Fitch Upgrades Sovcomflot to ‘BBB-‘; Outlook Stable
Fitch Ratings has upgraded Russia-based PAO Sovcomflot’s (SCF) Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘BBB-‘ from ‘BB+’. The Outlook is Stable. Fitch has also upgraded the SCF Capital Designated Activity Company’s senior unsecured notes, which SCF guarantees, to ‘BBB-‘ from ‘BB+’.
The upgrade reflects the reassessment of SCF’s Standalone Credit Profile (SCP) to ‘bb+’ from ‘bb’ due to a strengthening of SCF’s business and financial profile. This is supported by cash-flow visibility with half of total time charter equivalent (TCE) revenue coming from industrial business (LNG/LPG carrier and offshore services) with long-term contracts and creditworthy counterparties. The business profile is also supported by large scale of operations, fairly young and specialised fleet, and diversified customer base. Fitch also expects SCF will maintain its credit metrics with funds from operations (FFO) adjusted net leverage below 4.0x, despite high capex and shareholder distributions in 2021-2024. The rating also incorporates SCF’s exposure to the spot market typically through conventional business and currently low tanker rates.
The IDR continues to incorporate a one-notch uplift to its SCP, reflecting the links to the parent, the Russian Federation (BBB/Stable).
KEY RATING DRIVERS
Credit Profile Strengthening: SCF’s credit metrics improved primarily due to steadily increasing earnings exposure to the industrial business portfolio as well as a strong tanker market in 2020, which increased deleveraging capacity. The successful initial public offering (IPO) in late 2020 has also contributed to the company’s financial flexibility. Given the volatility of tanker rates, we take a through-the-cycle rating approach, assuming a 10-year tanker freight rate average. We anticipate the company’s EBITDA to average about USD750 million (post IFRS-16 adjustments) in 2021-2024 and FFO adjusted net leverage to average slightly below 4.0x (2.6x in 2020) despite an increase in capex.
Capex Increase and Extra Dividends: Our credit metric forecasts are based on the annual average USD500 million capex assumptions and a pay-out ratio of 50% of net income over 2021-2024. This includes expected extra funding for new vessels in 2023 both through the company’s funds and finance lease agreements, as well as post-IPO exceptional dividends in 2021 of about USD225 million. We expect SCF to generate healthy cash flow from operations in 2021-2024, but its FCF to turn negative.
Long-Term Contracts Add Visibility: SCF has expanded from being a pure tanker business into the industrial segment, which accounted for just over half of TCE revenue in 2020 and is targeted by the company to reach 70% by 2025. This segment remains more profitable and benefits from long-term, fixed-rate contracts. The company has entered into 30-year time-charter agreements for new icebreaking LNG carriers, with 14 icebreaking LNG carriers delivered to Arctic LNG 2 through its joint venture with PAO Novatek (BBB/Stable). As a result, future contracted revenue increased to USD24 billion at end-2020, including joint ventures (USD14 billion related to SCF), from about USD10 billion in 2019 with delivery from 2023.
Strong Operations: SCF is one of Russia’s largest shipping company and a global leader in maritime transportation of hydrocarbons, and its business profile benefits through servicing a diversified customer base of large international and Russian oil and gas companies, whose unconstrained credit profiles are generally stronger than that of SCF. The company owns and operates fairly young fleet with an average age of 11.6 years.
Tanker Rates Fall from 2Q20 Highs: Tanker rates recovered from 4Q19 and spiked in 2Q20 at the onset of the pandemic primarily driven by the floating oil storage demand. This has eased and tanker rates are back to more normalised levels. In our rating case, we used historical 10-year average rates from 2021. SCF is exposed to market risks as about half of TCE revenue comes from the transportation of conventional crude oil and oil products. About 30% of this operates on spot trading, with the remaining on fixed-term contracts of no more than two years. We assume that EBITDA (post IFRS-16 adjustments) will drop by about 15% in 2021 after a strong 2020.
IPO Proceeds: SCF raised a net USD481 million from an IPO in October 2020. The proceeds is mostly used for SCF’s intensive capex programme over 2021-2025, as well as deleveraging, which took place in 4Q20. The Russian Federation ceased to be SCF’s sole shareholder and became a majority shareholder, holding about 84% of SCF’s ordinary shares. The remaining 15.6% of SCF’s shares are in a free float. Further privatisation leading to the loss of effective control over SCF by the state may result in the removal of the one-notch uplift above the SCP.
One-Notch Uplift: SCF’s rating continues to incorporate a one-notch uplift to its SCP of ‘bb+’. Fitch views the status, ownership and control linkage of SCF with the sovereign as strong, due to the government’s majority ownership, while there is a moderate record of support. We assess socio-political implications of its theoretical default as moderate, considering that the company operates in a highly competitive market and could be substituted and that SCF plays an important role in the Russian oil and gas sector, and is considered a strategically important enterprise.
SCF is a global leader in maritime transportation of hydrocarbons and in servicing the offshore exploration of oil and gas majors. Its business and financial profiles are stronger than that of PT Soechi Lines Tbk (B/Stable). SCF has strong business profile supported by the large scale of its business, healthy share of long-term contracts, fairly young and specialised fleet and diversified customer base. The average age of Soechi’s fleet (weighted by capacity) is about 20 years, with a very high customer concentration risk. SCF’s EBITDA is about 10x larger than Soechi’s with FFO net adjusted leverage of 2.6x in 2020, while Soechi’s historical average FFO adjusted net leverage is about 4.5x. SCF benefits from the one-notch uplift due to strong support from the Russian government and is exposed to the operating environment in Russia.
Fitch’s Key Assumptions within Our Rating Case for the Issuer:
– 10-year average tanker rates in 2021-2024 for vessels operating on spot rates
– capacity growth as per scheduled deliveries
– contractual rates for time charters, 95% of utilisation rate for vessels on spot trading in 2021-2024
– annual capex of up to USD500 million
– dividends following IPO in 2021 totalling USD225 million, pay-out ratio of 50% of net income for 2022-2024
Factors that could, individually or collectively, lead to positive rating action/upgrade:
– Stronger links with the government.
– FFO net adjusted leverage below 3.0x and FFO fixed-charge cover above 4.0x on a sustained basis.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– Structural decline of tanker rates or more sizeable capex or dividends resulting in the deterioration of the company’s credit metrics leading to FFO adjusted net leverage above 4.0x or FFO fixed-charge coverage below 3.0x on a sustained basis.
– Weaker links with the government.
– Unencumbered assets falling well below 2.0x of unsecured debt on a sustained basis would lead to a downgrade of the senior unsecured rating.
Source: Fitch Ratings