Fitch Assigns CJSC Transmashholding First-Time 'BB-' IDR
22 Dec 2016 6:42 AM
Fitch Ratings-Warsaw/London-22 December 2016: Fitch Ratings has assigned Russian CJSC Transmashholding (TMH) first-time Foreign- and Local-Currency Issuer Default Ratings (IDRs) of 'BB-'. The Outlook is Stable.
TMH's ratings reflect a solid financial profile, which is broadly in line with the 'BBB' category for a diversified industrial company. This is characterised by sound operating margins and moderate leverage, offset somewhat by weak free cash flow (FCF) generation. The ratings are limited to the 'BB' category by TMH's limited diversification in terms of both its customer base and reliance on Russian entities for a large portion of its revenue. Corporate governance is also a constraint.
KEY RATING DRIVERS
Limited Business Profile
TMH has a strong position in the Russian locomotive, rail and metro car market. The company has good long-term relationships with key customers such as Russian Railways (RZD; BBB-/Stable) and Moscow Metro. Its relationship with 33.3% shareholder Alstom is a credit positive as it provides the company with strategy, engineering and marketing support.
However, the lack of geographical diversity and the rather low share of revenue derived from service work limits TMH's business profile. The share of export revenue may rise in the medium term but we assume TMH will remain reliant on the domestic market.
Moderate Financial Profile
TMH displays a financial profile which has many attributes of an investment grade diversified industrial and capital goods company. TMH's strong operating margins, both EBIT and funds from operations (FFO), and leverage, are broadly in line with those of an investment grade credit. Fitch views management's financial policy as conservative, which combined with a reasonably flexible operating cost structure, supports Fitch's expectation that key ratios are likely to remain stable through the rating horizon of 2016-2019.
Poor FCF Generation
The company's FCF is a constraint on the ratings. FCF has been negative for the past two years and will likely be negative again in 2016, beyond which we expect it to be positive, albeit weak, limited by high capex as well as working capital outflows.
Fitch expects capex to rise to over 6% of revenues through the medium term, from between 4% and 5% for the past three years, as the company extensively modernises its production sites. We expect significant recent working capital outflows, totalling RUB20bn in 2014-2016, to peak this year, with future working capital cash flows expected to reverse some of the prior build-up.
Fitch views TMH's corporate governance as a negative for the ratings, although this is in line with other rated privately-held Russian corporates. TMH has no independent board members and there is no audit committee, although a strategy committee is committed to a conservative and consistent financial policy. TMH also benefits from having three board members from Alstom. TMH's related party transactions are now limited since Russian Railways sold its stake in the company.
Volatile Market Dynamics
The Russian market for locomotives, rail and metro cars, motorised multiple units and trams is driven by the capex decisions of a few key operators, most of which are state- owned, and thus tends to be volatile. The market is expected to grow at mid-single digits in the medium- to long-term as a result of material pent-up demand to modernise fleets.
The recent RUB depreciation has helped TMH further cement its domestic market position, as it can offer materially lower prices without sacrificing its margins, while foreign producers do not have that flexibility. The share of export revenue is expected to remain broadly stable through the short term but could rise in the medium term.
Potential Bond Issuance
TMH's plan to issue RUB-denominated bonds would be a positive factor, by refinancing existing debt and further extending the maturities of the existing debt. However, existing debt at operating subsidiaries could result in holding company debt being structurally subordinated to operating company debt, which could result in the rating of the bond being notched down from the IDR.
TMH's 'BB-' rating is well-positioned relative to peers. A weaker geographical diversification compared with its global peers and weak FCF generation are offset by a strong local market position, long-term contracts and good relationship with key customers as well as an overall solid capital structure. No country-ceiling or parent / subsidiary aspects impact the ratings.
Fitch's key assumptions within our rating case for the issuer include:
- Revenue growth in 2016 and 2017 driven by unit production rise, while average prices remain stable
- Operating cost structure to remain broadly stable, leading to limited uplift in margins
- Capex at between 5% and 7% p.a.
- No dividend paid in 2016 and a gradual lift in dividend payments from 2017, assuming profitability increases
- Debt maintained at current levels
Future developments that may, individually or collectively, lead to a positive rating action include:
-Improved geographic, customer and service diversity
-Gross leverage remaining below 3x (2015: 3.2x; 2016E: 2.5x)
-FCF margin above 2% (2015: -3.2%; 2016E: -1.4%)
-Fixed charge cover above 4x (2015: 3x; 2016E: 3.3x)
Future developments that may, individually or collectively, lead to a negative rating action include:
-Gross leverage above 4x
-Negative FCF on a sustained basis
-Fixed charge cover below 3x
Fitch views the liquidity position of TMH as satisfactory. At end-September 2016, the group reported cash and short-term deposits of RUB7.1bn (end-2015: RUB9bn) on its balance sheet against short-term debt of RUB11.5bn. Almost all of the cash is held in RUB, with only 3.5% in EUR and USD. This is broadly matched with the currency of debt, as 100% of the debt is held in RUB. Approximately 15% of total cash is held at the holding level (TMH) with the remainder located at various operating entities.
TMH also had combined RUB29bn in available credit lines at end-September 2016 (across various operating entities) from major Russian banks. Maturities peak in 2H17, with RUB15.9bn due for repayment. A potential local bond placement of up to RUB10bn as well as the ongoing negotiation of the loan extensions could help spread maturities more evenly.
We forecast that FCF will be minimal until the end of the decade due to high capex. However, we do not expect the company to have material problems refinancing over the medium-term due to its good relationships with major Russian banks.
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Date of Relevant Rating Committee: 30 November 2016
Summary of Financial Statement Adjustments
Operating leases: operating lease expenses were capitalised using a multiple of 6x as the company is based in Russia.
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Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
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