Research: Rating Action: Moody’s assigns a Baa2 rating to the new notes proposed by Ceske Drahy; stable outlook

Paris, June 21, 2022 — Moody’s Investors Service (“Moody’s”) has assigned a Baa2 rating to Czech national rail operator Ceske drahy, as’s (“CD”, “Ceske drahy”, or the company) has proposed a new 500 million euro senior unsecured notes. At the same time, Moody’s affirmed the company’s long-term issuer rating Baa2, senior unsecured ratings Baa2 and basic credit assessment (BCA) ba2, which reflects the company’s stand-alone financial strength. The outlook is stable.

The proposed new bonds will be used to fund its growing capital expenditure needs over the next 18 to 24 months, repay maturing debt and support liquidity.

RATINGS RATIONALE

Affirmation of Ceske Drahy’s ratings and BCA reflects strong operating performance in 2021 despite severe and continued pandemic impact, driving Moody’s Debt/Adjusted EBITDA down 6.2x from 9.5x in 2020 However, the decision to increase balance sheet leverage by around 45% to support capex and liquidity rather than through equity will bring leverage down to around 6.6x in 2022, which will put pressure on the BCA as well as the overall Baa2 rating. Although Moody’s expects leverage to reduce to around 6x in 2023 in the base case, this leaves no cushion for underperformance.

Ceske Drahy’s Baa2 issuer rating incorporates a three-notch upside from the ba2 BCA, in line with Moody’s Government-Related Issuers methodology. The improvement reflects the strong and ongoing relationship between the company and its sole shareholder, the Czech Republic (Czech Republic, Government of, Stable Aa3).

CD’s ba2 BCA builds on the company’s strong market position in the Czech Republic and high revenue visibility, thanks to contracts it has signed with the government and 14 municipalities for railway operation of travellers.

The BCA also reflects CD’s operational improvements as it recovers from the challenges posed by the pandemic. Despite the modest revenue recovery to CZK 38.5 billion from CZK 36.4 billion in 2020, the company’s reported EBITDA margin improved to 20.7% from 14% in 2020. This was achieved mainly through increased productivity and lower personnel costs. CD’s reported EBITDA margin is expected to increase to over 25% over the next 12 to 18 months despite some inflationary pressures.

In addition to the company’s higher debt burden and therefore continued high leverage, which is expected to exceed 6.0x in 2022, the BCA is limited by the negative free cash flow that Moody’s expects over the next next 18 to 24 months, capital-driven spending needs. The investments will mainly be allocated to the continued modernization of passenger and freight rolling stock, which is key to remaining competitive.

Following the loss of several tenders in 2019 and 2020, the company continues to face the risk of losing tenders in the future. However, backed by recent contract wins, Moody’s expects the company to maintain a market share of well over 80% in the Czech passenger rail market.

LIQUIDITY

The CD has good liquidity. The company has access to at least CZK 34 billion of cash, of which CZK 1.8 billion of unrestricted cash on its balance sheet at the end of March 2022, CZK 10.4 billion available under committed facilities, CZK 7.2 billion unused bank loans (with maturities exceeding 12 months at the end of May 2022), Eurofima loan of CZK 7.2 billion, grants of CZK 1.2 billion and operating cash flow which Moody’s estimates at CZK 6.6 billion . This available liquidity will comfortably cover planned capital expenditures of nearly CZK 25 billion (post-IFRS 16) and debt repayments of CZK 3.9 billion in 2022. The proposed new bonds as well as increased liquidity from transactions will further improve liquidity, allowing for the repayment of the €400 million CD Eurobond maturing in May 2023.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook reflects Moody’s expectation that CD indebtedness will decline at or below 6x over the next 18-24 months despite proposed additional debt due to capital expenditure needs. The outlook also reflects Moody’s expectation that CD’s operating performance will continue to recover from the pandemic and that the company will continue to maintain good liquidity.

FACTORS THAT MAY LEAD TO IMPROVEMENT OR DEGRADATION OF RATINGS

Upward pressure on the rating would likely result from an upgrade of the BCA from CD to ba1 from the current ba2, following a sustained improvement in the company’s operational performance; EBIT margin remains in the mid-range (as a percentage), Moody’s Debt to Adjusted EBITDA ratio declines to around 4.5x on a sustainable basis and Free Cash Flow remains positive on a sustainable basis.

