October 24, 2014 |
23 October 2014: Fitch Ratings has affirmed DME Ltd.'s (DME or the group) Long-term Issuer Default Rating (IDR) at 'BB+' with a Stable Outlook. DME operates Domodedovo Airport (DME) in Moscow. Fitch also affirmed the rating of USD300m senior unsecured notes issued by DME Airport Limited at 'BB+' with a Stable Outlook.
The group owns the terminal buildings and leases the runways and other airfield assets from the Russian government. DME Airport Limited is a special purpose vehicle (SPV) registered in Ireland that has on-lent the proceeds from the notes' issue to Hacienda Investments Ltd, a 100% subsidiary of DME Ltd.
KEY RATING DRIVERS
DME's underlying credit profile remains strong and commensurate with investment grade, notwithstanding unfavourable economic conditions and weaker growth prospects following the economic sanctions and rouble devaluation. The ratings remain constrained to 'BB+' due to concerns about corporate governance and some regulatory uncertainty, which continue to prevail.
Growth Prospects More Moderate: Revenue Risk - Volume: Midrange
Moscow represents a large catchment area and captures a big portion of Russia's passenger air traffic (71% in 2013). Passenger traffic in Moscow continued to grow in 2013 and 2014 by over 10%. Moscow is served by three airports and DME (43% market share in 2013) competes with the state-owned Sheremetyevo airport (SVO, 41%) hosting Russia's national flag carrier Aeroflot, and Vnukovo (VKO, 16%).
DME benefits from a strong origin & destination traffic base of 73%, although most of the traffic is leisure-related. The airline base is well diversified, with no airline contributing more than 11% of revenues. S7 and Transaero are the largest airlines operating at DME.
Traffic at DME grew by 9.5% in 2013 reaching 30.8m passengers and strong growth continued in 2014. In the first 9 months of 2014, DME's traffic grew by 8.2% which is ahead of Fitch's base case projection. Slowing economic growth in Russia coupled with 25% rouble devaluation since the end of 2013 have not had a significant impact on DME's traffic so far, although the traffic mix is shifting towards domestic traffic. International traffic showed minimal growth during 9m 2014 while domestic traffic growth exceeded 20%. The effect is partially due to reclassification of flights to Crimea as domestic, but also due to the devaluation of the rouble (with people preferring to travel within Russia rather than abroad), and reduced economic activity between Russia and the EU / US brought by the economic sanctions against Russia. However, international traffic still dominates DME's traffic (14.4m vs 11.6m during 9m 2014).
The agency expects more tempered traffic growth in the next few years. Conservative traffic projections under Fitch's rating case capture the possible negative impact by assuming traffic decline of 3.5% in 2015 and a recovery afterwards.
More Commercial than Regulated, Moderate Exposure to Traffic: Revenue Risk (Price) - Midrange
DME's revenue structure remains well diversified as the airport provides a comprehensive range of services. DME operates under a favourable dual-till regime under which regulated and non-regulated businesses are considered separately by the regulator. Regulated revenues make only 26% of revenues (2013) - considerably less than in Western European peers. The regulatory framework provides for the recovery of operating and capex costs. Over 70% of revenues come from mostly unregulated auxiliary aviation services and commercial services.
DME is currently benefiting from rouble devaluation as over 40% of its revenues are denominated in EUR and USD (through regulated USD tariffs, auxiliary aviation services to foreign airlines and retail concessions) while most of DME's operating and capex costs are in roubles. Fitch expects some pressures on DME as the Russian airlines and retail concessionaires may seek to reduce the scope of services, to negotiate price reductions or switch to rouble-based contracts in light of slower economic growth and rouble devaluation.
Strong Cash Flow Generation, Terminal Expansion Needs: Infrastructure Renewal - Midrange
DME has substantial levels of excess cash flow after maintenance capex (ca USD275m p.a. at current exchange rate) to invest in assets and according to Fitch's base case, leverage needs are less than 50% of capex requirements over 2014-2020. DME's runway capacity is sufficient for current operations and future growth, but substantial investments are required into expansion of the terminal and related equipment. The capex program has been delayed in 2013 and 2014 for various reasons with expenditure shifting into later years. The expansion of Terminal 1 is delayed from 2014 to 2016. Works on the construction of a new Terminal 2 have started in 2014 with a planned completion in 2017. Works have also started on the reconstruction of Runway 2 which is funded through government funds.
