Fitch Ratings-Moscow/London-05 September 2017: Fitch Ratings has affirmed Kazakhstan Electricity Grid Operating Company's (KEGOC) Long-Term Foreign-Currency Issuer Default Rating at 'BBB-'. The Outlook is Stable. A full list of ratings actions is available at the end of this commentary.
Fitch rates KEGOC one notch lower than its ultimate dominant (90%) shareholder The Republic of Kazakhstan (BBB/Stable), on the back of the relatively strong links with the state in the form of state guarantees for part of the company's debt (about 39% at end-June 2017), the company's strategic importance in the utilities sector, and the strong operational ties between the company and the government. We would expect the state's timely support in case of need.
KEY RATING DRIVERS
One Notch Below Sovereign: The application of a top-down rating approach is justified by the relatively strong links with the state. This is underpinned by the company's strategic importance, its status as the national electricity transmission grid operator, state approval of tariffs and capex, the record of previous state support - although the company has not received it recently due to overall strong financial position - as well as state guarantees for a portion of the company's debt.
The share of state-guaranteed debt has fallen to 39% at 30 June 2017 from 44% at end-2015 and we expect it to fall further following the amortisation and early repayments of EBRD and IBRD loans and KEGOC's placement of KZT36.3 billion of local unsecured bonds with the National Pension Fund (about 50%), second-tier banks (24.8%), institutional investors (13.8%) and others in August 2017.
High, but Falling FX Exposure: KEGOC's debt exposure to currency risk fell to 69% at 30 June 2017 (39% in US dollars and 30% in euros) from 72% at end-2016 and 100% at end-2015. This share is expected to decrease further to around 55% following the placement of KZT36.3 billion of local unsecured bonds in August 2017. The company generates only a marginal portion of revenue in US dollars, which is related to transnational electricity flow.
KEGOC does not have any hedging arrangements, although the currency mismatch risk is mitigated by its holding most of its cash and deposits in dollars and euros. Vulnerability to FX risk will be reduced as KEGOC issues more local bonds or repays some of its loans early from bank deposits. Nevertheless, we expect the FX exposure to remain significant.
Capex Remains High: KEGOC's capex programme was scaled back to KZT200 billion for 2017-2021 from KZT230 billion expected a year earlier due to the postponement of some expansionary projects to later periods. The share of maintenance capex is 30% on average for 2017-2021, providing scope for further capex cuts. However, we do not expect substantial reductions to capex since the approval of high tariff growth is contingent on certain investments being realised. We also expect KEGOC to rely on new unguaranteed borrowings to finance its capex programme.
Favourable Tariffs: KEGOC continues to profit from favourable long-term tariffs for electricity transmission, dispatching and balancing, which are set until 2020. Tariffs were increased by 8% on average in 2016-2017 and are expected to grow by 7% on average in 2018-2020. Long-term tariffs provide earnings visibility, although they remain subject to revision if there is a macroeconomic shock or further tenge devaluation. In our rating case, we forecast tariffs to grow on average 2% below approved levels over 2017-2020.
Improving Standalone Profile: We assess KEGOC's standalone profile as commensurate with a high 'BB' rating category underpinned by the company's large size relative to Kazakh peers, its monopoly position in electricity transmission in the country and its sound financial profile. We expect KEGOC's FFO adjusted gross leverage to average 2.4x over 2017-2021, down from 3.2x at end-2016. We anticipate FFO fixed charge coverage will deteriorate to about 5.6x on average over 2017-2021 following the increasing share of local-currency-denominated debt with higher interest rates compared to FX-denominated debt.
KEGOC's standalone profile is constrained by large capex and dividends, which are likely to result in mainly negative free cash flow (FCF), and by a high, although decreasing, exposure to FX.
KEGOC is an electricity transmission company in Kazakhstan. Its business profile is similar to that of PJSC Moscow United Electric Grid Company (MOESK, BB+/Stable), the principal electricity distribution company in Moscow and the wider Moscow region, and weaker than that of PJSC Federal Grid Company of Unified Energy System (FedGrid, BBB-/Stable), the Russian electricity transmission operator, due to the latter's larger scale of operations and geographical diversification. KEGOC and its peers are subject to the regulatory uncertainties, macroeconomic shocks and possible political interference. Their investment programmes are usually sizeable. Though they have some flexibility. The financial profiles of the three companies are similar, but KEGOC's metrics are expected to improve due to favourable tariff dynamics.
