Fitch Ratings has upgraded Public Joint Stock Company Aeroflot - Russian Airlines' (AFLT) Long-Term Issuer Default Rating (IDR) to 'BB' from 'BB-'.

The Outlook is Stable. A full list of rating actions is below.

The upgrade reflects our reassessment of the strength of the links between the company and its majority shareholder, Russia (BBB/Stable) under Fitch's 'Government-Related Entities (GRE) Rating Criteria'. We now view financial implications of a default by AFLT as 'Moderate' versus 'Weak' previously and continue to view government ownership and control, and support track record as 'Strong' and socio-political implications of a default as 'Moderate'. This results in a support score of 20 under Fitch's GRE Criteria, which combined with AFLT's 'b' Standalone Credit Profile (SCP), leads to a top-down-minus-three rating approach compared with the previous bottom-up-plus-two rating approach

The Stable Outlook on the SCP reflects AFLT's strong domestic operations and gradual international flights recovery, with favorable yields. We expect profit margins and credit metrics to remain weak over 2021-2022, before strengthening from 2023. We estimate that liquidity will remain sufficient to sustain operations in 2021-2022, assuming available credit facilities from large state-owned banks and measures to preserve cash, such as slower expansion of the fleet and no dividends.

Key Rating Drivers

Domestic Segment Aids Recovery: AFLT as one of the key domestic carriers is better positioned than international peers to benefit from the early stages of air travel recovery. Limited international traffic, the absence of overseas travel opportunities, vaccination progress and loosening pandemic restrictions for domestic travel has driven a robust rebound in domestic leisure travel in the past 15 months. Domestic revenue passenger kilometers (RPK) and load factor outperformed pre-Covid-19 levels. While business and international travel remain weak, we still expect international travel to gradually recover to 2019 levels by 2023. The capacity removed during the course of the pandemic led to heightened 2021 yields, which we expect to normalise from 2022.

Expected Full Recovery from 2023: Fitch expects total RPK in 2021 and 2022 to be, respectively, 39% and 22% lower than 2019 levels before rebounding fully by 2023. Our assumptions for 2023 are essentially unchanged, as vaccine distribution throughout 2021-2022 should allow international traffic to normalise thereafter. Fitch still anticipates leisure travel to lead the recovery, and that competition will put pressure on international yields from 2022. We expect AFLT's passenger numbers, profitability and credit metrics to remain weak, breaching our negative rating sensitivities in 2021-2022, before returning to within their thresholds in 2023.

Delayed Deliveries, Higher Capex: Fitch expects free cash flow (FCF) to remain negative in 2021-2024, due to annual maintenance capex on average at RUB32 billion and our assumptions of resumed dividends from 2024. However, AFLT has managed to delay a significant share of aircraft deliveries from 2019-2020 to further periods, adding to financial flexibility. It is scheduled to increase its fleet to 353 aircraft by end-2021 and further from 2024. It has also agreed with VTB Leasing on delaying a part of lease payments. Aircraft deliveries are limited in 2022 and 2023, as AFLT still operates one of the youngest aircraft fleet among large airlines globally, with an active fleet of 342 aircraft at an average age of 7.1 years.

State Ownership and Control: State majority ownership (57.3%) of AFLT underpins our unchanged 'Strong' view of the airline's status, ownership and control. AFLT remains on the list of Russia's strategic enterprises and its operational and financial strategies are overseen by the government.

Strong State Support: We assess support track record as 'Strong'. In 2020, state-guaranteed loans reached 52% of AFLT's total bank debt (forecast 30% in 2024), AFLT received subsidies of RUB7.9 billion, while the Russian government issued a guarantee for a five-year RUB70 billion loan and also provided a RUB6.7 billion 2% loan under a state programme to support business activities and employment. Additionally, the state participated in AFLT's RUB80 billion equity increase via a secondary public offering. This, combined with the state-backed credit facility, supported liquidity in absorbing cash burn and covering short-term debt maturities.

Incentives to Support: The socio-political implications of a default by AFLT are 'Moderate', since the airline is important to Russia's economy (a solid domestic market share of 42.1% and 36,000 employees) and also for developing connectivity among various regions in Russia, while its substitution is likely to lead to a temporary disruption in service. However, exceptional tangible state support during Covid-19, deferral of lease payments by state-owned banks, and sizable debt quantum versus GRE peers' strengthened our assessment of the financial implications of default to 'Moderate' from 'Weak'.

