OREANDA-NEWS. Fitch Ratings has assigned Deutsche Post AG's (DP) proposed senior unsecured notes an expected rating of 'BBB+(EXP)'. The size of the issuance is expected to be EUR1.25bn in the form of a EUR750m bond due 2021 and a EUR500m bond due 2026. The rating is aligned with DP's Issuer Default Rating of 'BBB+'/Stable.

The notes are part of DP's EUR8bn notes issuance programme. The proceeds of the notes will be used to fund the pension deficit at DP. The assignment of the final rating is contingent on the receipt of final documents conforming to information already received.

DP's rating is not affected by the additional debt issuance and slightly weaker than expected FY15 results announced on 9 March 2016. The weakness was driven by underperformance at Post - eCommerce - Parcel (PeP) and Global Forwarding, Freight (GFF) divisions. Proceeds from the multi-tranche bonds issue will be used to fund DP's German pension obligations. The projected debt service of the new debt will be offset by lower ongoing contributions to the scheme.

Given its approach to unfunded pension schemes, such as that of DP, Fitch views this transaction (an increase of lease adjusted net debt by EUR1.25bn) as marginally credit negative as the Fitch-expected funds from operations (FFO) lease adjusted net leverage is set to increase to around 3.2x on average for 2016-2018 from our pre-transaction expectation of 3.0x. However, the rating impact is neutral because leverage is expected to remain within the guideline for the 'BBB+' rating at 3.5x. Fitch estimates that FFO fixed charge coverage will remain unchanged.

For unfunded pension schemes like many in Germany, Fitch's pension-adjusted leverage methodology recognises only a portion of the funded status, equal to a ratio of balance sheet debt to total assets (adjusted for funding status), assuming that the pension cash flow drain is less immediate. The transaction will improve DP's funding status, but increase pension-adjusted debt. However, the pension-adjusted leverage ratio will increase by less than the lease adjusted leverage used as the rating guideline (see 'Treatment of Corporate Pensions - EMEA and Asia-Pacific' dated 5 August 2011 at www.fitchratings.com).

KEY RATING DRIVERS
2015 Results Weaker
FY15 EBIT at PeP was impacted by a strike during 2Q15 and at GFF by weakness in the operating environment and the one-off impact from the New Forwarding Environment (NFE) investment write-down. The decline in FFO resulted in FFO adjusted net leverage at the end of FY15 increasing to 2.9x from 2.7x at the end of 2014. This is comfortably within Fitch's current negative rating guideline of 3.5x for FFO adjusted net leverage.

Balanced Risk Profile
The ratings reflect DP's balanced business risk profile, supported by the stable contribution of its core mail products despite structural volume declines, its strong position in global time-definite express services (DHL) and growth in internet-led domestic parcel volumes. This is offset by the more cyclical and competitive nature of express services, GFF and supply chain operations.

DHL Volumes More Volatile
DP, through its subsidiary DHL, has a dominant position in time-definite deliveries, underpinned by an extensive and strongly branded global logistics network. A broad range of contracts with major industrial, retail and government clients underpins volumes in both the Express division and supply chain operations. DHL volumes are highly correlated to GDP dynamics, and often at a multiple of GDP movement, which can result in sharp downturns in volume. Intra-modal transport competition (air to ocean) can exacerbate volatility. For 2015, DP's parcels and international express volumes and revenues grew by over 8% yoy.

Supply Chain Improvements
GFF and supply chain performance are directly correlated to general global trade volumes, although we expect supply chain operations to remain more vulnerable to changes in manufacturing output.

Fitch expects volume drivers to remain the same in 2016, although a slowdown in international growth could lead to flat or falling revenues. Fitch expects high renewal rates and new supply chain contracts to result in cash flow growth. More stable euro exchange rates may result in more predictable, albeit still low, margins.

Parcels Offset Declining Mail
Traditional mail volumes and revenues are declining due to higher email usage, despite a rise in regulated mail prices. These are offset by a rising contribution from domestic parcels, albeit with lower profit margins. Volume falls are lower for DP than its peers due to lower initial penetration of mail services in Germany. E-commerce revenue growth of 23.5% for 2015, driven by parcel growth due to the growth in online shopping, is in line with DP's expectations. Overcapacity in some markets remains a threat to both volumes and margins, albeit offset by DP's global network.

Stabilising Financial Profile
Fitch expects DP's financial profile to be broadly stable in 2016, reflecting a conservative funding strategy and expected margin improvement. Fitch forecasts free cash flow (FCF) to be moderately negative after assumed average capex of EUR2.4bn per year until 2018 and a 50% dividend pay-out. Fitch estimates FFO lease adjusted net leverage for 2016 to be 3.2x, up from 2.9x at end-2015, reflecting our forecast of growth in FFO for the full year offset by increase in debt due to the proposed EUR1.25bn notes issuance. We expect fixed charge coverage, including non-cancellable operating leases averaging EUR2.0bn per year, to stay close to 2.3x for 2016.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for DP include:
- Continued decline in mail volumes partially offset by growth at the parcels business
- Gradually improving profitability driven by growth in the Express division
- Liquidity to remain adequate due to an undrawn EUR2bn facility, moderately negative FCF and limited debt repayments
- Dividend payments in line with the company's policy of 40%-60% payout ratio
- Blended operating lease adjustment multiple of 5.5x, reflecting the large proportion of payments relating to office, IT, vehicles and building leases co-terminating with contracts.
- EUR1.25bn new bond issue proceeds will be used to fund German pension obligations.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- FFO lease adjusted net leverage below 2.5x and FFO fixed charge coverage above 3.5x on a sustained basis; an improving macro-economic outlook supporting performances of DHL's divisions; and continued increase in cash flow contribution from the domestic parcel business to compensate declining traditional mail profits supporting FCF generation.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO lease adjusted net leverage above 3.5x on a sustained basis and weakening of FFO fixed charges coverage; significant deterioration in business fundamentals due to a protracted economic downturn or structural changes leading to significant volume and margins reduction in the DHL divisions and consistently negative FCF.

LIQUIDITY
Liquidity at DP is adequate. At 31 December 2015, DP had a combination of strong cash balance, an undrawn credit facility and moderately negative FCF generation expected for 2016. On balance sheet cash at end-December 2015 was EUR3,608m (of which around EUR1bn was considered as restricted by Fitch), up from EUR2,978m at end-2014. DP maintains a committed undrawn EUR2bn credit facility maturing in 2020.