KEGOC and MOESK are subject to volume risk, while FedGrid's exposure to volume risk is limited since its tariffs are set based on, among other things, customers' declared electricity capacity needs and not on actual electricity consumption. KEGOC is rated one notch below the sovereign level, while FedGrid and MOESK are rated based on a standalone basis plus one notch uplift for state support.
Fitch's key assumptions within our rating case for the issuer include:
- Kazakh GDP to grow at about 2.4%-3.2% and CPI at about 7%-9% over 2017-2020;
- transmission volumes to grow above GDP in 2017 and slightly below GDP growth rate of 3% thereafter;
- tariff growth as approved in 2017 and 2% below the approved long-term tariffs growth rate in 2018-2020;
- capex in line with management expectations of about KZT200 billion over 2017-2021;
- 80% dividend payout ratio in 2017-2021, which is higher than the company's forecast of 70%.
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
-Positive sovereign rating action
-Strengthening of legal ties, for example if the share of guaranteed debt rises steadily above 40%
-Enhancement of the business or financial profile, possibly as a result of stronger regulation and higher equity funding, which would be positive for the unguaranteed debt profile of KEGOC and its standalone rating
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
-Negative sovereign rating action
-If the state tolerates a deterioration of the company's credit profile, for example through an increased capex programme without sufficient funding or downward revision of tariffs, leading to FFO-adjusted gross leverage persistently higher than 4x and FFO fixed charge coverage below 4x, we may consider widening the notching or changing the rating approach to bottom-up.
For the sovereign rating of Kazakhstan, KEGOC's ultimate parent, Fitch outlined the following sensitivities in its rating action commentary of 24 April 2017:
The following risk factors could, individually, or collectively, trigger negative rating action:
-a further weakening in the sovereign external balance sheet;
-materialisation of significant contingent liabilities above those already identified from the banking sector on the sovereign balance sheet;
-policies that hamper fiscal consolidation or undermine monetary policy credibility;
The following factors, individually or collectively, could result in positive rating action:
-a sustained recovery in external and fiscal buffers;
-steps to reduce the vulnerability of the public finances to future oil price shocks, for example by reducing the non-oil deficit;
-a sustained recovery in the economy supported by substantial improvements in the business environment and governance and greater diversification;
-substantial improvement in the performance of the banking sector.
Adequate Liquidity: At end-1H17 KEGOC's readily available cash and deposits (Fitch-calculated) of about KZT73 billion were sufficient to cover short-term maturities of KZT19 billion and expected negative free cash flow. Cash and deposits were mainly held at domestic banks, namely ATF Bank (B-/Stable), Eurasian Bank, Tsesna Bank (B/Stable) and Halyk Bank of Kazakhstan (BB/Stable) as well as in a number of smaller banks rated in the 'B' category by Fitch. At end-1H17 KEGOC accrued the allowance for impairment of funds of KZT2.6 billion of cash in defaulted Delta Bank and Kazinvestbank.
We believe that the company's access to liquidity for daily operations is adequate, but access to all cash held at Kazakh banks may be limited.
FULL LIST OF RATING ACTIONS
Long-Term Foreign-Currency IDR affirmed at 'BBB-', Outlook Stable
Long-Term Local-Currency IDR affirmed at 'BBB-', Outlook Stable
Short-Term Foreign-Currency IDR affirmed at 'F3'.
Local-currency senior unsecured rating affirmed at 'BBB-'.
Dmitry Doronin, CFA
+7 495 956 9984
+7 495 956 7099
Fitch Ratings CIS Ltd
26 Valovaya Street
Josef Pospisil, CFA
+44 20 3530 1287
Summary of Financial Statement Adjustments -
Operating leases: We applied a 6x multiple (relevant to Kazakhstan) to operating lease expenses to create a debt-like obligation.
Cash: We reclassified KZT4.7 billion at end-2016 from deposits to restricted cash as it includes cash in the defaulted bank or the bank whose license was recalled, bonds of associated company and other.
Allowance for doubtful receivables: We excluded allowance for doubtful receivables (mainly related to Uzbekenergo) in 2014-2016 from EBITDA calculations.
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Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary.
Corporate Rating Criteria (pub. 07 Aug 2017)
National Scale Ratings Criteria (pub. 07 Mar 2017)
Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017)
Parent and Subsidiary Rating Linkage (pub. 31 Aug 2016)
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