London, 30 June 2020 -- Moody's Investors Service (Moody's) has today affirmed the Baa2 issuer
rating and senior unsecured bonds ratings of Russian Railways Joint Stock
Company (RZD), the state-owned monopoly owner and operator
of Russia's rail infrastructure. Concurrently, Moody's has
affirmed the Baa2 backed senior unsecured rating and senior unsecured
bonds ratings of RZD Capital PLC. The outlook on both entities
has been changed to negative from stable.
Today's affirmation of RZD's ratings with a negative outlook reflects
the evolving pressure from the unprecedented coronavirus outbreak on the
company's operating and financial performance. Moody's
also notes the increasing role of the Russian Government (Baa3 stable)
in shaping up the company's credit profile and leverage in particular,
stemming from RZD's limited flexibility to scale down strategically
important for the state investment projects, to enable it to operate
within its internal financial policy and leverage guidance at times of
market downturn, and also recognising state support measures provided
on the funding side.
Moody's, however, expects RZD to be able to restore
its strong standalone credit profile in 2021-22, although
the recovery pace is subject to persisting uncertainties around the evolution
of the pandemic and the global economic outlook.
The rapid spread of the coronavirus outbreak, deteriorating global
economic outlook, low oil prices, and high asset price volatility
have created an unprecedented credit shock across a range of sectors and
regions. We regard the coronavirus outbreak as a social risk under
our ESG framework, given the substantial implications for public
health and safety. Transportation, including rail services,
is among the sectors, that face the greatest earnings pressure globally
and in Russia, given its sensitivity to consumer demand and business
activities. As a result, Moody's expects RZD's
adjusted EBITDA to decline by around 25% driven by a drop in volumes
across the freight, logistics, and passenger rail transportation
segments and the deep discounts the company is providing to support the
Given the critical dependence of Russia's economy on its rail transportation
system and the important social role, Moody's expects RZD
to secure additional state funding in various forms to help it through
the crisis. Although this may imply some greater reliance on the
state, the severe coronavirus crisis has made the support from the
government an important factor across many sectors of the economy including
privately-owned companies and RZD will likely restore its fundamentally
strong standalone positioning as its operations are back to normal.
At the same time, a greater level of support considered by the government
to RZD mostly aims at preserving RZD's ability to fund and execute
strategically important for the country development projects, while
operationally, the company's reliance on the state remains
limited to direct financial aid for its smaller passenger segment and
some tax allowances.
Moody's also notes that, despite the government's proven
track record of a rational approach towards RZD, the company's
flexibility to adjust its ambitious development programme in line with
the internal conservative financial guidance has somewhat reduced given
the high strategic importance of most of its sizeable projects.
Thus, despite certain cuts, the remaining RUB720 billion capital
spending plan on the consolidated group basis (or RUB640 billion on a
standalone basis) will still be substantial relative to RZD's weaker
earnings, even if some further reductions because of delays or implementation
bottlenecks are assumed.
At the same time, to mitigate the pressure on its capital structure
and limit the state's direct financial support, RZD is placing
a debut for the Russian capital market perpetual bonds issue (total amount
of the program is RUB370 billion) with no maturity and optional cancellation
of coupon payments, which the company and its auditors will treat
as equity. The government, in turn, helped RZD arrange
this issuance by setting-up a regulatory framework and will also
compensate the bondholders if RZD decides to skip coupon payments.
Moody's expects RZD to retain its prudent approach and, in
case it fails to place the bonds in full, to reduce the investment
programme accordingly or request additional funding from the state.
As a result, despite an imminent temporary step-up in RZD's
leverage in 2020, it will remain fairly comfortable with its reported
net debt/EBITDA at below 3.5x. On a Moody's-adjusted
basis, RZD's debt/EBITDA may increase up to 4.5x (assuming
0% equity credit for perpetual bonds), which Moody's
views as still adequate in the currently suppressed market. The
deterioration in credit metrics in 2020 will also be mitigated by RZD's
good liquidity, supported by its continuing access to domestic and
international debt capital markets. The company's consistent
focus on preserving its historically sound financial profile should further
help it weather the crisis, while gradually restoring its financial
position in 2021-22.
In addition, although the first RUB30 billion tranche under the
perpetual bonds programme will qualify for the 'basket A'
(100% debt treatment) for the calculation of the credit ratios
by Moody's (please refer to Moody's "Hybrid Equity Credit" methodology
published in September 2018) because of the 0.5% coupon
step-up provision in year five, the agency acknowledges a
greater (compared to senior unsecured class of the company's debt)
loss absorption capacity of the new instrument given there is (1) no event
of default provision; (2) optional deferral of coupon payments on
a non-cumulative basis; and (3) legal subordination of the
new instrument to the company's senior debt. Moreover,
although all subsequent tranches will have basic terms unchanged (no maturity,
subordination, discretionary coupon payment), they may still
vary resulting in a different classification across the baskets.
Thus, in case no coupon step-up takes place before year ten
and it is less than 100 basis points over the life of the bond,
all other terms equal, we will be classifying such tranche in the
'basket C' (50% equity credit), subject to the
continued limited use and current specifics of the company's existing
preferred shares programme, which RZD uses solely for the purpose
of receiving the state funding from the National Wealth Fund for its Far
East infrastructure projects.
