LONDON--(BUSINESS WIRE)--Fitch Ratings has affirmed JSC National company Kazakhstan Temir Zholy's (KTZ) Long-term Issuer Default Rating (IDR) and Kazakhstan Temir Zholy Finance B.V.'s senior unsecured rating at 'BBB'. The Rating Outlook is Stable.
The affirmation reflects the continued support from and strong links with Kazakhstan's government. Fitch notes however that while KTZ's IDR continues to be driven by the sovereign rating, its standalone credit profile, in Fitch's view, has weakened, and is now commensurate with high 'BB' rather than low 'BBB' rating category. The main factors weighing on the standalone credit profile are freight volume decline, tariff uncertainty and national currency devaluation.
KEY RATING DRIVERS
--Strong Links With State
KTZ's ratings reflect its 100% state ownership, indirect through the JSC National Welfare Fund Samruk-Kazyna (S-K), and its strategic importance to Kazakhstan ('BBB+'/Stable/'F2') as the monopoly owner/operator of the Kazakhstan rail infrastructure and provider of around half of freight and passenger transportation in the country. KTZ's tariffs are regulated and its investment plans approved and partially funded by the state, through equity injections and loans. The government also provides direct subsidies for the loss-making passenger business.
However, despite substantial financial support, KTZ is rated one-notch lower than the sovereign given the absence of significant explicit guarantees or cross-default provisions. The one notch differential accounts for the risk that the sovereign could cease to provide full support to KTZ before defaulting on its own obligations, given the sizeable debt of quasi-sovereigns relative to that of the sovereign.
--Weaker Operating Performance
Fitch expects a modest, low single digit growth of KTZ's revenue in 2014, hindered by the estimated 5% fall in freight turnover (tonne-kilometres). The fall reflects competitive pressure from other types of freight transportation, as part of the company's oil and oil product traffic switched to pipelines from rail. It had a knock-on effect on profitability as crude oil and oil products enjoy high freight tariffs. Fitch does not anticipate 2015's freight turnover to be significantly better as declining oil prices and slowing GDP growth continue to affect transportation volumes.
--Tariff Uncertainty Weighs on the Standalone Profile
In 2014, due to the national currency devaluation, KTZ's average tariff growth of 7% was not sufficient to cover inflation, leading to lower margins. The company's financial profile is very sensitive to inflation as the cost base is predominantly fixed or semi-fixed. Although KTZ benefited from high tariff increases of 15% in 2010-2012, more recent tariff increases have been substantially lower. KTZ's request for a 12.3% average tariff increase for 2015 is yet to be accepted by the state. Fitch notes that modest, inflationary tariff increases would be insufficient to sustain KTZ's financial profile if the company continues to invest at its current pace.
New asset based tariff regulation is due to be introduced in 2016, setting out the maximum tariffs for the five-year period to 2020. The details of the framework are uncertain. Once the details are available, Fitch will evaluate the new regulation's impact on KTZ's financial profile.
--Weaker Standalone Rating
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 weakening in credit metrics, particularly increased leverage, places considerable pressure on the company's underlying credit quality. Whilst Fitch expects KTZ's ratings to continue to be driven by the credit quality of the sovereign, Fitch no longer considers KTZ's standalone credit profile as commensurate with a 'BBB-' rating, and is lowering the standalone rating to 'BB+'. Fitch expects KTZ's credit quality will be weaker than the guidelines set for the 'BBB-' level, with gross leverage in excess of 3.0x in the short to medium term, tariff uncertainty and a weaker economic environment. If credit metrics weaken further, Fitch would reassess the strength of ties between KTZ and its parent company.
--Capex Programme Cut by Half
In response to the lower tariff growth and weaker operating environment KTZ has cut its 2015-2018 investment programme by half. While such reduction would benefit credit metrics, Fitch is uncertain whether it is sustainable given the track record of large-scale country-wide infrastructure project development on behalf of the government. Fitch incorporates in its forecasts a much smaller cut in capex of only c. 20%.
KTZ may undertake additional infrastructure projects in connection with the newly announced economic policy 'Nurly Zol'. If, however, KTZ funds projects relating to assets not legally owned by the company (for example airports under trust management), it would add to the negative rating pressures.
--Negative Impact of Tenge Devaluation
KTZ is vulnerable to currency exchange rate swings due to the currency mismatch in its earnings and debt. At the end of November 2014, around 55% of gross debt was denominated in foreign currency (mainly USD) versus only c. 20% of 2014 revenue (mainly transit, CHF-denominated). Most of the costs and capex are tenge-denominated. The devaluation of tenge by 19% in February 2014 negatively impacted KTZ's credit metrics, adding around 0.3x to FFO adjusted leverage. Given the economic conditions, the tenge could come under renewed pressure if either the bilateral exchange rate with the Russian rouble or oil prices weakens further, which could result in KTZ breaching its financial covenants on some of the bank loans.
KTZ's foreign exchange risk hedging is usually limited to monitoring exchange rates and maintaining a portion of cash in U.S. dollars. In light of this, Fitch notes KTZ's effort to reduce the currency risk exposure via the issue of CHF-denominated Eurobonds in June 2014 which match up with CHF-denominated transit revenue.
--Planned Privatization is Rating Neutral
Fitch does not expect the 'People's IPO' in which S-K plans to offer a 10% - 1 share stake in KTZ to the Kazakh public by 2016 to change the linkage between KTZ and the state. However, Fitch expects the IPO to enhance the transparency and quality of the company's information disclosure. Fitch believes that following the IPO, S-K would retain a majority stake in KTZ and the form, amount and timeliness of the government support will not change. Fitch expects People's IPO to be moderately positive for KTZ's credit metrics, depending on the dividend pay-out policy post transaction.
Positive: Future developments that could lead to positive rating actions include:
--A positive change in Kazakhstan's rating may be replicated for KTZ (with the current one notch differential), unless its links with the state weaken or unless KTZ's standalone credit quality deteriorates to below high 'BB' level;
--A material strengthening in KTZ's standalone credit profile to in line with the sovereign rating. This is currently considered unlikely.
Negative: Future developments that could lead to negative rating action include:
--A negative change in Kazakhstan's rating would be replicated for KTZ unless KTZ's standalone profile significantly strengthens;
--A sustained increase in FFO adjusted leverage beyond 3.5x would put pressure on KTZ's standalone profile and would prompt Fitch to reconsider the links with the Kazakhstan government and the amount of support incorporated in the rating.
LIQUIDITY AND DEBT STRUCTURE
KTZ's liquidity is good with KZT85.2bn of cash and equivalents, and KZT34.5bn of available credit lines more than sufficient to cover short-term debt repayments of KZT37.8bn. However, expected negative free cash flow (FCF) continues to add to funding requirements. According to Fitch's estimates, in order to fully fund its 2015 capex, KTZ would need to raise between KZT70bn and KZT90bn, in addition to KZT67bn of approved equity injections from the state.
Fitch notes that the company's debt maturity profile is relatively smooth, owing to amortizing profile of its bank borrowings. Eurobonds and long term loans from S-K have bullet maturities, with the next bond coming up for a repayment in May 2016. Fitch views KTZ's long term plan of accumulating cash for the repayment of its 2006 Eurobond as credit positive, which both facilitates refinancing and reduces foreign exchange risk.
Additional information is available on www.fitchratings.com
Applicable criteria, 'Corporate Rating Methodology', dated 28 May 2014, are available at www.fitchratings.com
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage