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May 7 (The following statement was released by the rating agency)
Fitch Ratings has assigned Far-East Capital Limited S.A.'s USD500m 8% notes due 2018 and USD300m 8.75% notes due 2020 a final senior unsecured rating of 'B+' with a Recovery Rating of 'RR4'. The notes are guaranteed by the majority of the operating subsidiaries of the Far-East Shipping Company PLC (FESCO or the company; 'B+'/Stable). A list of FESCO's ratings is at the end of this release.
The USD500m 8% senior secured notes due 2018 and the USD300m 8.75% notes due 2020, have been assigned a senior unsecured rating in line with FESCO's Long-term foreign currency Issuer Default Rating (IDR) despite security provided as part of the terms of the note agreements. This is due to the agency's assessment of possible limitations realising collateral granted for the benefit of the noteholders. Fitch's view of recovery upon default is reflected in the 'RR4' Recovery Rating.
FESCO's ratings reflect its position as one of the leading transportation and logistics companies in Russia with a growing focus on its port operations in the Russian Far East and niche market positions in rail. However, despite some diversification, FESCO is likely to remain subject to volume and pricing volatility, and in a sector of increased market consolidation, its rail business potentially faces greater competition from its larger rail transportation peers.
Despite forecast improvement, credit metrics are also considered weak with FFO net adjusted leverage expected to be in excess of 3.0x and FFO fixed charge cover of around 2.5x in the short term.
KEY RATING DRIVERS
- Port Key to Business Profile
In March 2012, FESCO obtained full operational control over the Commercial Port of Vladivostok, one of the largest ports in the Russian Far East, albeit small relative to global peers. Combined with the disposal of a large proportion of the company's loss-making shipping business in December 2012, this favourably increases the company's exposure to higher-growth, higher-margined businesses. Whilst not immune to cyclicality, the port benefits from around 50% of origin and destination volumes, which tend to be less subject to competition given the proximity to the point of consumption and distribution. Growth and margins in the port division should further benefit from increased integration between various stevedoring companies and terminals within the Commercial Port of Vladivostok. Until now these have operated as separate legal entities, often competing with each other.
- Vladivostok a Gateway to Asia
Vladivostok port is geographically key in the importing of consumer goods and exporting of commodities between Russia and Asia with a population of approximately 400 million within a 1,000km radius. FESCO's market shares in the Russian Far East region included 35% of all container handling and 15% of all bulk cargos. Whilst the port is not dominant relative to other ports in the Far East Basin, the Port of Vladivostok serves a large proportion of regional domestic markets, given its more developed rail networks, convenient access to the Trans-Siberian Railway and regularly-scheduled cabotage lines.
- Intermodal and Niche Rail Operations
FESCO is one of the few Russian transportation companies to have a full presence across the entire logistics chain, a key differentiator to peers. Whilst peers are also intensifying their focus in this respect, they tend to lack a presence in either port or shipping operations, which puts them at a competitive disadvantage. FESCO is one of the top 10 private railcar operators in Russia by number of railcars, with a market share of more than 40% in the Yakutia region, an area accounting for approximately 50% of Russia's total coal reserves. In addition, FESCO operates one of the largest fleet in the Ukraine.
- GDP to Drive Growth
FESCO's growth is expected to be driven by continued moderate to high GDP growth rates in both Russia and Asia, as well as the continuing trend towards further containerisation of cargo flows. Railroads are also expected to remain the main method of cargo transportation. Fitch forecasts that Russia and China's GDP should continue to grow at around 3.2% and 8.0%, respectively in FY13, and these levels should ensure relatively strong demand for Russian commodities and exports in the near term as well as the imports of consumer and industrial goods to the Russian Far East. The growth of rail freight turnover has on average tended to be around 1% below that of real GDP since 2002, whilst the Russian container market has witnessed growth of around 3x GDP since the 2009 crisis due to Russia's relatively low containerisation levels.
- Cyclicality Remains a Risk
Whilst GDP growth is forecast to continue in the medium term, the volatility of FESCO's earnings remains a key risk. Towards the end of 2012, growth in Russian container volumes slowed. Rail tariffs are also expected to be weaker relative to the higher levels in FY12. Fitch emphasises that further deceleration of the global economy could translate into tangibly reduced railway transportation and container throughput volumes at the Port of Vladivostok.
- Diversified but Commodity Exposure
FESCO is relatively well-diversified in terms of cargo types, facilitated by its balanced and flexible fleet portfolio. However, in common with some of its rail peers, commoditised goods including coal, iron ore and construction materials dominate its rail division, comprising around 77% of total transported rail volumes. FESCO's port and liner and logistics divisions provide the group with greater exposure to higher-value goods and geographical diversity. Trade flows in terms of container throughput are relatively well-balanced, although bulk cargo is skewed towards exports, given Asia's demand for raw materials.
- Moderate Customer Diversification
Although FESCO's customer base is relatively broad (around 1,500 customers spanning a variety of industries and of relatively good quality) it exhibits greater concentration relative to peers, particularly in the rail division where the five largest direct clients accounted for around 38% of the division's revenues.