High FX Exposure: AFLT remains significantly exposed to foreign-exchange (FX) fluctuations as the majority of its debt and aircraft leases are denominated in foreign currencies, mainly the US dollar. This is partially mitigated by more than half of its revenue being generated in US dollars or euros, or linked to euros, although we expect revenue from international flights to be under pressure from pandemic-related disruption.

Derivation Summary

AFLT's SCP has been less affected by the pandemic, due to strong domestic market performance and government support, compared with peers whose ratings were more severely affected, such as British Airways Plc (BB/Negative), American Airlines, Inc (B-/Stable), Air Canada (B+/Stable), and GOL Linhas Aereas S.A. (B-/Stable). AFLT's SCP of 'b' reflects a weaker competitive position on international flights, higher leverage, and FX exposure, which are somehow mitigated by the airline's favourable hub position and industry-leading average fleet age of 7.1 years.

AFLT benefited from its scale and diversity of operations (with around 40% of revenue generated in the domestic market, and above 60% during the pandemic), strong domestic market position and favourable cost position.

AFLT's 'BB' IDR is derived from our top-down-minus-three rating approach, reflecting links with and support from the Russian state.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Russian GDP to grow 4.3% in 2021 and on average 2.3% in 2022-2024

Russian inflation at 4%-6% during 2021-2024

RPK to fall 39% in 2021 and 22% in 2022, relative to 2019 levels, before recovering to 2019 levels by 2023

Load factor of about 80% in 2021 (81.1% for 9M21) and gradually recovering close to 82% by 2023

Oil price of USD63/bbl in 2021, USD55/bbl in 2022 and USD53/bbl in 2023-2024

Annual capex on average at RUB32 billions until 2023

Pre-delivery payment refunds totalling RUB29 billion in 2021

Fleet expansion in line with management's case for 2021-2023

No dividend payment for the next three years, dividends to resume from 2024 only

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Positive sovereign rating action

Strengthening links with the government, for example, in the form of explicit guarantees or cross-default provisions

Funds from operations (FFO) adjusted gross leverage falling below 5x on a sustained basis could result in positive rating action for the SCP

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Negative sovereign rating action

Weaker linkage with the state, via for example, diminishing or irregular state support

Inability to achieve FFO adjusted gross leverage below 5.5x and FFO fixed charge cover above 1x on a sustained basis, due to, among other factors, prolonged air-travel and social-distancing restrictions, substantial rouble depreciation, a protracted downturn in the Russian economy, weaker-than-expected yields or overly ambitious fleet expansion, would result in negative rating action for the SCP

The following rating sensitivities are for Russia (9 July 2021):

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Structural features: Imposition of additional sanctions that undermine macroeconomic and financial stability, or impede debt service payments

Macroeconomic policy and performance: Changes in the policy framework that undermine policy credibility or increase the impact of oil price volatility on the economy

Public finances: Sustained erosion of the sovereign balance sheet, including from the materialisation of contingent liabilities from the large public sector

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Macroeconomic policy and performance: Sustained higher real GDP growth, for example stemming from the implementation of a reform strategy addressing structural constraints to growth, while preserving improved macroeconomic stability

Structural features: Reduction in geopolitical risk, or improvement of governance standards (for example rule of law, voice and accountability and control of corruption), which could cause the removal of the -1 QO notch

Public and external finances: Significant additional strengthening of fiscal and external savings buffers compared with Fitch's current projections, for example, through sustained high oil prices and windfall revenues

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Comfortable Liquidity: At end-1H21, AFLT had cash and short-term deposits of RUB113.2 billion, plus credit facilities of RUB119 billion available for more than one year, in contrast to short-term debt maturities of RUB133 billion, including RUB116 billion of leases. The company does not pay commitment fees under its credit lines but, given its state ownership, we would expect funds from banks to be available. We expect FCF to be negative in 2021, due to the impact of pandemic-related disruption, which will add to funding requirements. AFLT would continue to use leases to fund its further fleet expansion.

Issuer Profile

AFLT is Russia's largest airline and one of the largest European and global carriers. In 1H21, it accounted for 40.5% (including foreign carriers' traffic) of Russia's air-travel market, carrying 18.6 million passengers (27.5 million passengers in 1H19).

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

AFLT's rating is linked to Russia's IDR.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

RATING ACTIONSENTITY/DEBT	RATING		PRIOR
Public Joint Stock Company Aeroflot - Russian Airlines	LT IDR	BB 	Upgrade		BB-
	ST IDR	B 	Affirmed		B
	LC LT IDR	BB 	Upgrade		BB-
	LC ST IDR	B 	Affirmed		B

senior unsecured

LT	BB 	Upgrade		BB-

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Additional information is available on www.fitchratings.com

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