Fitch Affirms DME Ltd and DME Airport's Notes at 'BB+'; Outlook Negative
The ratings have been affirmed despite weaker operational and financial performance in 2015 and 1H16 as DME's leverage remains low at 2.1x (total debt/EBITDA at YE 2015, below previous expectation of 2.4x under Fitch rating case), and in Fitch's view the airport should be able to withstand the currently observed stresses.
We considered DME's rating in line with investment grade when we initially rated it, but corporate governance risks and some political and regulatory uncertainty constrained the rating to sub-investment grade. Consequently, the ratings have some headroom to accommodate the current negative trends. The Negative Outlook reflects further potential deterioration in performance beyond Fitch's current expectations as traffic decline has not yet stabilised.
DME's traffic declined by 7.5% in 2015 and by 9% during the first eight months of 2016. The loss of traffic in 2015 reflected the economic decline in Russia with a significant 20% reduction in international traffic while domestic traffic continued to grow. Since 4Q15, the traffic decline also reflects the bankruptcy of Transaero, but mostly flight restrictions to Egypt and Turkey. Flight restrictions to Turkey were lifted at the end of August and we expect a marginal positive impact on traffic from September. DME lost its leadership of the Moscow aviation hub in 2015, with its market share declining from 43% in 2014 to 39% in 2015 due to dynamic competition from the other two main airports Sheremetyevo (SVO) and Vnukovo (VKO).
2015 revenues declined by 4% to RUB39.4bn and 1H16 revenues continued to decline at about the same rate. As DME generates almost 50% of revenues in USD and EUR, Fitch expected a positive impact on rouble revenues as a result of rouble devaluation in 2014, all else being equal. However, the substantial decline in international traffic, which contributes the bulk of FX revenues, and generally weaker operational performance resulted in an overall revenue decline. Compared with 2013, FX-denominated revenues in absolute terms declined by about 40%, although their share of total revenues is still high at the current exchange rate.
2015 EBITDA declined by 12% to RUB14.8bn and we understand from management that this trend continued in 1H16. Lower EBITDA also reflects the compression of operating margins in auxiliary aviation services such as jet fuel sales, fuelling and storage, catering and commercial activities. Nevertheless DME's leverage remains low with gross leverage at 2.1x at the end of 2015 and estimated to be the same level in 1H16.
The capex programme to expand the terminal complex has been delayed, with most of the expenditure shifting into later years. About a quarter of the planned capex has been spent so far, without the need to raise additional debt. The construction of Terminal 2 started in 2014 with a revised completion in 2018. DME is using cash flows from operations and previously accumulated internal liquidity to fund the near-term capex, but may need to raise additional debt in 2017/2018.
KEY RATING DRIVERS
Revenue Risk (Volume): Midrange
DME benefits from a strong O&D traffic base with Moscow's large catchment area of 36.8 million inhabitants, which represents most of Russia's air traffic. However, traffic at DME is leisure-dominated. The main airline operating at DME is S7, which accounted for 29% of departure seats in 2015. Fitch expects the exposure to S7 to increase in 2016 with the loss of Transaero. DME has elevated historical peak-to-trough volatility, with a peak-to-trough decline of 12.9% in 2009. DME competes with two other airports in Moscow - SVO, which hosts Russia's national flag carrier Aeroflot, and VKO. A fourth Moscow airport Zhukovsky started operations in 2016, although due to its small size, we expect competition to be limited.
Revenue Risk (Price): Midrange
DME's revenue structure remains well diversified as the airport provides a comprehensive range of services. Until early 2016, DME operated under a dual-till regime with regulated aviation and mostly unregulated auxiliary and commercial services. In early 2016, the regulation of aviation services was lifted and DME can now set tariffs with supervision from the regulator. However, we have maintained a Midrange assessment for price risk due to the lack of track record of operations in the liberalised regime and dynamic competition among Moscow airports.
Infrastructure Renewal: Midrange
DME's runway capacity is sufficient for current operations and growth, but substantial investments are required into expansion of the terminal complex and related equipment. The planned capex programme was delayed in 2013-2015 with the majority of expenditure shifting into later years.
Debt Structure: Weaker
DME Airport Limited (an Irish SPV) issued USD300m notes and on-lent the proceeds to Hacienda Investments Ltd (Cyprus), a subsidiary that owns most of the airport's fixed assets. The loan is guaranteed by the holding company DME Ltd and several other of DME's operational subsidiaries on a joint and several basis. The guarantors' combined EBITDA and total assets should amount to at least 85% of the consolidated group's EBITDA and total assets. The notes are structured as corporate unsecured debt. The notes bear foreign exchange risk and refinancing risk with a bullet maturity 2018.
Fitch's expects that DME should be able to refinance despite weaker performance and materially lower FX-denominated revenues, which have declined by about 40% from 2013 levels as a result of loss of international traffic. This view is supported by reasonable leverage expectations and continued partial natural hedge through a portion of FX revenues.
DME's leverage remains low with total debt/EBITDA of 2.1x at YE2015, which is below Fitch's previous expectation of 2.4x. Fitch rating case assumes 12% traffic decline in 2016 and a gradual recovery afterwards, and our projections have been updated to reflect the updated investment plan with some further capex postponement and full use of internal liquidity to fund the near-term capex needs. We now project gross leverage at 2.6x at YE 2016, peaking at 2.7x in 2018 under the revised rating case.
Future developments that could lead to negative rating action include:
- Consistent deviation in financial performance from Fitch's rating case.
- Significant decline of the share of revenues collected in USD/EUR.
- Consolidated net debt/EBITDA above 4x under Fitch's rating case.
Rating upside potential is limited. However, we could revise the Outlook to Stable when quarterly year-on-year traffic stabilises.
SUMMARY OF CREDIT
The group owns the terminal buildings and leases the runways and other airfield assets from the Russian government. DME Airport Limited is an SPV registered in Ireland.