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By John Helmer in Moscow

Steady as she goes — that isn’t exactly the message from Sovcomflot, Russia’s largest shipping company, and one of the five largest energy shipping, oil and gas tanker fleets in the world.

Analysts at Moody’s Investors Service have issued a rating downgrade for the state-owned shipping company Sovcomflot, with a report that focuses on growing doubt that the Russian government will or can support the refinancing requirements of Sovcomflot’s fleet.

According to the April 29 report from Moody’s analysts in Italy and France, Sovcomflot has been downgraded from Baa1 to Baa2. “The rating action,” says the report, “reflects Moody’s decision to lower the government support assumptions for the company in the framework of Moody’s rating methodology for Government Related Issuers. Although the rating agency continues to believe that SCF enjoys a high degree of support from the Russian government, the one-notch downgrade reflects the view that, in the current market conditions, such support provides a lower level of enhancement to the company’s own creditworthiness.”

Moody’s report cautions that the national credit ratings for Sovcomflot are not comparable to non-Russian companies, or to other international shipping companies. They differ “from global scale ratings, as assigned by Moody’s Investors Service, in that they are not globally comparable to the full universe of Moody’s rated entities, but only with other rated entities within the same country.”

Despite an April 6 warning from Moody that it had commenced a review, the downgrade appears to have taken Sovcomflot by surprise. For on April 21, a Sovcomflot press release claimed Sovcomflot “has an investment-grade credit rating from Moody’s, and significantly, on 17 December 2008, Moody’s Interfax assigned an Aaa.ru national credit rating to OAO Sovcomflot.”

Sovcomflot, which is 100% owned by the Russian government and is not listed publicly, does not provide conventional and regular financial reports. The chief executive is Sergey Frank, a former federal Minister of Transport; the chairman of the board is the Kremlin chief of staff, Sergey Naryshkin.

Annual reports from Sovcomflot, published on the company website, provide scant details of the company’s debt position, and do not identify its principal lenders. Three banks, Vneshtorgbank, Deutsche Bank, and Morgan Stanley, are currently represented on Sovcomflot’s government- dominated board. According to a 2-page financial summary in the publicly released report for 2007, without auditor’s notes, Sovcomflot’s liabilities totaled $5.3 billion; these included long-term debt of $2.1 billion. The debt totals had jumped 15% and 11%, respectively, over the 2006 levels. Interest payments in 2007 amounted to $90 million, up 17% on 2006.

Throughout the shipping industry, debt maturities, collateral cover, and interest payments are of growing concern, following the sharp fall in the second half of 2008 in oil and gas prices, tanker rates, shipping revenues, and the required write-downs in vessel and fleet values.

A Sovcomflot release of interim 2008 financial results, issued on April 21, does not provide comparative debt and interest payment figures. As of December 31 last, the Sovcomflot operating fleet comprised 132 vessels, with an average age of 6 years and amounting to 9.4 million deadweight tonnes (dwt). On order in shipyards are another 31 vessels of 2.7 million dwt. The company reports that its 2008 revenues were up 32% to $1.6 billion; cost of sales and of operations is not disclosed, and there is no release of the interest payment figure. Net profit is reported as falling 14% for the year to $406.2 million.

Sovcomflot reports its asset value at 31 December 2008 as $5.7 billion in aggregate; net asset value, $2.8 billion.

These 2008 financial results consolidate the revenue, cost and profit figures of Russia’s second tanker fleet company, Novorossiysk Shipping Company (Novoship), a partially state-owned company, which had been taken over by Sovcomflot in December 2007, and minorities bought out during 2008. Sovcomflot’s latest financial statement does not provide a like-for-like comparison, in order that Sovcomflot’s revenue and profit performance in 2007 and 2008 can be compared separately from the Novoship figures.

In March 2008, Novoship released financial results for 2007. This was just after the consolidation with Sovcomflot became official, and while Sovcomflot was in the process of buying the remaining 9.66% free float of Novoship shares. According to the Novoship report, the company generated revenues of $615.3 million in 2007; and earned net income of $247.6 million. The report also indicated that Novoship’s fleet comprised 63 vessels; 54 of which were pledged as collateral for bank loans. Net book value of the Novoship fleet as of December 31, 2007 – when it was absorbed by Sovcomflot – was given as $1.9 billion; market value, $3 billion. Total debt reported by Novoship at the time was $892.9 million, of which $94.5 million was listed as short-term.

According to this Novoship report, as of December 31, 2007, in the month of consolidation with Sovcomflot, Novoship’s total assets were valued at $2.3 billion; net assets, $1.4 billion. According to the latest Sovcomflot statement, Sovcomflot was estimating its net assets at $2.7 billion. This suggests that at the merger, Novoship’s assets were worth slightly more than Sovcomflot’s (52% of net assets). Comparison of the two companies’ financial reports suggests that for 2007 at least, Novoship was contributing 50% of the consolidated revenue figure, and 53% of the net profit. On the other hand, Sovcomflot appears to have been carrying relatively more debt.

Novoship has also reported that for 2008 it had available credit lines amounting to $313.9 million. Payment obligations for its newbuild contracts under way in Chinese and South Korean shipyards were reported for 20 vessels, and totaled $595.9 million.

Sovcomflot spokesman Andrei Kechashin confirmed for Fairplay that Sovcomflot has consolidated both companies’ financial results in the Sovcomflot reports for 2007 and 2008.

Sovcomflot’s explanation for last year’s profit drop is the first disclosure of the impact of the global shipping crisis on fleet asset value. According to Sovcomflot, the profit figure has been “adjusted… to reflect value impairment provisions for some vessels and newbuildings.”

