Fitch Ratings has upgraded JSC Ukrzaliznytsia Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to 'B' from 'B-', according to a report on the rating agency's website.

"The rating action follows the upgrade of Ukraine's ratings," it says.

"Under Fitch's Government-Related Entity (GRE) Criteria, Ukrzaliznytsia's score of 27.5 is unchanged and stems from a very strong assessment of the legal status, ownership and support due to state full ownership and control and moderate support track record and expectations by the Ukrainian state. The state provides guarantees on some of the company's external debt contracted from international financial institutions (IFIs) and used to treat UR's external debt as quasi-sovereign, as evidenced in 2016, when the company's eurobonds were included in the perimeter of debt restructuring led by the national government," Fitch said.

"The score also reflects moderate socio-political and strong financial implications of default. Fitch believes that Ukrzaliznytsia's potential default might lead to some service disruptions, but not of an irreparable nature, and not necessarily conducive for significant political and economic repercussions for the national government. At the same time Fitch considers a default of Ukrzaliznytsia on external obligations as potentially harmful to Ukraine, as it could lead to exacerbation of reputational risk for the state. Both Ukrzaliznytsia and the national treasury tap international capital markets for debt funding, as well as using loans and financial aid from the IFIs," according to the document.

"Ukrzaliznytsia's 'b' Standalone Credit Profile (SCP) factors our assessment of revenue defensibility as weaker, operating risk as midrange, and financial profile as weaker. SCP is supported by the company's position as the monopoly owner and operator of the rail infrastructure and by the expected decline in the debt burden and projected stabilization of the company's financial profile under our rating case scenario," it says.

"Fitch forecasts Ukrzaliznytsia revenue to grow at a CAGR of 6.4% in 2019-2023 (2014-2018: CAGR 11%), above UAH 100 billion mark in 2020 from UAH 85 billion in 2018, underpinned primarily by rising freight volumes. Revenue growth is linked to projected economic recovery: according to Fitch's forecast Ukraine's real GDP will grow at about 3.2-3.5% year-on-year in 2019-2021. Expected growth in freight turnover will be additionally supported by instituted tariff regulation changes, as since end-2018 Ukrzaliznytsia employs automatically adjusted tariff using PPI-linked indexing for cargo railcars rental. Nonetheless, overall Ukrzaliznytsia's revenue defensibility remains fragile and prone to volatility, associated with commodity markets risk, FX risk, limited geographical diversification, and marked exposure to Ukraine's economic and operating environment," the report says.

"Ukrzaliznytsia's costs are relatively predictable as two-thirds of them, at UAH 53 billion at end-2018, are represented by wages and depreciation. Despite projected salary increases, highly influenced by national government policy goals aimed at improving disposable income, continued efficiency improvement measures and headcount reduction should in our view keep staff costs at a manageable and predictable level over the forecasted period of 2019-2023. Fitch expects Ukrzaliznytsia to cope with rising energy (electricity and fuel) costs, passing the increases to customers, as the tariff system development accommodates. We also expect UR will adhere to capex implementation plan with most of projected capex be self-funded," Fitch experts stated.

"Ukrzaliznytsia's leverage was moderately with net debt/Fitch calculated EBITDA reducing to 2x in 2018 from 3x in 2014. In our rating case, we project net debt/Fitch calculated EBITDA to gradually improve to about 1x over the medium term. Fitch expects UR to restore its free cash flow (FCF) capacity with FCF margin rebounding to about 3-5% of revenue over the medium term (2018: negative 2.6%). FCF margin's deterioration in 2018 was driven by material increase in capex to UAH 15 billion (2017: UAH 10.9 billion), underpinned by acquisition of new locomotive stock and capital modernization of the rolling stock along with upgrading of rail lines," the report says.

"Fitch's assessment of Ukrzaliznytsia's liquidity profile is weaker. The company's liquidity cushion at end-2018 was 0.07, remaining below our guidance of 0.33, necessary for a neutral assessment. Nonetheless, with its recent Eurobond issue the company materially eased refinancing pressure on expected repayment of $300 million in H2, 2019 and subsequent $100 million in both 2020 and 2021 as per the re-profiled 2018 eurobond scheduled maturity. Ukrzaliznytsia's Fitch calculated total debt was UAH 33.5 billion at end-2018 (2017: UAH 34.2 billion), with 92% of the debt stock bearing FX-risk," it says.