OREANDA-NEWS. Fitch Ratings has affirmed Azerbaijan Railways Closed Joint Stock Company's (ADY) Long-term Issuer Default Rating (IDR) at 'BBB-' with a Stable Outlook.

ADY is the wholly state-owned operator of the national railway system in Azerbaijan (BBB-/Stable) and its rating continued to be aligned with that of the sovereign, the Republic of Azerbaijan, its sole shareholder, reflecting continued relatively strong links with the state.

The rating alignment primarily reflects Fitch's assessment of ADY's links with its parent as relatively strong, in accordance with Fitch's Parent and Subsidiary Rating Linkage criteria. Fitch's assessment considers ADY's high strategic importance to the national economy, including its position in transport of export-bound oil products and oil as well as freight transit, which contribute significantly to Azerbaijan's economy. The agency also views the operational links as strong due to the government's involvement in tariff setting, capex planning and funding, financial and business strategy and policy setting.

Fitch anticipates that ADY will remain 100% state owned in the foreseeable future, but notes that ADY's debt is not guaranteed by the government. At end-2013 debt was relatively modest at AZN238m, including three tranches from BNP Paribas of AZN46m that were repaid in full in March-2014. At present, ADY does not plan to raise new external debt. We expect that ADY's funds flow from operations (FFO) gross adjusted leverage will remain around 1x on average over 2014-2016. Any significant external debt increase, which does not coincide with stronger state support through state guarantees of a large portion of the company's debt and/or material equity injections, among other things, may result in ADY's rating being notched down from the sovereign rating. Additionally, a significant level of secured debt (in excess of 2x of EBITDA) may, in Fitch's view, be detrimental to ADY's senior unsecured creditors.

ADY's current AZN1.4bn investment programme over 2014-2017 was initiated by the Ministry of Transport back in 2010. The government of Azerbaijan continues to finance a large share of the investment programme via loans borrowed by the government without recourse to ADY (AZN390m), as well as equity injectionswhile the rest is expected to be funded with ADY's cash flows. We view this as a continuing sign of tangible support from the government. A change in the proposed funding terms may prompt Fitch to review its assessment of the strength of state support for ADY.

Fitch expects ADY to continue to report large negative free cash flows (FCF) over 2014-2017 owing to its ambitious capex programme of AZN1.4bn over the same period. ADY is responsible for about half of total capex, plus additional maintenance capex that Fitch assumes of around AZN40m annually to be funded from its operating cash flows. Fitch notes that ADY's expansionary capex is only committed to the extent that the earmarked government funds are available - the government is expected to finance a large share of ADY's capex over 2014-2017..

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating actions include:
- ADY's rating will likely remain at the current level if the sovereign rating of Azerbaijan is upgraded to 'BBB' and ADY's links with the government do not strengthen (i.e. not benefiting from government guarantees for ADY's debt).

Negative: Future developments that could lead to negative rating action include:
- A negative sovereign rating action driven, among other things, by the factors listed below would be replicated for ADY.
- ADY's rating would also be downgraded if the company's links with the government weaken, for example as a result of weaker tangible support.

For the sovereign rating of Azerbaijan, ADY's parent, the following sensitivities were outlined by Fitch in its Rating Action Commentary of March 28, 2014:
Positive: The main factors that individually or collectively could lead to positive rating action on Azerbaijan:
- A longer track record of sound management of the public finances in a context of static oil revenues; further growth in sovereign assets.
- Diversification and development of the non-oil economy, improvements in the business environment and other structural indicators.

Negative: The main factors that individually or collectively could lead to negative rating action on Azerbaijan:
- Rapid spending growth that would erode the country's fiscal strength in the medium term.
- A prolonged period of low oil prices.
- A domestic or regional geopolitical shock, such an escalation in hostilities over the disputed region of Nagorno Karabakh.