Fitch Ratings has revised the Outlook on PKP Intercity S.A. (PKP IC) to Positive from Stable and affirmed its Long-term foreign currency Issuer Default Rating (IDR) at ‘BBB-‘, Long-term local currency IDR at ‘BBB’ and National Long-term rating at ‘A(pol)’.
The Outlook revision reflects strengthening links with the company’s majority shareholder, the Polish state (foreign and local currency IDRs of A-/Stable and A/Stable) given that the share of debt guaranteed by the state continues to rise. The Outlook revision also incorporates improved remuneration under the public service contracts (PSCs) for passenger transport services agreed with the Ministry of Infrastructure and Development, which should allow for better cost coverage and higher cash flows from 2014.
KEY RATING DRIVERS
The Positive Outlooks indicate that Fitch could upgrade PKP IC’s ratings by one notch in the next one to two years. We currently assess PKP IC’s ratings as three notches below Poland’s Long-term foreign and local currency IDRs in accordance with Fitch’s Parent and Subsidiary Rating Linkage criteria. The top down rating approach is due to the strong legal links and the involvement of the state, in PKP IC’s financial and operational functions. However, the rising share of state-guaranteed debt and improved remuneration under the PSCs with the Ministry of Infrastructure and Development may lead us to narrow the notching down from the sovereign ratings to two notches from the current three notches and, as result, upgrade PKP IC’s ratings by one notch (assuming Poland’s ratings remain unchanged).
Around 50% of PKP IC’s debt is currently guaranteed by the state, up from 36% at end-2012. We expect the share of state-guaranteed debt to increase to about 60% by end-2014 as most of the new debt related to the capex plan is guaranteed by the state. The share of state-guaranteed debt being comfortably above 50% is a driver for an upgrade, together with a tested mechanism for higher remuneration under PSC in 2014 and the successful implementation of the capex plan with funding obtained mainly from EU funds and bank loans.
State Ownership and Influence
The state owns a 63.8% stake in PKP IC. The remaining stake is owned by fully state-owned Polish railways company Polskie Koleje Panstwowe S.A. (foreign and local currency IDRs of BBB/Stable and BBB+/Stable). The government has significant influence over PKP IC’s operations, for example, by preparing the long-term strategy for the railway sector and approving the company’s capex and funding plans. PKP IC’s large capex plan of PLN5.4bn for 2013-2016 is supported by the government within a broader plan of modernising the Polish railway sector using a combination of available EU funds, external funding and own sources.
Public Service Contracts
PKP IC generates the majority of its revenue (73.5% in 2012) and its passenger transport volumes (80% in 2012) from two long-term PSCs signed with the Ministry of Infrastructure and Development. The government pays compensation for unprofitable inter-regional and international trains operated within these two PSCs.
Fitch views positively the subsidy mechanism in PSCs. However, until 2013, the compensation received was insufficient to allow a fair remuneration on rendered transport services. The recent change in the calculation of subsidies by the inclusion of debt in the remuneration formula will have a positive impact on the company’s cash flow generation from 2014.
‘B’ Category Standalone Rating
Fitch considers PKP IC’s unguaranteed financial profile as commensurate with ratings in the ‘B’ category due to projected weak credit ratios and challenges related to the implementation of the ambitious capex plan. Fitch projects that despite co-funding from EU grants (covering about 50% of the capex plan for 2013-2016), the capex plan will substantially weaken PKP IC’s leverage and coverage ratios. We expect a steep rise in funds from operations (FFO) adjusted net leverage to about 15x in 2013 and 2014 from an already high 4.9x in 2012. This should drop to about 8x in 2015 mainly due to the projected increase in FFO due to higher PSC subsidies and the commissioning of the high-speed ETR 610 trains.
EBITDA and FFO Fluctuations
Fitch expects PKP IC to report much weaker EBITDA and FFO for 2013 compared with 2012, partly because increased costs will not be fully covered by PSC subsidies for 2013. Fitch projects EBITDA will increase in 2014-2015 due to higher PSC subsidies and the commissioning of the high-speed ETR 610 trains.
Finalised Funding for ETR 610
In line with Fitch’s assumptions in January 2013, PKP IC managed to finalise the funding structure of the company’s largest ongoing investment project, the purchase of 20 high-speed trains and related assets for PLN1.6bn (the ETR 610 project). This involved an increase in the loan amount from the European Investment Bank (EIB) by 53% in 2H13 following finalised discussions with the European Commission, which resulted in a lower than initially expected share of EU grant funding for the project (22% vs. 50%). Due to the amendment of the loan agreement with the EIB converting the loan amount from EUR342m into PLN1.4bn, the currency risk has been reduced. PKP expects that new debt to be taken on in the next few years will be zloty-denominated.
Funding from EIB
The EIB is PKP IC’s main lender. As of end-December 2013, PKP IC had two long-term loans from the EIB, a EUR50m loan raised in 2006 and a more recent loan of PLN1.4bn (equivalent of EUR324m), from which PKP IC made the first two drawdowns totalling PLN575m in December 2013. Debt from the EIB accounted for about 60% of PKP IC’s total debt. The loans from the EIB are guaranteed by the state. The first loan granted in 2006 is 100%-guaranteed, while for the more recent PLN1.4bn loan, the state guarantees 80% of the loan amount and related interest on a commercial basis, and the remaining 20% is guaranteed by a bank. The loans from the EIB have a cross-default provision to other debt of PKP IC, including the debt which is not guaranteed by the state.
Positive: Future developments that could lead to an upgrade include:
– An upgrade of Poland’s sovereign rating.
– Stronger links with the state, for instance rising state-guaranteed debt so that its share of total debt is comfortably above 50% or tangible state support in the form a large equity increase.
– Tested mechanism for improved remuneration under PSCs in 2014 and improved liquidity position.
– Successful implementation of the capex plan with funding obtained mainly from EU funds and bank loans.
Negative: Future developments that could lead to negative rating action include:
– A downgrade of Poland’s sovereign rating.
– A substantial increase in the share of PKP IC’s unguaranteed debt.
– Evidence of reduced state support.
– Failure to receive planned EU funds for any of the large capex projects, unless the company decides to cancel any of them.
LIQUIDITY AND DEBT STRUCTURE
At end-September 2013, PKP IC had weak liquidity, according to Fitch’s criteria, given that cash of PLN94m and committed unused short-term liquidity lines of PLN102m were insufficient to cover its short-term debt of PLN233m. Short-term debt comprises mostly of working capital loans from Bank Pekao and BRE Bank totalling PLN133m, which are the main lenders to PKP IC together with the EIB. PKP IC also had a PLN40m short-term loan from PKP. Fitch assumes that these short-term lines will be renewed in 2014.
Liquidity improved in 4Q13 given that at end-December 2013, cash of PLN176m (excluding the cash raised from the EIB loans in December to be allocated for capex) and committed unused short-term liquidity lines of PLN158m were sufficient to cover its short-term debt of PLN180m.
Apart from the high short-term debt, the company’s long-term debt maturity profile is well spread over the next 20 years. The new EIB loan of PLN1.4bn, from which PLN575m has been drawn to date, is amortising until 2035.
Negative free cash flow in 2014-2016 due to large investments will be covered with EU funds and bank loans (mainly from the EIB). At end-2013 PKP IC had available PLN0.8bn under the unused committed long-term loan from the EIB for the ETR 610 project. In December 2013, the company signed another long-term loan with the EIB for PLN0.8bn, which will obtain state guarantees (for 80% of the loan amount and related interest) in the next several months.