Fitch Affirms Rostelecom PJSC at 'BBB-'; Outlook Negative
OREANDA-NEWS. Fitch Ratings has affirmed Rostelecom PJSC's (Rostelecom) Long-term Issuer Default Rating (IDR) at 'BBB-' with a Negative Outlook. A full list of rating actions is at the end of this comment.
Rostelecom's ratings reflect its strong positions as a fixed-line incumbent operator with a leadership in traditional telephony, broadband internet and pay TV markets in Russia. The company faces limited facilities-based competition outside large cities and benefits from a benign regulatory environment. Fitch expects Rostelecom's leverage to increase moderately to 2.3x funds from operations (FFO) adjusted net leverage in 2016 driven mostly by higher interest expenses. However, it will remain comfortably below the downgrade trigger of 3.5x. The company's rating is capped by the sovereign rating of Russia (BBB-/Negative).
KEY RATING DRIVERS
Strong Incumbent Positions
Rostelecom's is likely to maintain its stable position as the largest fixed-line telephony and broadband operator in Russia, supported by its substantial network capex, effective regulatory protection and improvements in customer service. The company holds a market share of close to 60% in fixed telephony and above 35% in broadband, capitalising on its extensive fixed-line infrastructure.
Stable Revenue Outlook
Fitch projects the company's revenue will remain largely flat with declines in telephony segment compensated by robust performance of broadband and pay TV businesses. The increasing popularity of triple-play fixed-line offerings helps the company to partially address negative developments in traditional telephony, reduce churn and upsell premium services. Further growth in broadband and pay TV segments will likely be supported by acquisition of small regional players.
Operator of National Projects
Rostelecom has been selected as an operator of nationwide projects, such as wiring all polling stations to the internet for video monitoring of the elections, provision of universal services or bridging a digital divide in low population settlements. Rostelecom benefits from these projects as they generate additional revenue/EBITDA and provide various synergies with the company's core operations and create upselling opportunities.
MVNO with Tele2
Rostelecom aims to create a mobile virtual network operator (MVNO) with the fourth-largest mobile operator in Russia, Tele2, in which the company holds a 45% stake. The MVNO will enable Rostelecom to become the first operator providing quad-play services nationwide. Rostelecom does not face significant competition in bundles and the launch of quad-play is aimed at churn reduction rather than further market share expansion. The demand for fixed/mobile bundles in Russia is largely untested, so there is little visibility of market impact from quad-play introduction.
Fibre Project Completion
Rostelecom aims to complete its major fibre rollout project in 2016 covering 33 million households of a total 55 million. The company is well on track with its plan, covering 29.5m households at end-3Q15. Fitch expects that once the project is completed the company will have more flexibility in terms of capex spending. Combined with stable operating cash flow this would lead to improved free cash flow (FCF) generation with mid-single digits pre-dividend FCF margins in 2016-2018.
New Dividend Policy
The company will adopt a new dividend policy by YE2015. The existing policy sets the amount of dividend payouts based on a share of net income. The new policy is likely to focus on FCF and would imply higher dividend distributions. Management believes that the current capital structure is efficient and does not see the rationale for further leverage reduction. Thus a potential increase in shareholders' remuneration seems a reasonable step given company's ability to generate stable FCF.
Rostelecom's leverage was 2.0x FFO adjusted net leverage at end-2014. Fitch expects that the company will be able to finance its investment programme from internal sources demonstrating pre-dividend FCF margin in the mid-single digits. With the upcoming changes in dividend policy, Fitch projects that a major part of FCF will be paid out via dividends, which would keep leverage at around 1.9x net debt/EBITDA or 2.3x FFO adjusted net leverage in 2016-2018.
Low Forex Exposure
Rostelecom is exposed to forex risks mostly via capex, i.e. purchases of equipment denominated in hard currencies. Given the company's strong relationship with vendors it can somewhat mitigate these risks by renegotiating contract terms and getting discounts for large purchase volumes.
Government Control Positive
We view the government's control over Rostelecom as positive. It protects the company from risks that are typical for most Russian companies with a dominant private shareholding such as related party transactions, exposure to other group operations and excessive dividend distributions. Rostelecom is strategically important for the state and it enjoys various forms of indirect support including participation in major nationwide projects and benign regulatory environment. We therefore apply only a one-notch discount to Rostelecom's IDR.
Fitch's key assumptions within the rating case for Rostelecom include the following:
- High-single digits revenue decline in fixed-line telephony segment
- Revenue growth at 3-5% per year in broadband segment in 2016-2018
- EBITDA margin at 33% in 2016-2018
- Capex/revenue ratio at 20% in 2015 and declining in 2016-2018
- Dividend payments at RUB12bn-RUB15bn per year in 2016-2018
- RUB4.5bn spending on execution of put option by Deutsche Bank in 2017
- Gradual increase in cash interest expense as the existing debt is refinanced by more expensive new borrowings
- RUB2.5bn spending per year on acquisitions
Positive: Future developments that could lead to positive rating action include:
- Given that Rostelecom operates mainly in the domestic market, it is unlikely that Rostelecom would be rated higher than the Russian sovereign rating (BBB-/Negative). A change in the Russian sovereign's Outlook to Stable might lead to a change in Rostelecom's Outlook.
- Substantial and sustainable improvements in pre-dividend FCF generation coupled with a stable market position and operating performance could be positive for the ratings. This is only likely to happen when the company has completed its fibre roll-out project, which should lead to lower capex and an improved EBITDA margin.
Negative: Future developments that could lead to negative rating action include:
- FFO adjusted net leverage higher than 3.5x on a sustainable basis.
- Erosion of the company's solid FCF generation, with a pre-dividend FCF margin below 5% on a sustainable basis.
- Deterioration in the company's liquidity.
- A downgrade of the Russian sovereign rating would lead to negative rating action for Rostelecom.
Rostelecom has a robust liquidity profile with existing committed credit lines and cash and equivalents sufficient to cover debt maturities until 2Q17. The company benefits from strong relationships with the largest Russian banks, including state-owned. Rostelecom is actively managing its liquidity position and further improvement is likely by YE2015.
FULL LIST OF RATING ACTIONS
Long-term IDR: affirmed at 'BBB-', Outlook Negative
National Long-Term Rating: affirmed at 'AA+(rus)', Outlook Stable
Senior unsecured: affirmed at 'BBB-' and 'AA+(rus)