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Fitch Affirms Ukraine's Lemtrans at 'CCC'; Withdraws Ratings

July 14, 2016 | Cbonds

Fitch Ratings has affirmed Ukraine-based transport company Lemtrans LLC's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'CCC' and simultaneously withdrawn them for commercial reasons.

Lemtrans' ratings reflect its position as the largest private freight rail operator in Ukraine (CCC) with a market share of about 20% in freight transportation in open wagons, but also consider its exposure to the operating environment in Ukraine and financially weak customers. Its two major customers, DTEK Holdings B.V. (DTEK; RD) and METINVEST B.V. (Metinvest; RD), which accounted for about 90% of the company's revenue in 2015, are currently in the process of restructuring their obligations. This is mitigated by the fact that Lemtrans operates under prepayment terms and its transportation services are essential for DTEK's and Metinvest's operations. Both companies are the largest industrial companies in Ukraine and are part of the same holding group as Lemtrans - System Capital Management Limited (SCM).

Political Uncertainty Remains
The political and economic environment in Ukraine remains unstable, although the conflict in the Donetsk and Lugansk regions has subsided. Lemtrans does not have any significant fixed assets in these regions. However, a large portion of cargo is located there, as both DTEK and Metinvest have a fairly significant share of assets in these areas that weight on its operational and financial standing and uncertainty. Although DTEK and Metinvest reported a decline in their output over 2015, the effect on Lemtrans was smoothed as its share of the companies' total transportation needs increased to about 90% in 2015 from around 50%-75% in 2014. Fitch expects Ukraine's GDP to increase by about 1% and inflation to moderate to about 15% in 2016.

Higher Dividends
Lemtrans made contributions to its shareholder in the form of dividends and other financial contributions. The company's policy is that contributions to the shareholder must not exceed 50% of the company's net income. However, Lemtrans calculates this ratio as sum of dividends since 2010 divided by cumulative net income since 2010, allowing it to pay a substantial amount in 2015 (about five times higher than the previous year). Given the lower cash flow generation of the shareholder's main assets (DTEK and Metinvest) we assume a dividend payout ratio at 100% of net income in 2016-2019.

FX Linked Debt
Lemtrans is vulnerable to FX fluctuations as all of its debt at end-2015 (UAH2.9bn) is either linked to RUB or US dollar exchange rates or USD-denominated. However, FX risk is mitigated by a natural hedge as the majority of Lemtrans' tariffs is linked to the USD/UAH exchange rate, and by some foreign currency cash holdings (UAH659m or about 71% of total cash and cash equivalents) mainly in USD and EUR. At end-2015 Lemtrans reported funds flow from operations (FFO) adjusted gross leverage of 1.3x, down from 2.3x at end-2014. However, with leases and debt denominated in foreign currencies, a steep, sustained UAH weakening against the USD and RUB as well as a revision of the FX-linked tariff mechanism could weaken Lemtrans' credit metrics.

Strong 2015 Results
In 2015 Lemtrans reported revenue of UAH8.4bn and EBITDA of UAH1.9bn, a 56% and 76% year-on-year increase, respectively, on the back of a 75% revenue increase from freight transportation in its own rail fleet, which represented about 90% of total revenue. This was mainly due to an increase in infrastructure tariffs and to the hryvna depreciation, as the company's tariffs are tagged to the UAH/USD exchange rate, as well as 13% transportation volumes growth.

Lemtrans' EBITDA margin slightly improved to 22% in 2015 from about 20% in 2014. However, we expect EBITDA margin to slightly deteriorate to about 20%-21% over 2016-2018 due to overall continued weak market fundamentals, slowing hryvna depreciation, inflationary burden and continued pressure on two major customers' operating results. Fitch notes the latter reported some improvement in 1Q16 production volumes on year-on-year basis and that Lemtrans still has some headroom to increase its share in DTEK's and Metinvest's transportation needs.

Tariffs Increase
The state-owned Public Joint Stock Company Ukrainian Railway (UR; CCC) increased tariffs for cargo transportation by 30% from 1 February 2015 for all freights except coal, for which the tariff was increased by 10% and a further 18.2% from 1 April 2015. Another 15% tariff increase was approved from 1 April 2016. These tariff increases have not affected Lemtrans' margins as the company managed to pass the increase in tariffs onto customers.

Negative Free Cash Flow Expected
Fitch expects Lemtrans to continue generating solid cash flow from operations (CFO) of about UAH1.2bn on average over 2016-2019. For 2016 Lemtrans expects to scale down its investment programme to a maintenance level of about UAH0.1bn. However, its free cash flow may turn negative in 2016, mainly on the back of our expectations of increased dividend payments. We expect Lemtrans to rely on new borrowings to finance cash shortfalls. However, Lemtrans' capex programme is subject to market conditions and could be revised downwards if needed, as it mainly relates to the acquisition of new rail fleet and the modernisation of the existing rail fleet.

Fitch's key assumptions within our rating case for the issuer include:
- Transportation volumes to grow in line with domestic GDP, which we expect to grow by 1%-2% annually over 2016-2018.
- Inflation to grow at 15% in 2016 and at 5%-10% in 2017-2018.
- Tariff growth to reflect the currency depreciation, which we expect to weaken at about inflation level.
- Inflation driven cost increase over 2016-2018.
- Dividend pay-out ratio of 100% over 2016-2018.
- Capex in line with management's expectations for 2016-2017, at about the maintenance level in 2016 with an increase in 2017 to above the historical average of 2012-2015. Thereafter we expect capex to remain at the 2017 level.

Not applicable as the ratings have been withdrawn

At end-2015 Lemtrans' cash and cash equivalents stood at UAH925m, which just cover the upcoming short-term maturities of UAH919m, comprising UAH561m of finance lease and UAH358m of borrowings. Liquidity will depend on capex and on dividend pay-out. We expect liquidity to remain tight.

The company's liquidity position is weakened by its high exposure to domestic banks. At end-2015 about 98% of cash was deposited at First Ukrainian International Bank (FUIB), a related party bank. In our analysis, we assume a portion of cash held at FUIB as restricted due to its related party status and low credit quality of Ukrainian banks.

Company: Lemtrans

Full company nameLemtrans Ltd
Country of riskUkraine
Country of registrationUkraine


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