Although the company’s latest release claims that “the Group’s shipbuilding programme has been fully financed by equity and loan facilities,” and that “Sovcomflot has one of the lowest levels of leverage in its industry”, the latest Moody’s report indicates that Sovcomflot’s debt appears to have risen by 14% over last year to $2.4 billion. The Moody’s report claims: “As regards liquidity, in addition to its robust operative cash flow of around US$740 million, SCF relies on two main sources: (i) cash and marketable securities (as of FYE about US$300 million); and (ii) availability of committed bank facilities (as of FYE08 US$864 million). The relatively low percentage of encumbered vessels already provided as collateral will not affect future access to the capital markets in the coming years. Ownership of the group has so far limited any pressure to make dividend payments.”

Sovcomflot claims in its financial statement that it will pay Rb1 billion ($29 million) in 2008 dividend to the state, 4% more than in 2007.

Moody’s report contains several details, which have not been publicly released by Sovcomflot, including what Moody reports as “a negative Free Cash Flow on historical basis”. The ratings agency also reports liquid financial assets of nearly US$300 million and cash flow generation for this year “in the region of US$665 million”. According to Moody, this year Sovcomflot faces “debt repayments of US$470 million and vessel purchase commitments in the region of US$680 million.” To cover the shortfall, Moody’s report expects Sovcomflot to increase its borrowings. The report claims that as of last year, the company had “access to around US$864 million of un-drawn committed bank lines.”

With additional vessel collateral, and a state designation as “one of the enterprises that are strategic to the Russian Federation” Moody reports “that the default dependence between the Russian government and Sovcomflot is low.”

This could change, the agency claims, “in the event of weaker-than-expected market conditions and/or operational problems…if Retained Cash Flow/Net Debt ratio fell below 20%, the EBIT/Interest coverage ratio fell below 3x and/or the Debt/Ebitda ratio (all ratios on adjusted basis) increased to over 4.0x. A liquidity problem would immediately exert downward pressure on the rating.”

Sovcomflot is the second Russian fleet operator to be downgraded by Moody in as many months. In March, Far Eastern Shipping Company (Fesco) was downgraded by Moody’s, as vessel writedowns combined with falling cargo volumes and freight rates, triggered concerns at Fesco’s financial capacity to refinance its debts. Fesco is publicly listed, and reports its short and long-term debt position, as well as lenders.

According to Moody’s latest report, one of the factors underpinning Sovcomflot’s earnings potential is “its low exposure to spot markets.” In the Sovcomflot report of last week, CEO Frank is quoted as saying: “The volume of contracted future revenues and the Group’s strong financial position make it well positioned to withstand the current highly challenging environment and to achieve long-term sustainable growth.”

The company statement also claims that long-term chartering covers almost two-thirds of the fleet. “Over 60 per cent of its vessels are fixed on a time-charter basis, mainly with blue chip charters. In addition to all this the Group has around USD 4.0 billion of contracted future revenues.”

In June 2005, several months after Frank had ousted his predecessor as CEO, Dmitry Skarga, he claimed that Skarga had been negligent in fixing too high a proportion of the fleet on long-term charters. In interview with Fairplay on June 24, 2005, Frank said he had lifted Sovcomflot’s first-quarter revenue “because of increased spot exposure”. He also accused Skarga of using “Mickey Mouse intermediaries for long fixes”. He charged that Skarga’s pricing policy caused “a substantial discount”. Sovcomflot’s annual net income following his takeover, according to Frank, was $205 million. Claiming that the Skarga management had “80% of assets on time charters, [it is] hard to lift revenues.”

Sovcomflot’s first time-charter deal with Gunvor, the most important export trader of Russian oil, controlled by Gennady Timchenko, was initiated by Skarga, before Frank took over at Sovcomflot. An alliance between the Frank and Timchenko families has followed, and was reported by the Moscow newspaper Vedomosti in August 2008. When Timchenko’s London spokesman, Michael Prescott, was asked to confirm details of the marriage between Frank’s son and Timchenko’s daughter, he replied for the record: “I don’t actually know names of Mr T’s family members and haven’t had occasion to ask!” Timchenko’s Moscow spokesman, Dominique Winther, added: “Regarding Ksenia Timchenko, out of respect for the families involved, we are not commenting on this. Hope for your understanding on this – it’s a personal matter.”
Moody’s latest report suggests that, because of the high proportion of time charters currently signed up for its fleet, Sovcomflot’s “credit metrics tend to be more resilient to the shipping cycle than its main competitors. The global assessment on this factor was in the low end of the Baa region.”

Since 2005 Frank has made allegations against Skarga and others in a lawsuit, which is pending in the UK High Court. Skarga denies the allegations. Reports by international marine company auditor Moore Stephens, commissioned by Frank and subsequently submitted in the court file, do not substantiate the allegations. These are to go to trial soon in London, where Frank and Skarga will face cross-examination. When Frank appears, it will be the first time in recent history that a senior Russian government figure has been obliged to give testimony on oath in a UK High Court proceeding.

In February 2006, Lloyds List gave Frank the award of “Newsmaker of the Year”. According to Lloyds List at the time, “this will recognise the person from the maritime industries who has consistently captured the headlines.” Late last month, Frank, 48, gave an interview to Lloyds List in which he said he is thinking of retiring soon.
“The chief executive of a shipping business shouldn’t go beyond their mid-to-late forties,” Frank is quoted as saying. “For my generation it will be very difficult to be leaders for the people who were born in the 1980s, as in some areas, they are more talented and capable.” A source close to Sovcomflot warned against taking this too literally. Compared to Frank, who was 44 when he took over Sovcomflot, Skarga was 34 when he left.

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