Fitch assigns Azerbaijan Railways 'BBB-' rating

Fitch assigns Azerbaijan Railways
# 07 July 2014 13:45 (UTC +04:00)

Baku - APA-Economics. Fitch Ratings has assigned Azerbaycan Demir Yollari (Azerbaijan Railways Closed Joint Stock Company; ADY) a Long-term Issuer Default Rating of 'BBB-',Reuters reported. The Outlook is Stable. ADY's rating is aligned with that of Azerbaijan ('BBB-'/Stable), its 100% shareholder.

The rating alignment primarily reflect Fitch's assessment of ADY's links with its parent as strong, in accordance with Fitch's Parent and Subsidiary Rating Linkage criteria (available at Fitch's assessment considers ADY's high strategic importance to the national economy, including its position in transport of export-bound oil and oil products as well as freight transit, which are significantly contributing to the economy of Azerbaijan. The agency also views the operational links as strong due to the government's involvement in tariff setting, capex planning and funding, financial and business strategy and policy setting.

Legally, Fitch anticipates that ADY will remain 100% state owned in the foreseeable future, but notes that ADY's debt is not guaranteed by the government. The debt level is relatively modest (AZN227m at YE11), but Fitch does not anticipate any increase in the coming years. Any debt increase, especially if not guaranteed by the government would likely result in ADY's rating being notched down from the sovereign rating. Additionally, in Fitch's view, leverage above 2.0x could be detrimental to ADY's senior unsecured creditors (43% of total debt) relative to ADY's senior secured creditors (53%).

The agency views the government-approved tangible support in the form of significant committed state funds (both directly from the state budget - USD1.3bn equivalent and borrowed by the state without recourse to ADY - USD450m and EUR287m) for ADY's extensive capex programme over 2012-2016 (USD2.5bn) as a key factor for the rating alignment. Fitch expects these funds to be contributed to ADY as permanent equity, with the remaining 15% of the capex (and additional maintenance capex of around AZN30m p.a.) to be funded from operating cash flows of the company. A change in the proposed funding terms may result in ADY's rating being notched down from the sovereign rating.

Fitch assesses ADY's standalone credit profile as low in the 'BB' rating category. This is supported by its monopoly position, healthy profit margins, especially on transit cargoes, and the integrated nature of its business. However, its small size compared to some regional railway groups and exposure to higher event risk stemming from its concentration on two key routes and geopolitical events are constraining the ratings.

Fitch views Georgian Railway JSC (GR, 'BB-'/Stable) as ADY's closest peer, due to their similar operations and size. Fitch notes that GR's gross leverage and also profit margin are expected to be slightly higher than ADY's. The agency believes that ADY's business may benefit from the modernisation of the South-North corridor from Iran to Russia while both peers will similarly benefit from a new link with Turkey.

Fitch notes that ADY's expansionary capex is only committed to the extent that the earmarked government funds are available. ADY's liquidity excluding this capex is adequate, due to healthy operating cash flow and amortising structure of most of its debt.

ADY's rating will likely remain at the current level if the sovereign rating of Azerbaijan is upgraded to 'BBB' and ADY's links with the government remain the same (i.e. not benefiting from government guarantees for ADY's debt). A negative sovereign rating action would be replicated for ADY. ADY's rating would also be downgraded if the company's links with the government weaken, for example as a result of weaker tangible support.