OREANDA-NEWS. Fitch Ratings has downgraded Russia-based Far-Eastern Shipping Company Plc's (FESCO) Long-term foreign currency Issuer Default Rating (IDR) to 'CC' from 'B-'. Fitch has also downgraded FESCO's foreign currency senior unsecured rating to 'C' from 'B-' on weak recovery prospects. The Recovery Rating is RR6. A full list of ratings actions is attached at the end of this commentary.

The downgrade reflects FESCO's weak liquidity, continued deterioration of operational performance, weaker cash generation, and exposure to a contracting economy and rouble exchange rate volatility. We expect the company's financial performance to have deteriorated in 2015 and that an improvement in 2016 is uncertain.

Although FESCO has reduced its planned investments to a minimum in response to a tough market, we expect its funds from operations (FFO) adjusted net leverage to increase to above 10x on average over 2015-2018. FESCO may struggle with debt and interest/coupon repayments as a result of weaker cash flows generation.

KEY RATING DRIVERS
Insufficient Liquidity
Fitch assessed FESCO's liquidity position at end-3Q15 as insufficient for debt coverage over 4Q15-2016. The company's cash and cash equivalents of USD68m at end-3Q15 and Fitch-projected 4Q15-2016 negative free cash flows (FCF) do not cover expected maturities and coupon/interest payments over 4Q15-2016 of about USD150m and about USD125m, respectively. Fitch estimates that FESCO may cover its near-term maturities, Eurobond and local bonds coupon payments, but may struggle with further debt and interest/coupon repayments in 2H16.

Given the upcoming interest/coupon payments and debt maturities and continuing weak operating cash flows, we believe a debt restructuring is in prospect in 2H16. This is likely to lead to a further downgrade.

Financial covenants in the Eurobond documentation (i.e. fixed charge coverage ratio at 2.0x or higher and consolidated total leverage ratio of less than 3.25x) limit FESCO's ability to incur additional debt over certain limits but their breach does not constitute an event of default.

Low Coverage, High Leverage
At end-3Q15 FESCO's debt stood at USD921m. Fitch has also included USD220m Eurobonds that were bought back in May 2015 in its adjusted debt calculations as these Eurobonds were pledged as a collateral under USD44m loan agreement provided by an international bank for funding the Eurobond buyback and should be released back to FESCO upon the final fulfilment of obligations under this loan in February 2018.

We expect FESCO's FFO adjusted net leverage to increase to above 10x over 2015-2018 from slightly above 6x at end-2014 on the back of deteriorating operational performance. We expect FESCO to report negative FFO over 2016-2018 due to lower operational cash flows, resulting in FFO interest coverage falling to below 1x over 2015-2018, from slightly above 1x at end-2014.

Weak Market Fundamentals, Earnings Pressure
The Russian transportation market remained under pressure in 2015 from a contracting domestic economy and rouble depreciation, which affected import and transit transportation volumes and consumer purchasing power. The container throughput in the Far East ports and rail container transportation in Russia declined 24% and 8% yoy in 2015, respectively. This has negatively affected FESCO's operational performance in all business segments.

In 9M15 FESCO's port container volumes, intermodal transportation volumes and rail container transportation volumes fell 32%, 23% and 11%, respectively. We expect FESCO's 2015 revenue and EBITDA to drop by about 40% and 30% yoy, respectively, driven by lower volumes and rates. We expect 2016 to be another challenging year for container transportation as we forecast Russian GDP to decline further by 1.5% and for rouble to remain weak.

FX Risks Still High
Despite the buyback of foreign denominated debt in May 2015 and conversion of certain port tariffs to US dollars from rouble at end-2014, FESCO remains exposed to foreign currency fluctuations as 84% of its total debt at end-3Q15 was denominated in foreign currencies, mainly in US dollars. In contrast, about 60% of revenues in 9M15 were US dollar-linked or US dollar-denominated.

Negative FCF Expected
Despite significant reduction in capex to a maintenance level of about USD20m annually versus USD62m on average over 2012-2014 we expect FESCO to generate negative FCF. This is mainly due to weaker cash generation from operations on the back of falling volumes, continued pressure on rates and high interest/coupon payments on debt. We do not expect operating cash flows to improve in 2016.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Russian GDP decline of 3.7% in 2015 and 1.5% in 2016 and growth of 1.5% in 2017; Chinese GDP growth of 6%-6.9% over 2015-2017
- Russian CPI of 6.8%-12.9% over 2015-2017
- No dividends payments
- Capex of about USD20m annually over 2015-2017
- USD/RUB exchange rate of 70-75 over 2015-2017

RATING SENSITIVITIES
Negative: Future developments that could lead to negative rating action include:
- Imminent or inevitable default or standstill of the issuer

Positive: Future developments that could lead to positive rating action include:
- Attaining a more sustainable liquidity profile
- Improvement of the macro-economic environment and company's operational performance

FULL LIST OF RATING ACTIONS
Far-Eastern Shipping Company Plc
- Long-term foreign currency IDR downgraded to 'CC' from 'B-'/Negative
- Long-term local currency IDR downgraded to 'CC' from 'B-'/Negative
- National Long-term rating downgraded to 'CC(rus)' from 'BB-(rus)'/Negative
- Local currency senior unsecured rating downgraded to 'C' with a Recovery Rating of 'RR6' from 'B-'/'RR4'

Far East Capital Limited S.A. (Luxembourg)
- Foreign currency senior unsecured rating downgraded to 'C'/RR6 from 'B-'/'RR4'