On October 22, Fitch revises Kazakhstan Temir Zholy's (KTZh)outlook to negative from stable and affirmed long-term issuer default rating at BBB. In the agency's view "the state support is weakening during the rapid deterioration of KTZh's standalone creditworthiness". The agency may downgrade the rating of KTZh if it sees insufficient tariff increases or other support beyond 2015.
Financial ratios of the company was negatively affected by "a freight tariff freeze, a drop in freight turnover and a near 50% devaluation of the tenge against USD since August this year".
The agency expects a FFO adjusted gross leverage to rise to 5.4x in 2015 from 3.3x in 2014 and FFO interest coverage to fall to 3.1x from 6.2x. The company estimates the freight turnover to fall by 11% in 2015 following the decline by 6% in 2014 due to lower exports and slower transit cargo flows. The company expects tariffs to be indexed to inflation over the next five years. However there is a high uncertainty regarding the tariff increases in Fitch's view. According to Fitch, "the introduction of new asset-based tariff regulation has been postponed due to affordability concerns".
The company managed to reduce operating costs by 16.6% in 1H15 and its capex plan by 23% for 2015-2018, which is credit positive. However, the benefits of these measures are "limited by the company's inflexible cost base and pressure to invest heavily, in line with Kazakhstan's plans to maximize the country's transit potential".
The government provided T44bn so far of total T83bn to the company to fund infrastructure projects as a part of Nurly Zol economic policy.
The company is exposed to currency risks as 59% of its gross debt was denominated in foreign currency versus only 20% of revenue as of September 2015. The company plans to reduce FX- denominated debt by issuing tenge bonds.
Our view. We view the news as negative to the company's credit profile. Recall that S&P downgraded the rating of KTZh to BB+ and Moody's changed the outlook to negative in September 2015. We think that the company has a strategic importance to the country's economy, providing almost a half of the overall freight turnover. KTZh owns the country's strategic asset – the mainline railway network. Thus we view the probability of receiving support from the government as high.
Eurobonds of KTZh maturing in 2020 are trading at 6.7-6.9%, 110bp wider than KMG'20. We view the current level of yields of KTZh'20 as attractive and recommend to Buy.