With this background, Moody's incorporates some tolerance
for higher adjusted leverage into RZD's current rating. In
particular, while the company's leverage will likely reduce
by 2022 to within its internal target of reported net debt/EBITDA of 2.5x
and not exceeding 3.0x at temporary peaks, Moody's
would expect its adjusted debt/EBITDA (adding perpetual bonds to debt)
to go back down to below 4.0x on sustained basis in 2022.
RZD's Baa2 issuer rating reflects a combination of (1) its baa2 Baseline
Credit Assessment (BCA), which is a measure of the company's standalone
credit strength; (2) the Russian Federation's Baa3 local-currency
rating; (3) the high default dependence between RZD and the government;
and (4) the high probability of state support for the company in the event
of financial distress. RZD's BCA continues to factor in the company's
fundamentally strong standalone credit profile, with a degree of
resilience against the macroeconomic decline and sovereign stress,
supported by its (1) viable business model and strategically important
market positioning as the monopoly owner and provider of rail infrastructure
services; (2) diversified customer base and significant share of
export freight volume; (3) conservative financial policy and strong
liquidity; (4) improving transparency and flexibility of tariff setting;
and (5) still stronger leverage metrics at the distress compared with
those of its European peers with higher ratings.
RATIONALE FOR THE NEGATIVE OUTLOOK
The negative outlook reflects the continued uncertain prospects for the
rail transportation market recovery, which along with reduced flexibility
to adjust its extensive investment programme may constrain RZD's
deleveraging in 2021-2022.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
The rating is unlikely to be upgraded in the short term. Over time,
upward rating pressure could emerge if Moody's were to upgrade the
Government of Russia's rating and raise the foreign-currency bond
country ceiling, and if RZD (1) improves its financial metrics,
notably its Moody's-adjusted leverage below 3.0x and
funds from operations/debt above 30%, while sustainably delivering
on its operations and capital programme; (2) preserves its strong
liquidity; and (3) continues to operate as a standalone entity,
with the government's decisions remaining consistently supportive
of the company's operations and credit profile.
The rating could be downgraded if (1) there is a downgrade of Russia's
sovereign rating or the foreign-currency bond country ceiling is
lowered; or (2) there is evidence of the government's negative
interference in RZD's operations; and (3) there are clear expectations
that the company will not be able to maintain its liquidity and financial
profile compatible with its Baa2 rating by 2022, in particular if
its financial metrics weaken beyond its financial policy guidance with
reported net debt/EBITDA exceeding 2.5x on a sustained basis,
while Moody's-adjusted debt/EBITDA rises sustainably above
ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) CONSIDERATIONS
We consider environmental risks for the surface transportation and logistics
industry elevated, reflecting a gradual tightening of environmental
regulations and emission standards. Railroads remain heavy users
of diesel fuel, while their infrastructure is also exposed to natural
disasters and rail accidents (such as derailments of rail tank cars with
oil or other hazardous materials). RZD is also exposed to lower
demand for bulk freight that is exposed to environmental risks,
especially coal, but also crude oil, which together comprise
around 50% of total cargo volumes transported by RZD. To
mitigate these risks, RZD continues to invest in the implementation
of security measures and modernisation of its locomotive and car fleet.
Overall, the company spent around RUB280 billion in 2019 for the
above-mentioned projects. In particular, RZD was the
first Russian and CIS company to place a green €500 million eurobond
in May 2019, with the proceeds used to purchase electric locomotives
and passenger rail cars. In addition, while coal consumption
in Europe will continue to contract, demand from the Asian market
will likely remain robust, which should support transportation volumes,
especially once RZD completes its expansion of the rail infrastructure
in the Far East. Oil demand should also remain supportive until
it peaks in the next 10-15 years.
RZD's corporate governance considerations include RZD's historically
proven ability to sustain a comfortable balance between the growing development
capital spending needs and extra funding sources negotiated with the state,
which helps the company operate within its conservative financial policy.
While the company retains its internal comfortable leverage target of
reported net debt/EBITDA below 2.5x, the leverage may,
however, temporarily go up to a maximum of 3.0x during investment
peaks or market downturns, particularly taking into account the
reduced capacity following the implementation of the IFRS 16 standard.
The methodologies used in these ratings were Surface Transportation and
Logistics published in May 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1113382,
and Government-Related Issuers Methodology published in February
2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1186207.
Alternatively, please see the Rating Methodologies page on www.moodys.com
for a copy of these methodologies.
Russian Railways Joint Stock Company (RZD) is the 100% state-owned
monopoly owner and operator of Russia's rail infrastructure, and
provider of freight and passenger rail transportation services.
In 2019, RZD generated revenue of RUB2.5 trillion ($37.8
billion) and adjusted EBITDA of RUB585 billion ($9.2 billion).
For further specification of Moody's key rating assumptions and
sensitivity analysis, see the sections Methodology Assumptions and
Sensitivity to Assumptions in the disclosure form. Moody's
Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of
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same series, category/class of debt, security or pursuant
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Moody's general principles for assessing environmental, social
and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
At least one ESG consideration was material to the credit rating action(s)
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Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service Limited, Russian Branch
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Associate Managing Director
Corporate Finance Group
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