OREANDA-NEWS. Fitch Ratings has affirmed OJSC Mobile Telesystems' (MTS) Long-Term Issuer Default Rating (IDR) at 'BB+ and removed all ratings from Rating Watch Negative (RWN). The Outlook on the IDR is Stable. A full list of rating actions is at the end of this release.

MTS is a leading Russian and CIS mobile operator with modest leverage and strong free cash flow generation. It is the largest operator in Russia and the second largest in Ukraine by subscribers. The company is majority controlled by Sistema Joint Stock Financial Corp. (BB-/Stable).

KEY RATING DRIVERS
Litigation Risk for Sistema Removed
The RWN has been removed as we believe that Sistema is no longer at risk from any litigation against it in connection to Bashneft, Sistema's oil and gas subsidiary that was handed back to the state in line with a court decision. This in turn removes the risk that MTS would be negatively impacted by any developments at Sistema.

Fundamentals Overlaid by Shareholding
On a standalone basis, MTS's credit profile is commensurate with a low investment-grade rating. Its ratings are notched down for the negative influence of its controlling shareholder, Sistema. Under Fitch's methodology, a subsidiary can generally be rated a maximum of two notches above its parent in the presence of weak parent/subsidiary links.

Resilient Industry, Weak Economy
The weak economy in Russia will be weighing on the company's growth rates but is unlikely to lead to pronounced revenue pressure, in our view. The telecom industry is likely to demonstrate strong defensive qualities, as was evidenced in the aftermath of the 2008 financial crisis. We expect the company's revenue to remain largely flat supported by continuing strong demand for data. A key risk to this scenario may stem from additional macro pressures, significantly above Fitch's current expectations.

The Russian economic environment is weak with a reported yoy annualised GDP contraction of 1.1% in Jan 2015. The economic outlook for the country remains weak. Fitch expects the economy to contract by 4% in 2015. Consumer confidence has been negatively impacted by significant rouble depreciation in 4Q14. This also triggered a sharp rise in inflation to almost 17% in February 2015 although this is expected to abate by the year end, with Fitch forecasting end-2015 inflation of 8.5%.

Inflation and Cost Cutting
MTS's margins are likely to come under modest pressure, an impact of high cost inflation that may be only partially remedied by continuing efforts to reduce costs and improve efficiency. MTS's cost base is predominantly in roubles, which would protect it from the immediate negative impact of rouble depreciation.

However, a significant portion of network equipment and spare parts are imported. Higher rouble prices on imported items would inevitably weigh on the bottom line. We estimate the company will not be able to compensate this with higher prices as tariffs will not be raised in line with inflation.

Significant Ukraine Investment Unlikely
MTS won a 3G license in Ukraine in February 2015, where the network development is likely to require some parental financing. However, we do not expect significant new investment. Ukraine's business has been consistently cash flow positive as suggested by reported OIBDA minus capex, and should generate sufficient funds for maintaining operations and organic development. Capital controls in Ukraine effectively prohibit any cash outflows from this subsidiary to the parent. Under the circumstances, reinvesting accumulated cash into 3G development is the best available option.

Strong FCF Generation
MTS is likely to maintain or improve its strong FCF generation driven by a disciplined approach to network investment. We expect the company to sustainably maintain pre-dividend FCF margin in the low double-digit territory. Russian telecom operators are bracing themselves for a protracted period of high interest rates and limited liquidity which discourages active expansion plans. MTS is likely to be able to retain its competitiveness even with lower capex as long as its peers also remain disciplined with their investment plans.

Rational Competition To Continue
The Russian market is strongly competitive, with four national facilities-based mobile operators. However, the 2014 merger of Rostelecom's and Tele2 Russia's mobile assets into new company LLC T2 RTK Holding (B+/Stable) reduced disruptive pressures in many regions. While the new operator is targeting higher market share, the focus is likely to be on service quality with contained price competition in key areas, including in Moscow.

Moderate Leverage
MTS's leverage is likely to remain moderate at below 1.5x net debt/EBITDA and 2.5x FFO adjusted net leverage (estimated by Fitch at 1.3x net debt/EBITDA and 1.9x FFO adjusted net leverage without the potential positive impact of hedging and assuming Rub 21bn of restricted cash at end-2014) . High interest rates in Russia encourage deleveraging, but the company is likely to continue paying substantial dividends up-streaming almost the entire FCF to shareholders.

Sufficient Liquidity
The company's debt maturity profile is well spread, with annual principal payments of below RUB50bn per annum (equal to 0.3x of annual EBITDA) till 2019. Heavy rouble depreciation caused the proportion of foreign currency debt to rise to around 25% of the total at end-2014 vs. 23% at end-3Q14. We believe that the brunt of the rouble's depreciation has already taken place, so significant further negative impact from further currency weakness is unlikely. The company has sufficient bank liquidity to cover its short to medium term refinancing needs.

KEY ASSUMPTIONS
- Largely stable revenue
- Modest EBITDA margin pressure, most pronounced in 2015
- Gradually rising interest payments as historic low-interest debt instruments are replaced with more expensive debt
- Capital expenditure at around 22% of revenue
- Generous dividend distributions in the medium term, in line with the current dividend policy
- Modest investments into acquisitions, including into recapitalisation of partially-owned MTS Bank.

RATING SENSITIVITIES
MTS's rating could benefit from an upgrade of Sistema's rating provided that MTS continues to adhere to high corporate governance standards.

A downgrade could arise from weaker corporate governance but also excessive shareholder remuneration and other developments that lead to a sustained rise in funds from operations adjusted net leverage to above 3.0x. Competitive weaknesses and market-share erosion, leading to significant deterioration in pre-dividend FCF generation, may also become a negative rating factor.