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Rating Action:

Moody's affirms Russian Railways' Baa2 rating, outlook changed to stable

29 Jul 2021

London, 29 July 2021 -- Moody's Investors Service (Moody's) has today affirmed the Baa2 issuer and senior unsecured bonds ratings as well as the baa2 Baseline Credit Assessment (BCA) of Russian Railways Joint Stock Company (RZD or the company), the state-owned monopoly owner and operator of Russia's rail infrastructure. Concurrently, Moody's has affirmed the Baa2 backed senior unsecured and senior unsecured bonds ratings and the Ba1 junior subordinated bond rating of RZD Capital PLC. The outlook on both entities has been changed to stable from negative.

A full list of affected ratings is provided towards the end of the press release.

RATINGS RATIONALE

Today's affirmation of RZD's ratings with a stable outlook reflects its fundamentally strong standalone credit profile, proven against the severity of the shock from the coronavirus pandemic.

Although, along with the company's strained operating and financial performance, the pandemic increased the reliance by the company on the Government of Russia (Baa3 stable) in addressing RZD's credit profile and leverage, stemming from the company's limited flexibility to scale down strategically important investment projects, the rating action reflects the company's sustained degree of resilience, 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; and (3) retained adherence to conservative financial policy and strong liquidity. These factors allowed RZD to preserve its financial profile through the peak of the crisis and will help to restore its strong standalone positioning over the next two years.

In particular, RZD retained a fairly adequate operating performance backed by the more resilient freight rail segment, which has historically dominated its earnings. Thus, in 2020, cargo shipment declined by only 2.7% followed by a 4.6% increase in H1 2021, which was only 0.1% below volumes transported in 1H2019. As a result, RZD has recently revised upwards its forecast, which now expects freight volumes to grow by 3.3% in 2021 from last year and by 0.5% compared with 2019, to be largely supported by (1) a rebound in commodity exports including strong demand for coal globally; (2) pickup in oil and oil products after the unprecedented low levels caused by the pandemic-induced drop in consumption and production cuts under the OPEC+ deal; (3) active measures by RZD to stimulate freight transportation and the ongoing expansion of rail infrastructure in the Far East; and (4) the large-scale state-sponsored national construction projects. Along with the regular tariff indexations amid narrowing discounts, the robust pickup in volumes will support gradual recovery in the company's earnings and profitability through 2021-22.

The rating action also takes into account the government's historically rational approach towards RZD, which Moody's expects to continue, while the company's reliance on direct state support measures remained largely limited to funding state-initiated projects even during the pandemic.

Although Moody's notes RZD's reduced flexibility to adjust investments, given the high strategic importance of most of its sizeable projects for the country, the agency expects the company to retain its historically prudent approach to the investment programme, which it will continue to effectively balance against its conservative financial policy. In particular, although after RUB100 billion of cuts the remaining RUB740 billion cash capital spending in 2020 was still substantial relative to its weaker earnings, to mitigate the pressure on its capital structure and limit the state's direct financial support, RZD secured an alternative funding source by placing a debut for the Russian capital market perpetual bonds (RUB337 billion were issued in 2020-21 out of the total RUB370 billion programme), which the company and its auditors 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. In March 2021, RZD also issued a new CHF250 million junior subordinated loan participation notes, which, together with around RUB128 billion of approved state support measures, will help to fund a new significant step-up in its consolidated investment expenditures to a record RUB850 billion. RZD will also likely continue to implement adjustments to its initial plans or request additional funding from the state in the form of subsidies or equity injections, in case of substantial pressure on its financial profile.

Overall, in 2020, RZD's reported net debt/EBITDA increased to around 3.8x and its Moody's-adjusted debt/EBITDA to 4.9x, assuming a 50% equity credit for RUB 93 billion of tranches and a 100% debt treatment for the rest of the tranches placed in 2020 under the perpetual bond programme (please refer to Moody's "Hybrid Equity Credit" methodology published in September 2018). Nevertheless, despite this temporary step-up, Moody's continues to view the company's leverage in 2020 as manageable given the unprecedented pressure of the pandemic and competitive compared with that of its European peers with higher ratings. RZD's consistent focus on preserving its historically sound financial profile and liquidity further helped the company weather the crisis, while gradually beginning to restore its financial position during 2021.

In addition, although RUB244 billion of tranches under the perpetual bonds programme qualified for the 'basket A' (100% debt treatment), Moody's 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.

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 over the next two years towards its internal target of reported net debt/EBITDA of 2.5x and not materially exceeding 3.0x at temporary peaks, the agency expects its adjusted debt/EBITDA to return to below 4.0x on a sustained basis (including 50% equity credit for the new CHF250 million junior subordinated loan participation notes issued in March 2021). However, the pace of recovery still remains subject to persistant uncertainties around the evolution of the pandemic and the global economic outlook.

RZD's Baa2 issuer rating reflects a combination of (1) its baa2 BCA, which is a measure of the company's standalone credit strength; (2) the Government of Russia's Baa3 local-currency issuer 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.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook reflects the robust recovery in RZD's operations from the pandemic-induced crisis, which drives good prospects for the company to restore its credit profile to the level commensurate with the current rating over the next two years, despite the limited flexibility to adjust its extensive investment programme.

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 extensive capital investment programme.

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 strong liquidity and restore its financial profile compatible with a Baa2 rating by 2023, in particular if its financial metrics weaken materially beyond its financial policy on a sustained basis, while Moody's-adjusted debt/EBITDA rises sustainably above 4.0x.

ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) CONSIDERATIONS

Moody's considers environmental risks for the surface transportation and logistics industry elevated. Typically, railroads remain heavy users of diesel fuel, while their infrastructure is 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 45% 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. In particular, around 87% of the company's cargo is transported using electric traction, while RZD was also the first Russian and CIS company to place a green bonds, 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 has historically helped 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 increase to a maximum of around 3.0x during investment peaks or market downturns, particularly taking into account the reduced capacity following the implementation of the IFRS 16 standard.

Moody's regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety.

PRINCIPAL METHODOLOGY

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.

LIST OF AFFECTED RATINGS

Affirmations:

..Issuer: Russian Railways Joint Stock Company

.... LT Issuer Rating, Affirmed Baa2

....Senior Unsecured Regular Bond/Debenture, Affirmed Baa2

..Issuer: RZD Capital PLC

....Junior Subordinated Regular Bond/Debenture, Affirmed Ba1

....BACKED Senior Unsecured Regular Bond/Debenture, Affirmed Baa2

....Senior Unsecured Regular Bond/Debenture, Affirmed Baa2

Outlook Actions:

..Issuer: Russian Railways Joint Stock Company

....Outlook, Changed To Stable From Negative

..Issuer: RZD Capital PLC

....Outlook, Changed To Stable From Negative

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 2020, RZD generated revenue of RUB2.3 trillion ($31.7 billion) and adjusted EBITDA of RUB409 billion ($5.6 billion).

REGULATORY DISCLOSURES

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 debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1288435.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Ekaterina Lipatova
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service Limited, Russian Branch
7th floor, Four Winds Plaza
21 1st Tverskaya-Yamskaya St.
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Russia
JOURNALISTS: 44 20 7772 5456
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David G. Staples
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

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No Related Data.
© 2021 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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