Fitch Ratings-London-23 November 2015: Fitch Ratings has upgraded Russia-based PAO Sovcomflot's Long-term Issuer Default Rating (IDR) to 'BB' from 'BB-'. The Outlook is Stable. Fitch has also upgraded SCF Capital Limited's senior unsecured notes, which are guaranteed by PAO Sovcomflot, to 'BB' from 'BB-'.
The upgrade reflects the steady improvement of Sovcomflot's financial profile mainly driven by the tanker shipping sector's recovery, while the company maintains heavy capex plans. Given the volatile nature of the shipping sector, the sustainability of improved tanker shipping fundamentals is key to further positive rating momentum.
The company continues to benefit from a strong business profile, which is compatible with that in the high 'BB' rating category. Sovcomflot's 'BB' Long-term IDR incorporates a one-notch uplift for state support to its standalone rating of 'BB-'. We continue to align the senior unsecured rating with the company's Long-term IDR.
KEY RATING DRIVERS
Stronger Financials Support an Upgrade
The upgrade reflects our expectation of Sovcomflot's stronger than previously forecast financial performance in 2015 and over 2016-2018, primarily driven by improved tanker shipping sector fundamentals and, to a lesser extent, by bunker price reduction. The improvement in conventional fleet performance, along with the shift of the company's portfolio to higher-margin segments (eg gas and offshore) should support higher profitability and visibility in the medium-term.
We forecast funds from operations (FFO) adjusted net leverage to drop to 4.4x in 2015 from 5.4x in 2014 and to remain well below 5x over 2016-2018. We expect FFO fixed charge cover to increase to 3.4x in 2015 from 3.1x in 2014 and to remain above 3x in 2016-2018. This forecast is driven mainly by sector fundamentals and does not take into account the proceeds from the company's potential IPO. Given the volatile nature of freight rates, we have taken a through-the-
cycle approach and assumed 10-year average spot tanker rates for the company's spot operations from 2016.
Improving Tanker Shipping Fundamentals
We continue to expect better supply/demand balance for tanker shipping in 2016 due to moderate supply growth supporting capacity discipline and growing oil consumption, coupled with regional changes in oil demand patterns having a positive tonne-mile effect on tanker demand. While the improving sector fundamentals may lead to higher vessel orders, they are likely to be contained by limited available funding as banks remain cautious with shipping exposure and are therefore
unlikely to materially pressure tanker rates over the next two-to-three years. We expect tanker rates to demonstrate stronger performance in 2016 but to remain volatile.
Sovcomflot's business profile benefits from a fairly high share of long-term contracts coverage with USD8.1bn of contracted revenue, half of this will be generated over 2015-2022. About two- thirds of the fleet operated on time charters in 1H15. Operational strength is also underpinned
by a gradual shift towards more profitable segments (eg LNG and offshore), which are expected to account for half of the company's revenue by 2020, from just over a third in 2015. Strong
operations are also supported by the company's leading global position as tankers owner and in certain niche markets, a fairly young fleet and diversified customer base.
Sizeable Capex to Continue
We expect Sovcomflot to remain highly capital-intensive in the medium-term as the company maintains its modern and technologically advanced fleet, and to support its LNG and offshore business. Sovcomflot plans to acquire eight more new vessels (including four Icebreakers, three shuttle tankers and one LNG vessel) over 2016-2017 following the delivery of 1 VLCC and 4 LNG carriers in 2014 and 2015, respectively. All vessels are planned for operation under long-term contracts.
As a result, we do not expect a significant reduction of average annual capex, which will remain around USD500m. Maintenance capex is low at around USD40m annually. As a result of the intensive capex programme, we forecast that Sovcomflot will remain free cash flow (FCF)- negative over 2015-2018, despite rather solid cash flow from operations. This implies that a large portion of its capex is debt-funded.
Diversified Customer Base
Sovcomflot has a diversified customer base consisting of large international and Russian oil and gas players. Exposure to any counterparty is limited to about 10% of revenue. The company has purchased all of its LNG vessels for projects which are currently operational, except for one vessel, which is on order now for the Yamal project. According to Sovcomflot, the rate under long-term contracts is set for the duration of the contract and not dependent on oil or gas prices dynamics.
One-Notch Uplift for State Support
Sovcomflot's 'BB' Long-term IDR incorporates a one-notch uplift to its standalone rating of
'BB-' for state support as Fitch assesses the strategic, operational and, to a lesser extent, legal ties between the group and its 100% parent (the state) to be moderately strong, despite the planned partial privatisation of the company. The strength of the ties is supported by Sovcomflot being integral to the Russian government's energy strategy, Russia's growing oil and gas market, close working relationship with state-owned oil and gas companies and previous tangible financial support.
Senior Unsecured Rating
The rating of the senior unsecured notes remains aligned with the company's Long-term IDR, given adequate unencumbered assets, the value of which remains at 2x of unsecured debt. However, we would consider decoupling the ratings, should the amount of unencumbered assets fall below this level.
Fitch's key assumptions within the rating case for Sovcomflot include:
- No proceeds received by the company from potential IPO.
- 10-year average freight rates for spot operations from 2016; contractual rates for time charters
- Capex and capacity expansion as per management business plan.
Positive: Future developments that could lead to positive rating action include:
- Material improvement of the company's credit metrics, with FFO adjusted net leverage well below 4.5x and FFO fixed charge cover above 3.5x on a sustained basis, due to, among other things, strong recovery of the tanker industry, significant downsizing of the capex programme and/ or reinvestment of IPO proceeds
- Evidence of stronger state support
Negative: Future developments that could lead to negative rating action include:
- Decline of tanker rates and/or more sizeable capex resulting in deterioration of the company's credit metrics (eg FFO adjusted net leverage above 5.5x and FFO fixed charge coverage below 2.5x on a sustained basis)
- Evidence of weaker state support
- Unencumbered assets falling below 2x of unsecured debt, which would lead to a downgrade of the senior unsecured rating.
Fitch views Sovcomflot's liquidity as adequate. The company's unrestricted cash position of USD388.1m at end-9M15, along with its undrawn portion of committed credit lines at USD515m (81% of which is due in 2029), was sufficient to cover its short-term debt of USD271.8m. Its debt repayment schedule is well balanced with a peak in 2017 due to the maturity of its USD800m eurobonds, which the management plans to refinance with new bond issuance. As a global tanker shipping player, the company has demonstrated good access to financial markets, having raised USD920m in bank financing during December 2014-November 2015. We expect Sovcomflot to remain FCF-negative over 2015-2018.
FX risk is low due to natural hedge as the company generates revenue and cash flow in USD and raises debt in USD. Capex is also denominated in USD, while most of operating costs are in USD.
In accordance with Fitch's policies the issuer appealed and provided additional information to Fitch that resulted in a rating action which is different than the original rating committee outcome.
Additional information is available on www.fitchratings.com. 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.