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June 23 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned JSC National Company Kazakhstan Temir Zholy’s (KTZ) CHF100m 2.590% notes due 2019 and CHF185m 3.638% notes due 2022 a final foreign currency senior unsecured rating of ‘BBB’. The notes are guaranteed by KTZ’s subsidiaries JSC Kaztemirtrans and JSC Locomotive.
The senior unsecured rating is in line with KTZ’s Long-term foreign currency Issuer Default Rating (IDR) of ‘BBB’/Stable. The bonds’ proceeds will be used to finance the development of infrastructure projects of KTZ-Express, KTZ’s new wholly owned logistics subsidiary as well as to finance its own capital expenditures and for its general corporate purposes.
Strong Links With State
KTZ’s ratings reflect its 100% state ownership, indirectly owned through the JSC National Welfare Fund Samruk-Kazyna (S-K), and strategic importance to Kazakhstan (BBB+/Stable/F2) as monopoly owner/operator of the Kazakhstan rail infrastructure and provider of around half of the freight and passenger transportation in the country. KTZ’s tariffs are regulated and its investment plans approved, and directly co-funded by the state through equity injections and loans. The government also provides direct subsidies for the loss-making passenger business.
However, despite relatively substantial and timely financial support, KTZ’s ratings are one notch lower than the state given the absence of explicit guarantees but also past instruction by the state for KTZ to undertake relatively sizeable social projects at the group’s expense.
Sound Operating Performance
Fitch expects KTZ’s earnings will continue to be supported by fairly robust volumes due to still strong GDP growth rates (expected by Fitch to be in excess of 5.5% in 2014 and 2015) and demand for the transportation of commodities, KTZ’s key revenue driver. The 8% proposed average tariff increase for 2014 is also expected to be supportive, although it remains lower than pre-2013 levels.
Growth rates are therefore unlikely to witness the highs of previous years, due in part to some dampening effect of the unification of tariffs in the Single Economic Space, expected to lead to reduced export tariffs, which accounts for around 40% of KTZ’s freight turnover. Nevertheless, cost optimisation programmes aimed at increasing efficiency should help offset pricing pressures and maintain margin levels as witnessed in 9M13.
Material Capex Drives Increased Leverage
Continued material increases in capex are expected to drive sizeable negative free cash flow (FCF) over the medium term despite the expectation of strong earnings and cash flow from operations (CFO). In line with management’s guidance, Fitch forecasts capex of over KZT1.1trn compared with CFO of roughly KZT700m over FY13-FY15. Fitch acknowledges that a large proportion of capex (around 80%) is discretionary and where willing, may be deferred or cancelled by KTZ. However, assuming the full capex spend, Fitch forecasts that funds from operations (FFO) gross adjusted leverage may weaken to over 3.0x, whilst fixed charge cover is likely to deteriorate to about 5.0x.
Weaker Standalone Credit Profile
KTZ’s business profile remains strong, benefiting from its monopolistic position, relatively diversified product and customer mix with balanced exposure to domestic, transit and export markets. However, the expected weakening in credit metrics, particularly increased leverage and negative FCF generation, places considerable pressure on the company’s underlying credit quality. Whilst KTZ’s ratings are, and are expected to remain related to the sovereign’s credit quality, we would not consider KTZ’s standalone credit profile commensurate with a low ‘BBB’ rating while leverage exceeds 3.0x on a continuous basis. If credit metrics are allowed to weaken substantially, this could prompt Fitch to reconsider the strength of ties between KTZ and its parent company.
Positive: Future developments that could lead to positive rating actions include:
- A positive change in Kazakhstan’s rating may be replicated on KTZ (with the current one-notch differential), unless its links with the state weaken.
- A material strengthening in KTZ’s standalone credit profile to in line with the sovereign rating. This is currently considered unlikely but could be possible if credit metrics substantially improve owing to a material increase in earnings and/or decrease in capex leading to a strengthening in FFO adjusted leverage.
Negative: Future developments that could lead to negative rating action include:
- A negative change in Kazakhstan’s rating would be replicated on KTZ unless KTZ’s standalone profile significantly strengthens.
- A sustained increase in gross leverage beyond 3.0x would put pressure on KTZ’s standalone profile and may prompt Fitch to reconsider the strength of state support. However, Fitch expects KTZ to moderate leverage through a reduction in capex where necessary, especially taking into account some bank covenants and an internal financial target set by S-K at around 3.5x debt/EBITDA.
At end-2013 cash and cash equivalents stood at about KZT86bn, sufficient to cover short-term debt maturities of about KZT37bn. However, expected negative FCF continues to add to funding requirements.
The recent 19% tenge devaluation is likely to further weaken KTZ’s credit metrics given about 70% of KTZ’s debt at end-2013 was denominated in foreign currencies, mainly US dollars. KTZ monitors exchange rate changes and maintains some cash in US dollars but Fitch believes that a lack of hedging could increase leverage by 0.3x-0.5x. However, a weaker tenge could have a positive impact on transit revenue, about 18% of freight revenue in 2013, as tariffs are set in Swiss francs and part of the US dollar debt falls due in 2016.