Debt Service: Low Leverage and Sound Profitability
DME's EBITDA reached RUB15.3bn (USD373m at current exchange rate) in 2013. Profitability remains strong with an EBITDA margin at 37% in 1H14 (38% in 2013, 36% in 2012). DME's use of leverage has been limited to-date, with total debt/EBITDA ratio at 1.3x (2013) following the issuance of the rated notes as per Fitch's calculation - well below the covenant of 3x. Fitch's traffic projections are more conservative than the company's, but even under that scenario, cash flows should be sufficient to serve the overall debt. Total debt is now projected to reach a maximum of 2.5x of EBITDA in 2016 under our rating case, up from 2.2x predicted last year. Leverage may however be lower if some of the currently planned capex projects are postponed.
Corporate Governance and Some Regulatory Uncertainty
Concerns about corporate governance practices and transparency of the structure of the group are the main constraining rating factor. The group has a complex corporate structure with over 20 DME subsidiaries located in Russia and offshore (Cyprus, Isle of Man and British Virgin islands). The group's decision-making is intricate and concentrated with the sole shareholder, Mr. Dmitry Kamenschik, and the group's CEO. The absence of an effective board of directors and a well-defined dividend policy are additional weaknesses. Fitch is concerned about high dividend pay-outs since the issue of the notes against a backdrop of deferred capex program.
Regulatory uncertainty relates to the government's stance towards the airport's corporate and ownership structure and the runway/land lease agreements (litigated in the past, but with favourable outcomes for DME). Fitch gained some comfort from DME's important role in the Moscow hub and its unique development potential. There is further uncertainty regarding the new concession regime for Moscow airports. The main concession principles have been laid out with a tentative transition to the new concession in 2015. Under the new concession, DME will gain the responsibility for investments into runways and airfield-related infrastructure, which are currently funded through government funds. This may result in higher leverage in the future.
Residual Exposure to Cyprus
Most of the group's assets used in the airport's operations are physically located in Russia and all operating cash flows are generated by Russian subsidiaries. Residual cash flows are up-streamed to the treasury/financing companies of the group in Cyprus/Isle of Man. DME completed the process of transferring the main operating bank accounts from Cyprus to a Western European jurisdiction in the beginning of 2014 as expected, so cash from Russian operations is not accumulated in Cyprus. However, DME continues to use Cyprus banks for dividend distributions and as of September 30 the proportion of cash and bank deposits placed in Cyprus was 13%. Fitch is concerned about the group's residual exposure to Cyprus. If the proportion of cash placed with Cyprus banks is significant at any time, the ratings may be downgraded to Cyprus' Country Ceiling (currently 'B') in accordance with Fitch's 'Rating Non-Financial Corporates Above the Country Ceiling'.
Weaker Debt Structure Mitigated by HoldCo Guarantee: Debt Structure - Weaker
USD300m notes have been issued by DME Airport Limited (an Irish SPV) and on-lent to Hacienda Investments Ltd (Cyprus). The loan is guaranteed by DME Ltd and some of its subsidiaries on a joint and several basis. The guarantors' combined EBITDA and total assets should amount to at least 85% of the consolidated group's EBITDA and total assets. Guarantor cover ratios significantly exceeded these thresholds in 2013 and 1H14.
The notes are structured as corporate unsecured debt. The notes bear foreign exchange risk and refinancing risk with a bullet maturity 2018. Fitch considered these risks manageable due to the partial natural hedge through revenues, however the risks have intensified following the recent events in Russia.
Fitch considers several features of the notes weak: (i) the nature of the borrower (Cyprus-registered property company) and its ability to ensure that some of the covenants and undertakings under the on-loan are enforced across the whole group; (ii) the formula of the 85% guarantor EBITDA test which excludes the negative EBITDA values and the lack of transparency in the ratio calculation, and (iii) the possibility that the group's other subsidiaries that are not guarantors may raise debt that will be more senior to the notes. Fitch considered that these weaknesses are mitigated by the presence of DME's guarantee and the high inter-dependency between Hacienda and DME Ltd. Therefore the notes' rating is aligned with DME's IDR.
Positive: Rating upside potential is currently limited: corporate governance concerns remain material and substantial improvements would need to be demonstrated for the rating to be considered for an upgrade, including streamlining of DME's corporate and organizational structure and improvements in the group's insurance practices. Greater clarity with respect to the regulatory framework (transparent and comprehensive concession regime) would be positive for the rating, but would not justify rating upgrade absent improvements in corporate governance and transparency.
Negative: Conversely, material adverse regulatory events (i.e. interruption or regulatory intervention in some of DME's 'Auxiliary aviation services') or operational events (i.e. sustained loss of volume/pricing power) could put the rating under pressure. Furthermore, an upward revision to the capex plans that necessitate additional leverage than currently anticipated may lead to a negative rating action. A significant proportion of the group's liquidity placed with Cyprus banks would lead to rating downgrade to the level of Cyprus country ceiling (currently 'B').
Company: DME Airport Limited
|Full company name||DME Airport Designated Activity Company|
|Country of risk||Russia|
|Country of registration||Ireland|