S&P: State-Owned Railway Operator JSC Georgian Railway Downgraded To 'B+' On Declining Freight Volumes; Outlook Stable
At the same time, we lowered our rating on GR's senior unsecured bonds to 'B+' from 'BB-'.
The rating action primarily reflects our assessment that the financial leverage at Georgian Railways has increased as a result of the decline in freight volumes in the first half of 2016, and will recover to previous levels in the next 12-24 months.
We estimate that, in the first eight months of the year, GR has lost up to 47% of oil product turnovers, one of its most profitable cargo types. There was also a decline of about 16% in dry cargo volumes, with some items falling by more than 30%. The causes vary between cargo types and include weaker economic environments in neighboring economies and repair and maintenance works in the oil and gas processing plants that supply liquid products. The increase of about 78% in sugar turnovers helped to keep the dry cargo decline relatively moderate, compared to the oil products.
GR has managed to grow volumes of crude oil transportation by up to 70% thanks to a contract with Turkmenistan. However, the smaller absolute numbers and lower profitability of crude oil operations limits the positive effect on overall performance. Overall, the financial results have weakened at GR. We now expect that its debt to EBITDA will increase to more than 5.0x and funds from operations (FFO) to debt will be below 12% at the end of 2016, compared with the 2015 levels of 3.2x debt to EBITDA and 24% FFO to debt.
At the same time, we expect financial metrics to improve in 2017 and 2018, following the recovery of transportation volumes on major freight types. Certain types of goods, such as oil products, sugar, and grains, have already demonstrated positive dynamics in August and we expect the trend to continue in the coming months. We have consequently revised our view of GR's financial risk profile to aggressive, which reflects our expectation that its debt to EBITDA will stay below 5x and FFO to debt above 12% in 2017, with both ratios improving further in 2018.
Our base case assumes: Revenues to decline by 23%-27% in 2016 with a subsequent recovery of 10%-15% in 2017-2018.S&P Global Ratings-adjusted EBITDA margin to fall to 45%-50% in 2016 and stay in the 45%-50% area over the next two-to-three years. Dividends distributed in line with company policy. Based on these assumptions, we arrive at the following credit measures: Debt to EBITDA of 5.0x-5.5x in 2016, 4.5x-5.0x in 2017, and 4.0x-4.5x in 2018.FFO to debt of 8%-12% in 2016, 12%-15% in 2017, and 15%-19% in 2018.We continue to assess GR as a government-related entity with a very high likelihood of government support. Our view is based on our assessment of GR's:Very important role for the Georgian government given GR's monopoly position as the manager and owner of the national rail infrastructure and sole nationwide rail freight provider. In our view, GR plays a key role in implementing Georgia's infrastructure development plan, underpinning its strategic importance for the government and the economy. Furthermore, GR is a major player in the domestic economy, with revenues accounting for about 2% of Georgian GDP. In addition to being the largest employer in the country, with about 12,500 staff, GR is also one of the largest taxpayers in Georgia; andVery strong link with the Georgian government, given that it is 100% state-owned (via the fully government-owned State Partnership Fund), even though the state may dilute its ownership through an IPO of a minority stake. The government retains control of the company and appoints its management and supervisory board via the Partnership Fund, thus retaining control over main strategic decisions. The stable outlook on GR reflects our expectation that the company should be able to stabilize its operating performance in the remaining months of 2016 and begin to gradually improve its financial measures. We expect that the company should be able to maintain its margins within the 40%-50% range and its FFO-to-debt measures will be sustainably above 12%.
We could lower our ratings on GR if the company were unable to stabilize its performance and maintain EBITDA margins above 40% or if its FFO-to-debt ratio were to stay below 12% for a sustained period. We could also take a negative rating action if company's cash balances deplete, materially weakening its liquidity position. Also, if we were to downgrade Georgia, we would likely take a similar rating action on GR.
We could raise the rating on GR if the company were to demonstrate meaningful improvement in its operating performance and profitability, leading its FFO-to-debt ratio to increase sustainably to above 20% and debt-to-EBITDA ratio to fall below 4x.