Federal Passenger Co. 'BBB-' Ratings Affirmed; Outlook Negative

  • In our view, Federal Passenger Co.'s (FPC's) planned sizable strategic capital expenditure (capex) program could result in significantly higher leverage if fully implemented.
  • However, we understand that FPC expects about Russian ruble (RUB) 51 billion of capital injections over 2019-2022 from its parent, state-owned Russian Railways (RZD), to support capex, which could protect FPC's financial metrics.
  • We are therefore affirming our 'BBB-' rating on FPC.
  • The negative outlook reflects our view that we could downgrade FPC if its leverage increases significantly over the next 12 months, with funds from operations (FFO) to debt falling below 30%, or if pressure on liquidity materializes.

MOSCOW (S&P Global Ratings) March 14, 2019--S&P Global Ratings today took the 
rating actions listed above. The affirmation reflects our assessment that 
FPC's 2018 results are likely to be better than we expected, due to improved 
EBITDA generation and some delay in capex. However, we continue to see a 
possibility that FPC's FFO to debt will reduce to below 30% in the next 24 
months if the company continues to execute its ambitious capex program, and 
RZD, its state-owned parent, fails to provide FPC the expected capital 
injections. We note that FPC has some flexibility in its capex, but we also 
understand that its capex program is strategic, aimed at asset modernization 
and higher quality passenger service, which should eventually trigger higher 
EBITDA generation.

We estimate that FPC's year-end 2018 leverage was significantly less than we 
previously estimated, with FFO to debt of about 50%, compared with our 
expectation of just over 30%, and adjusted debt to EBITDA of 1.6x compared 
with our previous expectation of 2.4x. This is because, in 2018, FPC's 
revenues increased by about 5% to RUB 226 billion and adjusted EBITDA 
increased to RUB26 billion (corresponding to 11.5% EBITDA margin), compared 
with our previous assumption of about RUB21 billion. This is due to stronger 
revenue generation because of higher passenger volumes and ongoing cost 
control. Additionally, we believe that FPC spent about RUB46 billion on capex 
in 2018, compared with our previous estimation of RUB51 billion, with certain 
capex spending rolled over to 2019. 

We understand that FPC anticipates it will receive up to RUB51 billion of 
capital from RZD in the next four years–-RUB15 billion per year in 2019-2021 
and RUB6 billion in 2022. This should reduce pressure on FPC's leverage, and 
could lead to FFO to debt of over 30% throughout the heavy capex period. We 
understand that these injections have been approved by RZD but still need to 
be approved by the government, which could happen in the fourth quarter of 
2019. We therefore do not include them into our base case scenario at this 
stage, but will continue to monitor the process, as well as FPC's financial 

We forecast that, without the injections, FPC's FFO to debt will fall to 
30%-34% in 2019, 27%-31% in 2020, and 25%-29% in 2021. Our capex forecast 
reflects FPC's current financial policy and covenant levels at 2.5x net debt 
to EBITDA, which we understand the company does not currently plan to revise. 
We also recognize that FPC has some flexibility in capex, and could reduce it 
under certain circumstances. Therefore, in our base case we forecast RUB40 
billion of capex in 2019 and RUB30 billion per year in 2020-2022, compared 
with RUB44 billion-RUB48 billion annually as per management's plans. 

If and when capital injections are approved by the government, and all else 
remaining equal, FPC's forecast FFO to debt could improve, compared with our 
base case, to 38%-42% in 2019, 32%-36% in 2020, and 27%-31% in 2021. This 
would also mean that FPC would be able to execute its capex program in full 
amount, with capex of up to RUB44 billion-RUB48 billion per year in 2019-2022.

FPC's sizable capex program focuses on upgrading and replacing up to 29% of 
FPC's rail car fleet in the next seven years, improving efficiency and 
competitiveness compared with other modes of transport. We forecast a moderate 
positive effect on EBITDA generation in 2019, continuing into 2020.

New and modernized rail cars can be used more intensively, allowing the same 
level of service to be provided with fewer rail cars, thus leading to lower 
operational costs and EBITDA improvement. Part of the future capex will used 
to buy new rolling stock for connecting midsize cities, primarily in the 
European part of Russia. We note that margins on faster, short-distance trains 
tend to be higher. As price competition with airlines becomes difficult on 
many long-distance routes, FPC is increasingly focusing on short-to 
medium-distance routes, where airlines are less competitive or unavailable. 
The company is increasing speeds on shorter routes of 300-1,000 kilometers, to 
make more destinations available with its "day express" service. In the long 
term, we believe that trains will remain a preferred means of transportation 
in Russia for such routes, because the country's underdeveloped road system 
suffers from congestion and accident risk. Rail passenger traffic increased by 
an estimated 5% in 2018, after falling by 2.6% in 2017. To a large extent, 
this growth is supported by the expansion of the new, higher speed services 
developed by FPC, such as the "day express" service. We estimate that the 
football competition held in Russia during summer months of 2018 had a 
relatively small impact, only contributing about 300,000 of additional 
passengers to the overall increase of 6 million.

Our ratings on FPC continue to reflect our view of the company as a 
government-related entity with a high likelihood of receiving extraordinary 
support from the state in the case of need. This is due to its very important 
social role as a provider of affordable long-distance travel for Russia's 
population, as well as its strong link with the government through 100% 
ownership via the government-controlled infrastructure monopoly RZD. We view 
FPC as a strategically important 100% subsidiary of RZD because it is one the 
largest companies within the RZD structure. 

We expect FPC will continue to receive state subsidies to compensate for the 
regulated part of tariffs. Other forms of ongoing support have also been 
demonstrated, such the reduction of value-added tax on rail transportation 
services to 0% from 18% over 2016-2017. 

The negative outlook reflects our view that we could downgrade FPC if its 
leverage increases significantly over the next 12 months, with FFO to debt 
falling below 30%, or if pressure on liquidity materializes.

We could also consider a downgrade if the RUB51 billion capital injections are 
not approved by the Russian government and FPC must continue to finance its 
capex program with its own resources and debt. This could require a change in 
FPC's financial policy and revision of its 2.5x net debt to EBITDA covenants 
on its outstanding debt, allowing the company to maintain much higher 
leverage. Rating pressure would also arise if the company's EBITDA is 
materially weaker than we forecast due to lower passenger volumes, higher 
costs, or insufficient subsidies, forcing FPC to borrow more. We could also 
take a negative rating action if FPC's liquidity were to weaken materially due 
to insufficient covenant headroom or unfunded debt maturities. 

We could revise the outlook to stable if we believed FPC's FFO to debt will 
remain above 30%.

This could happen if the RUB51 billion capital injections were approved for 
FPC towards the end of 2019, with EBITDA generation remaining solid.

We could also revise the outlook to stable if the capital injections are not 
approved but we understand that the company will significantly reduce its 
capex so that its FFO to debt will remain above 30% in the coming years. 
However, this is not our base case scenario given the strategic nature of 
FPC's capex plan.

In order to revise the outlook to stable, we would also require FPC to 
maintain adequate liquidity at all times.
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