While sovereign ties are seen as strong and an upgrade in the Czech Republic’s rating would be positive for CD’s credit quality, it is unlikely to translate into an upgrade in CD’s rating which is currently constrained by the ba2 BCA.

The issuer’s rating could come under pressure in the event of further deterioration and downgrade of the BCA, and if this is not adequately offset by stronger sovereign support or increasing strategic importance for the Czech Republic.

The BCA is weakly positioned due to the increase in the level of indebtedness on the balance sheet and consequently a still high indebtedness despite an improvement in the company’s results. If the company does not perform as expected by Moody’s and fails to reduce leverage below 6x over the next 12-18 months, the BCA could be downgraded from ba2 to ba3 accordingly. The BCA could also come under pressure if free cash flow remains negative for an extended period or if there is a deterioration in the company’s liquidity profile.

A Ceske Drahy downgrade could also be triggered by a significant downgrade in the Czech Republic’s sovereign rating and/or a weakening of the close ties between the company and its sole shareholder.

MAIN METHODOLOGY

The methodologies used in these ratings were passenger railways and bus companies published in December 2021 and available at https://ratings.moodys.com/api/rmc-documents/360649and Government-Related Issuers Methodology published in February 2020 and available at https://ratings.moodys.com/api/rmc-documents/64864. Otherwise, please see the Scoring Methodologies page on https://ratings.moodys.com for a copy of these methodologies.

COMPANY PROFILE

In 2021, CD recorded a total core business turnover of CZK 38.5 billion (€1.6 billion), of which approximately 67% (including other income) came from passenger transport and approximately 33% of freight transport. The company has approximately 22,186 employees as of December 31, 2021 and is one of the largest employers in the Czech Republic.

REGULATORY INFORMATION

For details on key rating assumptions and Moody’s sensitivity analysis, see the Methodological Assumptions and Sensitivity to Assumptions sections in the Disclosure Form. Moody’s rating symbols and definitions can be found at https://ratings.moodys.com/rating-definitions.

For ratings issued on a program, series, category/class of debt or security, this announcement provides certain regulatory information regarding each rating of a subsequently issued bond or note of the same series, category/class of debt, security or under a program for which ratings are derived exclusively from existing ratings in accordance with Moody’s rating practices. For ratings issued on a media provider, this announcement provides certain regulatory information relating to the credit rating action on the media provider and each particular credit rating action for securities whose credit ratings are derived from the support provider’s credit rating. For the provisional ratings, this press release provides certain regulatory information relating to the provisional rating assigned, and to a final rating that may be assigned after the final issuance of the debt, in each case where the structure and conditions of the transaction n have not changed prior to the final rating being assigned in a way that would have affected the rating. For more information, please see the issuer/transaction page of the respective issuer at https://ratings.moodys.com.

For all relevant securities or rated entities receiving direct credit support from the lead entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action , the associated regulatory information will be that of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to the jurisdiction: Ancillary services, Disclosures to the rated entity, Disclosures to be provided by the rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued without modification as a result of such disclosure.

These notes are solicited. Please refer to Moody’s Policy for the Designation and Assignment of Unsolicited Credit Ratings available on its website. https://ratings.moodys.com.

The regulatory information contained in this press release applies to the credit rating and, if applicable, the outlook or rating revision relating thereto.

Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis are available at https://ratings.moodys.com/documents/PBC_1288235.

The worldwide credit rating on this credit rating announcement has been issued by one of Moody’s affiliates outside the UK and is approved by Moody’s Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the United Kingdom. . Further information on the UK endorsement status and the Moody’s office that issued the credit rating can be found at https://ratings.moodys.com.

Please see https://ratings.moodys.com for any updates on changes to the lead rating analyst and Moody’s legal entity that issued the rating.

Please see the issuer/transaction page at https://ratings.moodys.com for additional regulatory information for each credit rating.

Kristin Yeatman
Vice President – Senior Analyst
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