MOSCOW & LONDON--(BUSINESS WIRE)--Fitch Ratings has placed Far-Eastern Shipping Company Plc (FESCO) ratings, including its Long-term foreign currency Issuer Default Rating of 'B' on Rating Watch Negative (RWN). A full list of ratings actions is provided at the end of this commentary.
The rating action reflects the underperformance in FESCO's rail division and substantial rouble depreciation which hits its credit metrics as over 80% of its debt is in U.S. dollars. While liquidity is currently adequate, Fitch expects that weaker margins, foreign currency mismatch and working capital outflow including for margin calls relating to FESCO's stake in OJSC TransContainer (BB/Stable) may weaken FESCO's liquidity in 2015.
Fitch may downgrade the ratings during the next six months if the agency thinks that FESCO is unlikely to achieve funds flow from operations (FFO) net adjusted leverage towards 5x by year-end 2015 (YE15) or if its liquidity deteriorates.
KEY RATING DRIVERS
FESCO is subject to foreign currency fluctuations risks as more than 80% of its total debt at end-September 2014 was denominated in U.S. dollar, comprising two eurobonds that mature in 2018 and 2020. This contrasts with only around 46% of revenues that are U.S. dollar-linked or U.S. dollar-denominated. The company is seeking to improve the natural hedge of its earnings through renegotiation of its contracts and through focusing on exports at the Vladivostok port. Fitch notes that while repayment risk is not imminent in the short term, the recent decline of rouble versus the U.S. dollar crystallises conversion risk.
Continued Rail Division Underperformance
FESCO's rail division reported revenue of USD126m and EBITDA of USD37m in 9M14, a 37% and 50% year-over-year (yoy) decline respectively. This was mainly driven by about 21% decline of gondola rates and the 5% yoy reduction of non-container cargo transportation volumes. Freight rail volumes and prices declined in 9M14, mostly due to overall stagnation of the Russian economy - in particular industrial production, and intensifying competition. Fitch does not expect significant volume recovery in the short-to-medium term given the expected GDP fall in 2015, nor does Fitch expect gondola rates to increase given the current surplus capacity.
Port Division Demonstrates Weakening
FESCO's port business is a key source of the company's earnings representing 55% of group's EBITDA in 9M14, and given its higher margins. Company's volumes in port segment improved substantially, mostly due to intensified international trade between Russia and Asian countries. Vladivostok is one of the largest ports in the Russian Far-East and is key in the import and export of commodities as well as consumer goods. Total container and non-container volumes demonstrated strong growth, while the revenue and EBITDA of this division declined by 7.8% and 10.5% yoy in 9M14. This was mostly due to rouble depreciation as well as average rates decrease. However, the port division continues to perform better relative to the rail division and Fitch expects faster EBITDA margins recovery within this division in the short-to-medium term period.
2014 FCF Expected Negative
Fitch expects FESCO's free cash flow (FCF) to be negative for 2014 mostly due to increased gross capex of about USD70m. However, Fitch notes, that the company's capex programme is fairly flexible and subject to market conditions, that together with its policy of zero dividend payments until fixed charge coverage ratio is below 2.0x and consolidated total leverage ratio is above 3.25x, may allow management to keep FCF in the positive territory for 2015-2018. Maintenance capex is estimated to range USD25-30m.
Credit Metrics Deteriorate Further
Fitch sees it as unlikely for FESCO to reduce its FFO net adjusted leverage to below 5.0x by YE15, primarily as a result of weaker operations and rouble depreciation. Although REPO loan of EUR73m as of December 2014 with a pledge over FESCO's 24.1% stake in TransContainer is outside of the restricted group and ring-fenced, Fitch starts to include it in its leverage calculations as margin calls payment during 2014 was partially funded by cash from within the restricted group.
LIQUIDITY & DEBT STRUCTURE
At end-9M14, FESCO's cash and cash equivalents stood at USD160m compared to short-term debt of USD195m, including REPO loan of USD150m which was subsequently refinanced and partially repaid. Additionally, as of end-9M14, the company had unused credit facilities. Fitch expects FESCO to report negative FCF for 2014, owning to its substantial capex programme. FESCO's debt repayment profile is spread with local bonds of RUB5bn (about USD80m) due in 2016 and eurobonds of USD550m and USD325m due in 2018 and 2020 respectively.
Financial covenants (i.e. fixed charge coverage ratio at 2.0x or higher and consolidated total leverage ratio of less than 3.25x) per the eurobonds documentation limit the ability to incur additional debt over certain limits but their breach does not constitute an event of default as these are not maintenance covenants. The company adhered to its covenants as at 9M14.
Negative: Future developments that could lead to negative rating action include:
-Inability to reduce FFO net adjusted leverage towards 5.0x by YE15 and maintain FFO fixed charge cover above 1.5x due to weaker-than-expected operational performance, rouble depreciation or and/or material debt-funded acquisitions or dividends;
-Weaker liquidity position;
-Signs of additionally increased competition or greater volatility of earnings in the port and/or rail business.
The ratings are on Rating Watch Negative. As a result, Fitch's sensitivities do not currently anticipate developments with a material likelihood, individually or collectively, of leading to an upgrade. Future developments that could, nonetheless, lead to a positive rating action include:
-A sustainable improvement in FFO net adjusted leverage to below 4.0x and FFO fixed charge cover trending towards 2.0x.
Fitch may affirm the ratings at the current levels if the company's cash conservation measures allow it to demonstrate ability to reduce FFO net adjusted leverage towards 5.0x by YE15 and to maintain FFO fixed charge cover above 1.5x as well as preserve adequate liquidity.
FULL LIST OF RATINGS
Far-Eastern Shipping Company Plc
-Long-term foreign currency IDR of 'B' placed on RWN;
-Long-term local currency IDR of 'B' placed on RWN;
-National Long-term rating of 'BBB+(rus)' placed on RWN;
-Local currency senior unsecured rating of 'B' placed on RWN.
Far East Capital Limited S.A. (Luxembourg)
-Foreign currency senior unsecured rating of 'B' placed on RWN.
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