Ben Aris in Moscow -

"We are in the midst of a crisis now and it is worse than the crisis of 2008-2009," the CEO of Brunswick Rail, Russia's biggest privately owned rail freight operator, tells bne in an exclusive interview.

Set up by US investors Martin Andersson and Gerald De Geer, who made a fortune after they sold their investment bank Brunswick to UBS in 2003, Brunswick Rail was founded a year later as Russia's only independently owned leaser of freight rail cars in order to cash in on the state's liberalization of the rail sector.

The company is unusual, as it was created from scratch in a sector dominated by companies left over from the Soviet-era and is run entirely along western principles. But life has been hard for the last few years. Brunswick's business is dependent on the commodity cycle and the economic slowdown over the last two years has hurt commodity prices and spilled over into the freight sector.

In the first quarter of this year, the cost of renting a gondola was $16-17 a day, but even though this price has since recovered to $20-22, that is still way off the peak price of $46-$48 seen in the first quarter of 2012. The volume of freight carried in Russia is also down by 3.5% on year, says Genin, but over the last nine months was down by only 1.5% so the trend is now going in the right direction. "Russia's economy is still dependent on the price of commodities and transport is a derivative of this," says Genin sitting in his modern offices suitably overlooking the Paveletskaya train station. "The global price for commodities - especially coal and ore - is depressed. The current crisis is very different [from the short shock in 2008] and has been going on for more than a year. The forecast for the next six to 12 months is for turbulence, but after that we hope things will start to improve."

Squeezed from all sides

Transport companies are being squeezed from all sides. In addition to the lower volumes of goods to carry, they are also being forced to buy new freight cars by fresh regulations imposed by the government to support the makers of rolling stock.

Gondolas, the simplest kind of freight cars, have 22 years of useful life fixed by law. In the past, an operator could look forward to doubling the useful life of the cars by renovating them at the end of this period. However, under new rules introduced this year, even if you renovate a car after 22 years of use, it can only be used for another year before having to be repaired again. The rule is an administrative way of forcing operators to modernise their fleets or pay a heavy de facto tax to continue using old cars.

The changes have hurt the biggest companies the most, which have the highest proportion of old cars, mostly close to the maximum of 22 years against the industry average of 15 years. "The cost of repairing a car has also gone up. The economics of the sector are now totally different. You have to weigh the cost of renovating a car to get one extra year against the cost of buying new cars," says Genin.

On this score Brunswick Rail has a big competitive advantage, because it has the youngest fleet in the sector with an average car age of only five years. Owners of old cars are trying to salvage what they can from their aging rolling stock. Selling an old car for scrap nets some $5,000-$7,000 and you can strip them out for spare parts, but a new gondola still costs about $50,000, which is a significant outlay for all the companies in the sector.

From the government's perspective, the policy seems to be working. The Tikhvin Freight Car Building Plant, a leader in the industry, has invested heavily in state-of-the-art equipment and can produce rolling stock to the highest international standards, as well as making cars under a US license. At the same time Uralvagonzavod (best known for making the T-90 main battle tank) has developed its own high-tech cars that are going into production now and are supposed to be as good as anything produced outside Russia. Brunswick Rail is taking delivery of its first 62 Uralvagonzavod cars this December to see how they perform and will order more if they live up to their promise.

Expansion plans

One man's problem is another man's opportunity and Genin says that this is now the perfect time to grow. The company hopes to double the size of its fleet over the next few years ahead of a possible IPO. "We have very ambitious plans. It's best to grow in the midst of a crisis, as the prices for new cars are low," says Genin, adding that the company hopes to go from the current 24,300 cars to about 40,000 by 2018, which would give it a 5% market share.

That will cost a lot of money. Last year the company issued its first Eurobond, an innovative deal involving preferred equity - a first for Russia. Brunswick is also in advanced talks with the European Bank for Reconstruction and Development, which is reportedly intending to invest $150m. "We have plans to raise more debt over the next two years, up to $300m, from international capital markets. And we also have our own cash resources," says Genin, who says many of the major international banks are ready to offer the company funding.

The company's own resources are significant. Revenue last year was $306m, while operational cash flow, or Ebitda, was $241m. Results for this year will be less good due to the continuing crisis, down by some 20% to 25% Genin predicts, but should recover by next year.

The company also has plans to IPO, but the time is not yet ripe. "We could IPO now, but what would we get?" asks Genin. "It's better to grow now and then we can present a much prettier picture in two or three years when we have 4-5% market share and a more stable operating environment."

And the company could go through a major transformation by then. Brunswick operates freight cars, but state-owned Russian Railways (RZhD) has a monopoly over the locomotives that pull them. That is about to change; as part of reforms that are supposed to put the sector on a commercial basis at the start of November, Russian President Vladimir Putin ordered the government to draw up a plan to liberalize the locomotive services market by the end of this year.

Nothing is decided yet, but investors are watching closely to see whether the reforms happen. Brunswick is not waiting around; despite RZhD's monopoly, there are already some private companies operating under special exemptions and Genin says that the easiest way into the business is to form partnerships with these operators. "It will be a huge change," says Genin. "We can transfer our business model for the freight cars to the locomotive business, expect there the yields are even higher and the payback times even shorter than the best possible deals for rail cars."