CORPORATESSECTOR IN-DEPTH 14 JULY 2015TABLE OF CONTENTSCargo volumes are on the decline as domestic demand contracts 2 Railcar surplus has driven down freight rates2Ongoing government support to producers may limit positive effects of uptick in scrapping4Long-term contracts, strong niche positions support capacity utilisation rates for some&.4..&.but continuing low freight rates will affect operating profitability across the board5Achieving a market balance will be challenging 5 Moody's Related Research 6ANALYST CONTACTSJulia Pribytkova 7-495-228-6071 VP-Senior Analyst julia.pribytkova@moodys.comVictoria Maisuradze 7-495-228-6067 Associate Managing Director victoria.maisuradze@moodys.comRail Freight Transportation Services - RussiaWeak Domestic Economy and Railcar Surplus Put Sector on the Wrong Track Summary¯ Russian rail freight operators will come under pressure in 2015-16. A decrease in transportation volumes, persistently low freight rates as a result of an unbalanced market and constrained liquidity will create challenging conditions.¯ Oversupply problems have led to a plunge in freight rates. We estimate that the market is oversupplied by about 26% based on the current total rail fleet. Massive investment into the fleet post its liberalistion in 2009, limited scrapping activity and government support to railcar producers have led to a sharp increase in supply at a time of weakening demand. As a result, freight rates have been falling since 2011 and are currently around 70% lower than they were that year.¯ Scrapping activity is likely to pick up. Despite opposition from the largest market players, new regulations should stimulate more scrapping as the cost of certifying railcars that have reached the end of their useful lives is likely to be high. In addition, high levels of indebtedness are likely to eschew operators from making replacement purchases. However, ongoing government support to railcar producers with social mandates may limit the positive effects on the supply-demand imbalance in the short term.¯ Long-term contracts, strong niche positions will help support capacity utilisation rates for some. Companies, such as Globaltrans Investment PLC (Globaltrans, Ba3 stable), that operate on long-term contracts with producers and shippers and niche operators, such as TransContainer JSC (Ba3 stable), are likely to be more resilient than pure spot market players and leasing operators.¯ Freight rates are unlikely to go up in the next two years. This will adversely affect the profitability of all companies active in the rail freight market. Companies with high debt service requirements and exposure to foreign currency risk, such as Brunswick Rail Limited (Caa3 negative), will face severe liquidity pressure during the next 24 months. Consolidation of this very fragmented market is inevitable, but will likely lead to asset write-offs as the fair market value of railcars is adjusted by market participants and creditors....
