ACRA affirms А(RU) to JSC Concern Kalashnikov, outlook Stable

The credit rating of JSC Concern Kalashnikov (hereinafter, Kalashnikov, the Company, or the Concern) has been affirmed in view of a substantial growth in the Company's portfolio of orders and a relevant improvement in its financial profile. The credit rating of the Company is based on its strong business profile, adequate corporate governance, high profitability, and strong liquidity. The rating is further supported by a high strategic importance of the Company for the state. On the other hand, the Company's medium size, high leverage and FCF shortage restrict the credit rating.

JSC Concern Kalashnikov is the Russia's largest manufacturer of firearms, which is the main supplier of small arms to the RF Armed Forces and controls the manufacture of high-precision guided weapons for army aviation. In 2018, the Company's revenue surged against 2017 on a growth of the portfolio of orders and an inflow of proceeds that have been overdue since 2017. 25% plus one share in the Concern belong to Rostec Corporation and 75% minus one share belong to private investors.

Key rating assessment factors

Strong business profile and strong market positions. Kalashnikov supplies up to 95% of small arms to the Russian market. In addition, the Concern manufactures guided weapons systems that are in high demand in Russia and abroad. The exports share in the sales exceeds 50%. Sanctions raised against the Company in 2014 did not affect its creditworthiness, because the volume of exports to sanction imposing countries has historically been insignificant, while the need for imported components is low. The Company has a complete and long-term portfolio of orders, and the utilization ratio of its manufacturing capacities is about 100%.

Adequate corporate governance is due to a high assessment of the management strategy, the implementation of which allowed the new owners of the Company to restructure OJSC Concern Izhmash that went bankrupt. The strategy is aimed further at increasing revenues from sales of civilian products, as well as such promising products as UAVs, motorboats and boats. The Agency notes that there are virtually no financial risk management regulations in the Company, however, the actual level of accepted currency and interest risks is minimal. The management structure allows the Company to minimize conflicts of interest, since two of nine members of the board of directors are independent directors, and all key decisions are coordinated with the largest lender. The Company’s structure is rather complicated but matches the scale of its business. Financial transparency is acceptable, taking into account the confidential nature of the Concern’s activities.

High profitability is underpinned by the current state defense order contracts and the pricing policies for weapons. In 2020, the Company is expected to start manufacturing products that are more marginal. In 2018, the FFO margin before net interest and taxes has restored to 25% against 7% in 2017, and the margin is expected to be at least 10% in the period from 2019 to 2021. The size of the Company's business is assessed by the Agency as medium, as the annual average FFO before net interest and taxes is estimated at RUB 6 billion for the period from 2015 to 2021.

High leverage and medium coverage. The Agency expects that by late 2019, the growth in the Company's leverage will slow down and then the Company will push down its debt. According to ACRA's estimates for 2015–2021, the annual average ratio of total debt/FFO before net interest is expected to reach 4.9x, and the coverage of interest payments to be about 3.2x.

High liquidity of the Company stems from the comfortable terms of payment for its products. The Agency notes that the defense sector payment regulations imply strict targeted use of advance payments, therefore, not all cash was taken by the Agency in its calculations of liquidity. The Agency also notes a significant amount of unwithdrawn loan limits in banks and available credit lines. As a result, despite a significant shortfall in free cash flow in 2019, ACRA expects that in 2020–2021, the free cash flow will become positive in view of a drop in capital expenditures down to the level of supporting investments, as well as the absence of significant debt repayments.

Key assumptions

  • 5.7% annual growth of Company’s costs;
  • Dividend payments at about 25% of the net profit.

Potential outlook or rating change factors

The Stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18-month horizon.

A positive rating action may be prompted by:

  • The FCF margin going above 5%;
  • Lower leverage: the total debt to FFO before net interest going below 3.5х.

A negative rating action may be prompted by:

  • A growth in the total debt above 5.0х of FFO before net interest, or coverage of interest payments going below 2.5х;
  • The FFO margin before fixed charges going below 15%;
  • A shrink in the contractual base;
  • A substantially worsened access to external sources of liquidity and a lower liquidity assessment.

Rating components

Standalone creditworthiness assessment (SCA): а-.

Support: 1 notch up to the SCA.

Issue ratings

No outstanding issues have been rated.

Regulatory disclosure

The credit rating has been assigned under the national scale for the Russian Federation and is based on the Methodology for Credit Ratings Assignment to Non-Financial Corporations under the National Scale for the Russian Federation, Methodology for Analyzing Member Company Relationships within Corporate Groups, Methodology for Analyzing Relationships Between Rated Entities and the State, and the Key Concepts Used by the Analytical Credit Rating Agency Within the Scope of Its Rating Activities.

The credit rating assigned to JSC Concern Kalashnikov was first published by ACRA on August 16, 2017. The credit rating and its outlook are expected to be revised within one year following the publication date of this press release.

The assigned credit rating is based on the data provided by JSC Concern Kalashnikov, information from publicly available sources, as well as ACRA’s own databases. The credit rating is solicited, and JSC Concern Kalashnikov participated in its assignment.

No material discrepancies between the provided data and the data officially disclosed by JSC Concern Kalashnikov in its financial statements have been discovered.

ACRA provided no additional services to JSC Concern Kalashnikov. No conflicts of interest were discovered in the course of credit rating assignment.

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