Fitch Ratings – London – 29 May 2019:
Fitch Ratings has upgraded Russia-based PAO Sovcomflot’s (SCF) Long-Term Issuer Default Rating (IDR) to ‘BB+’ with Stable Outlook from ‘BB’/’Positive’. Fitch has also upgraded SCF Capital Designated Activity Company’s senior unsecured notes, which are guaranteed by SCF, to ‘BB+’.
The upgrade reflects SCF’s improved business profile due to an expansion in industrial business, which contributed about 57% in total time charter equivalent (TCE) revenue in 2018, up from 34% in 2016. The upgrade is also supported by our expectation of funds from operations (FFO) adjusted net leverage moderation to about 5x in 2019 and to about 4.6x on average over 2020-2022 down from a peak of slightly above 7x in 2017. The rating also incorporates SCF’s large scale of operations, fairly young and specialised fleet, diversified customer base and exposure to market risks through conventional business.
The ‘BB+’ rating incorporates a one-notch uplift to its standalone credit profile (SCP) of ‘bb’, reflecting the links to parent, the Russian Federation (BBB-/Positive).
KEY RATING DRIVERS
Improved Business Profile: SCF materially expanded its operations in the industrial segment, including gas transportation and offshore services, which accounted for about 57% of total TCE revenue in 2018, up from 34% in 2016. The industrial segment is generally more profitable and benefits from long-term, fixed-rate contracts, improving cash flow visibility, unlike the conventional segment, including oil and oil products shipping, which is typically contracted for less than two years or runs on spot trading. At end-2018, SCF contracted revenue for USD8.4 billion (including JVs), of which USD3 billion is scheduled over 2019-2022. Fitch expects industrial business to contribute more than half of total TCE revenue in 2019-2022.
Leverage Moderation Expected: In 2018, SCF’s Fitch-calculated FFO adjusted net leverage decreased to 5.7x from a capex- and low rates- driven peak of 7.4x at end-2017; we expect it to moderate further to about 5x in 2019 and to about 4.6x on average over 2020-2022 on stable cash flow from the industrial segment and lower-than-historical level of capex. We expect SCF will generate healthy cash flow from operations in 2019-2022, but that its FCF will be negative in 2019, and neutral to slightly positive in 2020 on an increase in EBITDA following the introduction of seven new vessels over 2019-2020.
Tanker Rates Remain Low: Tanker rates continued to decline in 2018, with some recoveries witnessed from 4Q18, which continued in 1Q19. In our rating case we apply the more recent 12 months average freight rates for spot operations for 2019 and historical 10-year average from 2020. SCF is exposed to market risks because about 40% of total TCE revenue comes from the transportation of conventional crude oil and oil products, of which around 70% operates on spot trading, with the remaining on fixed term contracts of no more than five years and the vast majority of them expiring in the next 12 months.
Diversified Customer Base: SCF has a diversified customer base consisting of large international and Russian oil and gas companies, whose unconstrained credit profiles are generally stronger than that of SCF. Top 10 customers accounted for 77% of TCE revenue in 2018, with no single counterparty contributing more than a fifth of TCE revenue.
One-Notch Uplift: SCF’s ‘BB+’ IDR includes a one-notch uplift from its SCP of ‘bb’. Fitch views the status, ownership and control linkage of SCF with the sovereign as strong, due to the government’s full ownership of the company while there is a moderate record of support. We assess socio-political implications of its theoretical default as moderate because the company operates in a highly competitive market and could be substituted, despite SCF playing an important role in the Russian oil and gas sector and being included in the list of strategically important enterprises.
We consider SCF’s business as less strategically important than oil and gas or utilities. SCF is not a direct proxy of the state creditworthiness, we therefore believe a company default would have a moderate impact on the government’s ability to finance itself and therefore assess the financial implications of SCF’s theoretical default as moderate.
The one-notch uplift would be capped at one notch below the Russian sovereign rating and thus SCF’s rating upside is limited.
Partial Privatisation Rating-Neutral: We view the potential privatisation of 25% minus one share as rating-neutral, as we believe it will not affect the relations between SCF and the state, given the company’s integral part of government’s energy strategy in transporting Russia’s oil and gas and its close working relationship with state-owned oil and gas companies. Further significant privatisation leading to loss of the effective control over SCF by the state may result in removal of the one-notch uplift above the SCP.
Senior Unsecured Aligned with IDR: We continue to align the senior unsecured rating with the company’s Long-Term IDR. We would consider decoupling the ratings were the amount of unencumbered assets to fall well below 2x of unsecured debt on a sustained basis, which we believe would indicate a structural subordination that is detrimental to the unsecured debt.
Despite SCF having higher leverage than PT Soechi Lines Tbk (B/Stable), its SCP of ‘bb’ is higher than Soechi and is underpinned by its significantly stronger business profile supported by the large scale of its business, healthy share of long-term contracts, fairly young and specialised fleet and diversified customer base. While Soechi’s historical average FFO adjusted net leverage is around 4x, SCF’s EBITDA is around 10x larger than Soechi. SCF’s ‘BB+’ rating incorporates a one-notch uplift to its SCP of ‘bb’, reflecting the links to parent, the Russian Federation.
Fitch’s Key Assumptions Within Our Rating Case for the Issuer
– 12-month average freight rates for spot operations for 2019 and 10-year average from 2020, capacity as per scheduled deliveries;
– contractual rates for time charters;
– annual capex of around USD450 million;
– dividend of around USD25 million in 2019 and dividend pay-out ratio of around 50% of net income in 2020-2022.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
– Stronger links with the government.
– FFO adjusted net leverage well below 4.3x and FFO fixed-charge cover above 4.0x on a sustained basis may lead to a stronger SCP. However, with the current strength of the parent links SCF’s IDR is capped at one notch below that of the Russian Federation unless its SCP is the same or above the government, which we do not expect.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
– Structural decline of tanker rates or more sizeable capex resulting in deterioration of the company’s credit metrics (eg FFO adjusted net leverage above 5.3x and FFO fixed-charge coverage below 3.0x on a sustained basis)
– Weaker links with the government.
– Unencumbered assets falling well below 2x of unsecured debt on a sustained basis would lead to a downgrade of the senior unsecured rating.
LIQUIDITY AND DEBT STRUCTURE
Strong Liquidity: SCF’s end-2018 unrestricted cash position was USD268 million along with its undrawn portion of committed credit lines of USD436 million, USD85 million of which are revolver for general corporate purposes and the rest related to capex. This compares comfortably with short-term debt maturities of USD317 million and negative post-dividend free cash flow of around USD32 million that we estimate for the subsequent 12 months. In May 2019, SCF signed an additional capex-related credit line of USD297 million.
SUMMARY OF FINANCIAL ADJUSTMENTS
Operating Leases: Although the company is based in Russia, we continue to apply 8x multiples to operating leases as the majority relates to vessels leases, which are US dollar denominated and for which we assume implied interest rates significantly below those in Russia.
Cash: We have reclassified as restricted cash at end-2018 cash related to the retention accounts of USD27.4 million designated by the group’s lenders for the purposes of the secured bank loan agreement to cover future loan principal and interest repayments, restricted deposits of USD1 million, which represent additional security for the purpose of certain secured loan agreements and bank deposits accessible on maturity of USD0.5 million.
EBITDA: loss on sale of assets, loss on sale and dissolution of subsidiaries, allowance for credit losses, share of profits in equity accounted investments and vessels and other impairment provision were excluded from EBITDA calculations.
Cross-currency Interest Rate Swap: Net asset/liability for cross-currency interest rate swaps are treated as debt
Sources of Information
PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS
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