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.
Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email:
firstname.lastname@example.org; Adrian Simpson, London, Tel: +44 203 530 1010, Email:
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)
Copyright © 2017 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch’s factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch’s ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.
The information in this report is provided “as is” without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.
For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001