OREANDA-NEWS. Fitch Ratings has affirmed Russia-based Ventrelt Holdings Ltd's Long-Term Foreign Currency Issuer Default Rating (IDR) at 'BB-' with Stable Outlook. A full list of rating actions is at the end of this commentary.

The affirmation reflects Ventrelt's stable operations as water and waste water operator, the company's long-term leasing and concession agreements with municipalities, solid credit metrics over the rating horizon, bond refinancing in 2015 and a comfortable debt maturity and liquidity profile. However, Ventrelt's ratings are constrained by its limited size and diversification relative to larger peers and 'BB' rated Russian companies, as well as the evolving regulatory framework for tariff-setting. In addition, its capex relative to cash flow is sizeable and results in negative free cash flow (FCF) for 2016-2017.

KEY RATING DRIVERS

Improved Financial Profile

Ventrelt reported better than expected 2015 financial results, mainly driven by cost cutting. At the same time, the company has spent the necessary capex as per the concession agreements. Staff costs have increased at a rate significantly lower than inflation. The EBITDA margin increased to around 21% in 2015 from an average 17% over 2012-2014. Improved profitability helped reduce leverage. To better capture operational performance, Fitch calculates net debt/connection fee adjusted EBITDA (deducting connection fees - the capital element included in EBITDA) that decreased to 1.2x at end-2015 from 2.7x on average over 2012-2014.

Our forecasts of Ventrelt's 2016-2019 EBITDA are based on our expectations that tariffs will be capped by CPI, which is on average 200bp below annual approved tariffs growth rate. Fitch forecasts the EBITDA margin to slightly deteriorate to 18% on average over 2016-2019 due to expected decreased water supply and drainage volumes as well as our assumption that fixed operating costs will be inflated at a rate slightly outpacing water supply and drainage tariffs growth.

Tariffs Capped by Inflation

Fitch expects the pre-election period in Russia and economic slowdown might affect the company's performance and favourable tariff-setting. Despite the fact that the regulator approved long-term tariffs for all Ventrelt's water channels until 2019, the company expects the 2017-2019 tariffs to be capped by inflation. In our base case, we forecast tariffs to grow slightly below inflation. Ventrelt provides services mainly to households, which are heavily affected by the downturn. However, the company's cash collection rates remained at historical levels of around 98% as of end-2015 and do not materially impact working capital.

Equity Injection Received

At 10 June 2016, Ventrelt had received USD16.2m (RUB1bn) equity injection from its key shareholder Alfa Group to repay an existing loan at the Ventrelt Holding Ltd level within the de-offshorisation law signed by the president at end-2014, i. e. an EBRD loan of RUB375m, as of 30 June 2016 as well as a RUB580m loan at UK Rosvodokanal from Raiffeisenbank and EBRD loan of RUB23m at Tver Vodokanal LLC. We believe the equity injection could improve the Ventrelt's credit metrics. We estimate this equity injection will reduce net debt/connection fee-adjusted EBITDA to around 1.0x on average for 2016-2019, which would be sufficient to ensure credit metrics remaining within our rating guidelines, even with substantial capex needs.

Decreased Cost of Debt

At the beginning of July 2016, Ventrelt refinanced its remaining EBRD loans of RUB814m at Barnaul Vodokanal, RVK Voronezh and Orenburg Vodokanal levels (around 14% from company's total debt as of end-1H16), maturing in 2021-2024 with a floating rate of MosPrime3M+margin with a loan from Rosbank (BBB-/Negative) at a fixed interest rate of 12.1% maturing in five years. This results in a more favourable cost of debt for the whole group. According to the company, the existing upstream and cross-sureties under the EBRD loan remain in place for the new loan, with an exception of sureties from Tver Vodokanal. We note that a lower level of upstream and cross-sureties would likely weaken the links between operating and holding companies within the group, which may result in reconsidering our rating approach to Ventrelt. However, we do not expect this to materialise in the rating horizon.

Sufficient Liquidity

At 30 June 2016, Ventrelt had adequate liquidity of RUB4.1bn cash and cash equivalents (including RUB1bn cash from equity injection), which accompanied by unused credit facilities of RUB5.6bn from multiple banks, including Alfa-Bank (BB+/Negative), Vnesheconombank (BBB-/Negative) and AO Raiffeisenbank (BBB-/Negative) comfortably covered the company's short-term maturities of RUB1bn. We note that a major part of outstanding debt is represented by RUB3bn 13.5% bonds maturing in December 2020. Fitch expects Ventrelt to continue generating solid cash flows from operation. However, FCF is likely to be negative in 2016-2017 due to capex needs. At end-2015 outstanding loans were rouble-denominated.

Refinanced Bond Benefits From Sureties

At end-2015, RVK-Finance (a wholly-owned indirect subsidiary of Ventrelt) issued a RUB3bn local bond to repay RUB3bn loans, which were raised to redeem the RUB3bn November 2015 bond. The bond benefits from sureties totalling RUB3bn provided on a several basis by RVK-Invest LLC, Krasnodar Vodokanal LLC, Tyumen Vodokanal LLC, Barnaul Vodokanal LLC and Voronezh Vodokanal LLC, which are all wholly-owned indirect subsidiaries of the group. The senior unsecured rating is equal to Ventrelt's Long-Term Local Currency IDR, reflecting that the level of prior-ranking debt is below Fitch's threshold of 2.0x-2.5x EBITDA. In addition, the combined EBITDA of subsidiaries providing sureties for the bonds comprised 60% of the group's 1Q16 EBITDA.

Expansion Strategy

Ventrelt remains Russia's leading private water and wastewater operator operating under the name of Rosvodokanal, serving about 5.1 million customers in Russia, operating about 15,000km of water and sewerage pipelines and supplying over 580 million cubic metres of water annually. Its strategy envisages further expansion into Russian cities with at least 350,000 residents. It plans to participate in most of the available tender for concession agreements, although the company intends to remain focused on profitability according to management. We view this as an aggressive target, given potential investment needs and considering that most Russian water utilities continue to be owned by municipalities.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Domestic GDP decline of 0.7% and inflation of 8.2% in 2016

- Tariffs to increase slightly below inflation over 2017-2019

- Capital expenditure in line with management's forecasts

- Equity injection of RUB1bn in 2016 with simulations repayment of respective debt

- Absence of dividend payments over the rating horizon

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action, include:

- Increased revenue and earnings visibility following the implementation of long-term tariffs.

- Sustainable positive FCF generation.

Negative: Future developments that may, individually or collectively, lead to negative rating action, include:

- An increase in leverage above 4x net debt/connection-fee adjusted EBITDA to fund additional capital expenditure or acquisitions.

- A sustained reduction in cash generation through a worsening operating performance or deteriorating cash collection.

FULL LIST OF RATING ACTIONS

Ventrelt Holdings Ltd

Long-Term Foreign and Local Currency IDRs affirmed at 'BB-'; Stable Outlook

National Long-Term rating affirmed at 'A+(rus)'; Stable Outlook

RVK-Finance LLC (wholly-owned indirect subsidiary of Ventrelt Holdings Ltd)

Local currency senior unsecured rating affirmed at 'BB-'

National senior unsecured rating affirmed at 'A+(rus)'