January 17, 2017 | Cbonds
|Fitch Ratings has affirmed PJSC Rostelecom's (Rostelecom) Long-Term Issuer Default Rating (IDR) at 'BBB-' with a Stable Outlook. A full list of rating actions is at the end of this commentary.|
Rostelecom is Russia's leading fixed-line telecoms operator, and the largest broadband and pay TV provider. It is the key infrastructure provider in the interests of national security and is the sole contractor for many nationwide projects that will likely preserve its incumbent status.
Fitch expects the company's net leverage to moderately increase to 2.5x funds from operations (FFO) by 2018 from an estimated 2.3x in 2016, driven primarily by higher dividend payouts. However, Rostelecom retains comfortable headroom below the downgrade threshold of 3.5x FFO adjusted net leverage.
KEY RATING DRIVERS
Strong Incumbent Positions
Rostelecom retains its strong market positions in all key fixed-line segments, supported by its substantial network and fibre deployment, effective regulatory protection and continuing improvements in customer service. The company leads the market in fixed broadband and pay TV services, holding around a one-third market share by revenue in both segments, and ahead of number two and three players by a significant margin. Rostelecom continues to expand its positions in other digital services segments, such as data centres where the company became the number one player in 2015.
Fixed Voice Decline Mitigated
The fixed line voice segment continues to demonstrate sharp revenue declines, driven primarily by fixed-to-mobile substitution and growing popularity of VoIP services. Rostelecom is able to offset these declines with robust revenue growth in other segments, primarily broadband, pay TV and value added services (VAS) & clouds services. However, the change in the revenue mix combined with inflationary pressures is putting pressure on Rostelecom's EBITDA margin. Combined with sustainable capex, this puts moderate pressure on free cash flow (FCF) generation.
Broadband Retains Growth Potential
We believe that Rostelecom can grow its fixed broadband revenue by low- to mid-single digit percentages for the next three to four years. The Russian broadband market is close to saturation but a number of factors favour further growth of Rostelecom's revenue, including low penetration of fibre outside large cities and increasing demand for faster internet plans. The broadband market remains fragmented with almost 70% of subscribers controlled by the five largest players and more than a 30% share held by smaller regional operators.
Capex to Moderately Decline
Rostelecom is approaching its targeted fibre coverage of 33 million households in Russia, which is likely to be reached in 2017. The completion of this major project implies some future flexibility in capex for the company. Fitch expects capex to gradually decline to 18.5% in 2018-2020 from 21.1% in 2015. A faster decline in capex is unlikely given the necessity to continue investing in the core network and in new segments such as data centres and cloud services.
Leverage to Moderately Increase
Fitch expects Rostelecom's FFO-adjusted net leverage to increase to 2.5x in 2018-2020 from 2.1x in 2015, driven primarily by higher dividend payments, but also by EBITDA declines and the expected exercise of a put option on Rostelecom shares by Deutsche Bank in 2017. Fitch expects the company to retain substantial headroom below the downgrade threshold of 3.5x FFO-adjusted net leverage.
Bridging Digital Divide Funding Delays
Rostelecom expected some pressure on EBITDA in 2016 related to delays in receiving government compensation for network construction under the state's Bridging Digital Divide (BDD) programme. The company has the flexibility to reduce capex in case of delayed funding from the state. This limits its exposure to delayed payments to RUB2bn-RUB5bn and is unlikely to put pressure on the company's liquidity.
Rostelecom is the sole implementation agent of the BDD programme aimed at providing internet access to the less populated regions of Russia. The programme is funded by the government, which compensates the company the construction of network on a quarterly basis.
Mobile Service Launch
Rostelecom launched a mobile virtual network operator (MVNO) with the fourth-largest mobile operator Tele2 in which the incumbent holds a 45% share. This move enables the company to provide quad-play services nationwide. Fitch believes that Rostelecom will use this mobile service as a way of reducing customer churn and increasing average revenue per household, rather than aggressively targeting mobile market share gains. Fitch does not expect mobile services to have a material impact on financials in the next three to four years.
Rostelecom's IDR is comfortably positioned in the 'BBB' category on a standalone basis. The ratings are supported by the company's leading market position in fixed telecoms, low leverage, and a lack of material forex exposure. The company faces limited network-based competition outside the larger cities and benefits from a benign regulatory environment.
Fitch views the government control over Rostelecom as positive and believes that it protects the company against risks that are typical of most Russian corporates with a dominant private shareholding, such as related-party transactions, exposure to other group operations and excessive dividend distributions. Fitch applies only a one-notch discount for corporate governance, compared with two notches for most Russian private companies. The company's rating is capped by the sovereign rating of Russia (BBB-/Stable).
Fitch's key assumptions within the rating case for Rostelecom include the following:
- High-single digit revenue declines in the fixed-line telephony segment
- Revenue growth of 3%-5% per year in the broadband segment in 2016-2019
- EBITDA margin of 32% in 2016 and slightly declining thereafter
- Capex/revenue ratio at 20% in 2016 and declining in 2017-2019
- Dividend payments (adjusted for treasury shares) at around RUB12bn per year in 2017-2019
- RUB4.4bn spending on the exercise of put option by Deutsche Bank in 2017
- RUB2.5bn spending per year on small acquisitions
Positive: Future developments that could lead to positive rating action include:
- Substantial and sustainable improvements in pre-dividend FCF generation coupled with a stable market position and operating performance. This is only likely once the company has completed its fibre roll-out project, which should lead to lower capex and an improved EBITDA margin.
- An upgrade of the Russian sovereign rating, together with the abovementioned improvements of the company's profile. Rostelecom's high exposure to the domestic market makes it unlikely for the company to be rated higher than the sovereign.
Negative: Future developments that could lead to negative rating action include:
- FFO adjusted net leverage above 3.5x on a sustained basis.
- Erosion of the company's solid FCF generation, with a pre-dividend FCF margin below mid-single digits on a sustained basis.
- Deterioration in liquidity.
- A downgrade of the Russian sovereign rating.
Rating Sensitivities for the Russian sovereign:
The main factors that could, individually or collectively, lead to negative rating action, are:
-A weakening of the policy framework that undermines macroeconomic and fiscal performance.
-A sharp decline in international reserves.
-A rise in geopolitical tensions or imposition of significantly tougher sanctions.
The main factors that could, individually or collectively, lead to positive rating action, are:
-The rebuilding of fiscal and external savings buffers, for example through a sustained recovery in oil prices.
-Fiscal reforms and commitment to a credible medium-term fiscal framework.
-Implementation of structural reforms that would boost potential growth.
Strong Liquidity Profile
Rostelecom has a robust liquidity profile with around RUB82bn in undrawn committed credit lines and RUB4.4bn of cash and equivalents, which would be sufficient to cover debt maturities until 4Q17. The company benefits from strong relationships with the largest Russian banks, including state-owned banks.
FULL LIST OF RATING ACTIONS
Long-Term IDR: affirmed at 'BBB-', Outlook Stable;
National Long-Term Rating: affirmed at 'AA+(rus)', Outlook Stable;
Senior unsecured rating: affirmed at 'BBB-' and 'AA+(rus).
|Full company name||Rostelecom OJSC|
|Country of risk||Russia|
|Country of registration||Russia|