November 30, 2017 / 12:17 PM / in a year

Fitch Affirms OJSC LSR Group at 'B'; Outlook Stable

(The following statement was released by the rating agency) MOSCOW/LONDON, November 30 (Fitch) Fitch Ratings has affirmed the Long-Term Foreign-Currency Issuer Default Rating (IDR) of OJSC LSR Group at 'B' with a Stable Outlook. Fitch has also affirmed the senior unsecured rating of the outstanding bond issues at 'B'/RR4 and assigned the senior unsecured ratings of 'B'/RR4 to RUB5 billion bond maturing in September 2021, RUB5 billion bond maturing in April 2022 and RUB5 billion bond maturing in September 2022. The affirmation reflects Fitch's expectation that LSR's leverage will remain within the rating sensitivities, despite the large working capital increase driven by its sizeable investment in the development of the large housebuilding site (ZIL) in Moscow. KEY RATING DRIVERS Interest Rates Drive Mortgage Market Householders are likely to rely on the mortgage market more heavily, given the challenging economic environment, which would support housebuilders. The mortgage market has stabilised following a gradual decrease in the Central Bank of Russia's (CBR) key rate, which has allowed Russian banks to reduce mortgage rates to historical lows below 11%. The volume of mortgages is still smaller than in 2014, but further cuts to the CBR's interest rates will support the market. Prominent Market Position in Russia LSR is one of the top-three real estate developers in the highly fragmented Russian residential construction market. The company is the largest homebuilder for high-end residential real estate, and is also one of the leading mass-market real-estate companies in St. Petersburg and Moscow. LSR is also the leading producer of building materials in Russia, which offsets some of its construction risk. Large Housebuilders Preferred Some housebuilders continue to struggle despite cuts in interest rates in the mortgage market. This allows larger housebuilders, such as LSR, to increase market share, because customers as well as banks and construction companies choose established companies. Smaller housebuilders tend to be more opportunistic, but this might hurt their financial profiles and could result in their bankruptcy. Because of its size, LSR is in a stronger position to develop more lucrative projects, especially in Moscow, and to attract more customers who prefer to work with the stable housebuilders. Diversified Portfolio The majority of LSR's real-estate portfolio is located in St. Petersburg and the surrounding Leningrad region (64% of the net sellable area and 60% of the market value). With the acquisition of ZIL and other smaller projects, LSR has become one of the largest companies in the most lucrative markets including Moscow. LSR has also increased its share of higher-end "business class" projects, which provide higher revenue and margins. Fitch views the further diversification into the Moscow region and higher-end projects as being credit positive for the company, as we consider the Moscow market to be the most stable in Russia. Working Capital Outflow Drives Leverage Fitch expects LSR's EBITDA and funds from operations (FFO) margins to remain stable over 2017-2020 and revenues to increase following the completion of projects. Fitch expects the outflow of working capital over 2017-2018 to affect LSR, due to the need to invest in large projects. This could lead to an increase in the company's FFO leverage to above 4.0x, the level of our negative rating guideline in 2017-2019 from 3.5x at end-2016. By end-2020, we expect the company to reduce the FFO leverage to 3.4x as a result of working capital reversal. Moscow Renovation Might Pressure Ratings A comprehensive urban renovation project in Moscow would, if it goes as planned, create a massive oversupply of housing in the region and could force most of the housebuilders to quit the Moscow market in the long-term. The Moscow and the Federal Government have announced the start of the renovation project aims to replace around 25 million square meters of buildings with new housing for sale on the open market, with the total cost of the programme to be around RUB3.5 trillion. Operating Environment Discount Fitch applies a one-notch discount to account for the company's exposure to the Russian operating environment from the standalone rating level of the company of 'B+'. DERIVATION SUMMARY LSR is one of the leading Russian housebuilders focused on the most lucrative areas - St. Petersburg and Moscow - with a large portfolio of projects. The company compares well with other Russian housebuilders in terms of scale, geographical diversification and financial profile. Within the EMEA region, operating and regulatory environments vary significantly, making comparisons hard. Fitch views French housebuilder Kaufman & Broad as a 'BB' credit because the favourable VEFA framework and land option system does not fully offset its high leverage position. UK housebuilder Taylor Wimpey (BBB-/Stable), operates in a more stable environment and has a GBP450 million net cash position. We view the ratings of LSR to be constrained by the cyclical and capital-intensive nature of the housebuilding industry; high execution risk should the company develop too many projects simultaneously; a lack of medium-term certainty over project development; and higher-than-average risks associated with the Russian business environment and jurisdiction. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Double-digit revenue growth in 2017-2018 - Stable margins - Large working capital outflow over 2017-2018 followed by a reversal of working capital in 2019-2020 RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Sustainable improvement in the financial metrics leading to EBIT margin above 15%. - FFO-adjusted gross leverage below 3x for a sustained period. - Positive FCF generation on a sustained basis. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Market deterioration leading to EBIT margin below 10% and/or worsened liquidity. - FFO-adjusted gross leverage sustainably above 4x. LIQUIDITY Satisfactory Liquidity Position: LSR's short-term debt as of 1H17 was RUB7.4 billion, while the company's cash position stood at RUB28 billion. This, coupled with available undrawn credit facilities from the major Russian banks should be sufficient to cover immediate liquidity requirements. The company does not pay commitment fees for the undrawn credit facilities, which is a common practice in Russia. The company is not exposed to FX risk, as all of the debt is raised in roubles. Full List of Rating Actions -Long-Term Foreign-Currency IDR affirmed at 'B'; Outlook Stable -Local-currency senior unsecured rating affirmed at 'B', Recovery Rating 'RR4' - Local currency senior unsecured rating assigned at 'B', Recovery Rating 'RR4' to RUB5 billion bond maturing in September 2021, RUB5 billion bond maturing in April 2022 and RUB5 billion bond maturing in September 2022. Contact: Principal Analyst Alexey Evstratenkov Associate Director +44 20 3530 1089 Supervisory Analyst Marina Bordakova Associate Director +7 495 956 2400 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow 115054 Committee Chairperson Paul Lund Senior Director +44 203 530 1244 Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email:; Adrian Simpson, London, Tel: +44 203 530 1010, Email: Summary of Financial Statement Adjustments: Fitch adjusts the company's cash position by RUB5 billion for the intra-year working capital swings. Additional information is available on For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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