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June 18 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned Baghlan Group FZCO (Baghlan) a Long-term foreign currency Issuer Default Rating (IDR) of ‘B-'. The Outlook is Positive.
Baghlan is a privately owned, diversified Azerbaijani corporate benefiting from the expected structural growth of the country through its transport services, construction and oil & gas activities. Although moderately leveraged for the rating category recent investments into start-up oil and gas assets have increased the debt quantum. The agency expects funds from operations (FFO) gross leverage to remain below 2.5x into FY13. Fitch expects on-going stability from its transport services business to offset lumpy cash flow generation from its construction segment. The oil and gas segment over FY13 & FY14 is expected to be a modest drain on cash flows. However, the potential for this unit to outperform and up-stream dividends to the group - indicative of standalone strength - is a potential positive rating event.
Diversified Operating Segments:
The operating risk profile benefits from its diversified nature, although the concentration on large contracts is a weak point. Transport and logistics services benefit from strong domestic market share, recurrent cash flow and privileged contracts with government bodies. Construction is primarily focused on one large civil works contract with a few more contracts in the order book coming on-stream over the next few years. Although this business risk exhibits a higher risk with volatile working capital movements and fragmented market share, profit margins and growth prospects are strong. Oil and gas operations are in a run-up phase and still required financial support from the group, although expected to be cash flow positive from FY15 onwards.
Stable Transport Services Unit:
As the leading freight agent in Azerbaijan this operating segment requires minimal debt funding and has a solid track record of generating reasonable free cash flow (FCF) for the rest of the group to grow. This stability stems from Baghlan’s leading position as the key freight agent for Azerbaijani Railways selling on its behalf around 60% of all freight volume through the Azerbaijani railway network. The unit has high barriers to entry with Baghlan benefiting from an exclusive medium term contract with Azerbaijani Railways.
Real Estate Divestments:
Strong FY13 expected FCF generation is dependent on the disposal of this portfolio of primarily residential, multi-purpose units in central Baku. The positive impact on FCF of around AZN60m from these divestitures would aid de-leveraging, although not required to maintain consolidated FFO gross leverage below 2.5x for FY13. Baghlan is currently in negotiations with investors and banks to sell these units in block sales.
Volatile Working Capital Movements:
Solid P&L profits posted in recent years have not fully converted into cash flow. Negative working capital outflows during 2011 and 2012 have led Baghlan to fund a working capital requirement of around AZN181m as at FY12 (inventory plus current receivables less current payables). Although working capital is likely to become positive in 2013 and 2014 it is closely linked to divesting real estate assets, receiving payment from deferred consideration following the sale of a JV interest (AISBG) and successful execution of their construction contracts. Receivables risk is largely contained with the majority of receivables linked to Azerbaijani state authorities.
Reduced Bank Debt Dependency:
As typically for a private Azerbaijani issuer, access to long term bank funding is constrained by the relatively under-developed banking market. Positively, Baghlan used the international debt markets issuing a secured USD150m note in 2012 to fund the increased stake in their existing oil and gas business. Baghlan continues to refinance its bank debt largely with the International Bank of Azerbaijan (‘BB’/Stable) that has in recent years shown solid support for the domestic non-oil sector.
Positive: Future developments that could lead to positive rating actions include:
- Improved operating risk profile with reduced concentration on large single contracts.
- Positive working capital generation and successful divestment of real estate assets.
- Extension of existing debt maturities and diversifying sources of funding.
- Sustainable financial metrics with Fitch adjusted FFO gross leverage below 3.0x and FFO gross interest cover above 4.0x.
- Oil and gas activities to be self-sufficient and generate sustainable FCF to upstream dividends.
Negative: Future developments that could lead to negative rating action include:
- Continued working capital outflows and increased requirement to use local bank funding.
- Failure to renew key contracts or loss of licenses in the Transport segment.
- Oil and gas activities to drain material cash flow from the overall group and /or an underperformance on the oil and gas segment.