- Rail Market Consolidation a Threat
Fitch expects competition in the rail sector to intensify due to further market consolidation in the coming years as economies of scale become more important and expansion demands greater capital expenditure. Relative to its rail peers, FESCO has a smaller fleet, limited rail container terminals and given its niche focus, its rail network is also less extensive. With greater competition this may erode FESCO's rail market shares and margins in its bulk and general cargo operations. Its current stake in TransContainer is a partial mitigant to this.
- Potential Competition to Vladivostok Port
Growth in the trade flows between Russia and Asia is expected to lead to increased capacity in the region, including significant expansion by Vostochnaya Stevedoring Company (VSC), Vladivostok's main competitor with 30% of regional container volumes. Vladivostok's own market share in terms of container traffic flows decreased to 34.6% in FY12 from 39.2% in FY10, and VSC's plans to quadruple capacity to TEU2.2bn compared with Vladivostok's intentions to increase capacity to 650,000 TEU may place further pressure on this. However, unlike Vladivostok, VSC's volumes are primarily focused on serving international cargo flows, with the majority of its import volumes transported to the central and western regions of Russia, including Moscow, a less captive market for Vladivostok.
- Credit Metrics Major Rating Constraint
Net FFO adjusted leverage and FFO fixed charge cover are currently considered weak. In FY13, leverage is forecast to be around 4.2x and FFO fixed charge cover is expected to be around 2.0x, considerably weaker than rail transportation peers. However, the agency recognises the marginally stronger business profile of the port business and due to strong forecasted cash flows, expects these metrics to strengthen to more commensurate levels of around 3.5x leverage and around 2.5x FFO fixed charge cover by FY14. Cash flows are contingent on continued high growth rates, substantial cost-efficiencies, particularly in the port division, and moderate capex levels.
Management has confirmed its intention to delever to below 2.5x net debt/EBITDA over the next 18 months and does not intend to distribute dividends in the medium term. FESCO has been historically acquisitive but has used disposal proceeds to partially fund these.
- Senior Secured Notes Rated as Unsecured
The senior secured notes have been assigned a senior unsecured rating in line with company's IDR despite security provided as part of the terms of the note agreements. This is due to the agency's assessment of possible limitations realising collateral in Russia granted for the benefit of the noteholders. The senior secured notes rank pari passu to all existing and future secured debt, benefit from cross-default provisions (within a threshold set at USD30m) and be guaranteed by the majority of the company's operating companies. The Commercial Port of Vladivostok is expected to accede as a guarantor shortly after the issuance of the bonds.
Security comprises an expected USD560m of hard asset security including railcars, buildings and containers (exact constituents of the hard asset security package to be defined within 180 days of bond issue date) as well as share pledges over various holdings in the group including the company's main operating subsidiaries. Fitch highlights that debt issued at entities that do not act as guarantors are structurally senior to the notes. Structurally senior debt is expected to total USD69m but has been taken into consideration in Fitch's recovery analysis.
LIQUIDITY & DEBT STRUCTURE
- Adequate Liquidity
Short-term maturities as at FY12 amounted to USD219m. Of this amount, up to USD120m of debt will be funded by the proposed bond issuances, ensuring that the remaining USD99m will be more than sufficiently covered by FY12 cash and cash equivalents of USD232m. FESCO is expected to have undrawn committed credit facilities of approximately USD10m, albeit USD8.4m is forecast to expire in FY13.
- Covenant Headroom under OpCo Loan
Headroom in the cash flow cover covenant under the acquisition-related OpCo Loan in FY15 and FY16 is tight. This is given continually high interest payments and a tightening in the cash flow covenant to exclude cash and cash equivalents. Adherence to this covenant will be dependent on the company's ability to generate strong cash flows and delever ensuring interest payments are kept to a minimum. Fitch considers headroom under the net debt/ EBITDA and interest cover financial covenants to be sizeable.
Financial covenants per the acquisition-related OpCo Loan restrict dividend payments until the company delevers to 2.5x net debt/EBITDA. This provides noteholders with some comfort over the company's intention to delever, although Fitch emphasises that the acquisition-related OpCo Loan matures in December 2017 before the maturities of the notes, and FESCO has the option to repay the acquisition-related OpCo Loan early. Amendments have already been made to the cash flow covenant to ensure this was not breached in FY13 and FY14.
Positive: Future developments that could lead to positive rating actions include:
- A sustainable improvement in FFO net adjusted leverage to below 3.0x and FFO fixed charge cover trending towards 3.0x.
Negative: Future developments that could lead to negative rating action include:
- A deterioration in FFO net adjusted leverage to around 4.0x and FFO fixed charge cover consistently below 2.0x given lower than expected growth and/or efficiency-savings in the port division and/or material debt-funded acquisitions or dividends.
- Signs of increased competition or greater volatility of earnings in the port and/or rail business.
FESCO's ratings are as follows:
Long-term foreign currency IDR of 'B+'/Stable
Long-term local currency IDR of 'B+'/Stable
National Long-Term Rating of 'A(rus)'/Stable
Foreign currency senior unsecured rating of 'B+'
Local currency senior unsecured rating of 'B+'