (A-/A/Stable).

KEY RATING DRIVERS
Strong Links with the State
Fitch rates PKP IC using a top down approach from the sovereign rating in accordance with the agency's Parent and Subsidiary Rating Linkage criteria. This is due to the strong links with the Polish state on the back of its state-guaranteed debt, full direct and indirect ownership by the government, the government's railway policy and PKP IC's public service contracts (PSCs) with the Ministry of Infrastructure and Construction for unprofitable train connections. The company's ratings are currently two notches below the country's Long-term foreign- and local-currency IDRs.

Increased Share of State-guaranteed Debt
PKP IC's capex has been largely funded by investment loans from European Investment Bank (EIB, AAA/Stable), which are guaranteed by the Polish state. At end-2015 the share of state-guaranteed debt in PKP IC's total debt increased to 61%, from 36% at end-2012. The company does not plan to undertake further loans from EIB following the execution of its largest investment projects (in particular ETR 610 high speed trains, and largely inter-regional trains EZT).

However, as the planned repayments of non-guaranteed debt in the next several years are larger than the repayments of guaranteed debt, we expect the share of state-guaranteed debt to moderately rise to about 70% by 2018.

State Ownership and Influence
The state owns a 40.85% stake in PKP IC with the remaining stake owned by fully state-owned Polskie Koleje Panstwowe (PKP, BBB/Stable). The government has significant influence over PKP IC's operations, for example, in devising its long-term strategy for the railway sector and approving the company's capex and funding plans.

PKP IC's large capex plan is supported by the government within a broader plan of modernising the Polish railway sector, using a combination of available EU funds, external funding and its own resources. A capital increase of PLN1bn by PKP in October 2015 funded mostly from the privatisation of two of its subsidiaries during 2015 will be used for the development capex of PKP IC.

Improving Standalone Rating
Fitch considers PKP IC's standalone financial profile as commensurate with ratings in the 'B' category. The standalone rating Outlook is Positive due to the completion of a major part of the company's ambitious capex plan, in turn reducing operational and investment risk, and a PLN1bn equity injection, among others. The company has also reversed the downward trend in the number of passengers and EBITDA, with the commencement of the new ETR 610 high speed trains, much shorter travel time on key routes and higher subsidies under PSCs.

We project that in line with growing EBITDA due to the rising number of passengers and average revenue per passenger PKP IC's funds from operations (FFO) adjusted net leverage will decline to about 5x in 2018-2019, from about 10x in 2014.

Public Service Contracts
PKP IC generates two thirds of its passenger transport volumes from PSCs signed with the Ministry of Infrastructure and Construction. The government pays compensation for unprofitable inter-regional and international trains operations within these PSCs. Government compensation under PSCs increased to PLN461m in 2014 (after inclusion of debt in the compensation formula) and to close to PLN500m or 24% of total revenue in 2015.

Over the next three years, when the new inter-regional trains (EZT) become fully operational, management expects compensation from PSCs in the range of PLN500m-PLN600m.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Share of state-guaranteed to total debt at 60%-70%
- Capex at around PLN4bn in 2015-2019, co-funded with EU grants
- Further recovery in the number of passengers and EBITDA

RATING SENSITIVITIES
Future developments that could lead to positive rating action include:
- An upgrade of Poland's sovereign rating.
- Evidence of stronger state support.

Future developments that could lead to negative rating action include:
- A downgrade of Poland's sovereign rating.
- A substantial increase in the share of PKP IC's non-guaranteed debt.
- Evidence of reduced state support.
- Failure to receive planned EU funds for large capex projects, unless the company decides to cancel any of them.

For the sovereign rating of Poland, PKP IC's ultimate parent, Fitch outlined the following sensitivities in its rating action commentary on 15 January 2016:

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 negative rating action:
- Relaxation of the fiscal stance that worsens the government debt trajectory.
- Weakening of policy credibility or economic performance, for example due to deterioration in the business environment.

The following risk factors could individually or collectively, trigger positive rating action:
- Greater confidence that a track record of low budget deficits and declining government debt ratios is being established.
- Continued reduction in external debt ratios.
- Favourable GDP growth that supports income convergence towards EU and 'A' category medians.

LIQUIDITY
At end-2015 PKP IC had PLN581m of unrestricted cash and committed unused short-term liquidity lines of PLN225m against short-term debt of PLN146m, which comprises mostly medium-term bonds purchased by banks and working capital loans. Fitch assumes that short-term lines will be renewed in 2016 (similar to previous years). The company's long-term debt maturity profile (EIB loans) is well spread over the next 20 years.