Kazakhstan Electricity Grid Operating Company (KEGOC) Kazakhstan Electricity Grid Operating Company's (KEGOC) ratings reflects the continued application of a top-down minus one notch from the Republic of Kazakhstan rating (BBB/Stable) approach under its Government-Related Entities Rating Criteria. This reflects KEGOC's strong links with its ultimate dominant (90%) shareholder, the Republic of Kazakhstan, whose support includes debt guarantees. We view KEGOC's Standalone Credit Profile (SCP) as commensurate with 'bb+', mainly reflecting evolving regulatory framework, fx exposure, sound financial profile, its monopoly position in electricity transmission and size relative to Kazakh peers.
Key Rating Drivers
Strong 9M20 Results: In 9M20 KEGOC reported revenue of KZT256 billion and EBITDA of KZT80 billion, a 34% and 23% yoy increase, respectively, mainly due to higher tariffs and slightly increased volumes. In 2020 the company operated at the level of long-term tariffs approved at end-2015, while 2019 results were affected by the downward revision by about 10%-22% of initially approved long-term tariffs for 2019. We expect the company to report a 15% yoy increase in EBITDA in 2020. Tariff Approval Postponed: In 2020, KEGOC applied for approval of tariff caps for regulated services and investment programme for the next five-year regulatory period (2021-2025), but the regulator refused to approve the application. From January 2021, the company has provided services at 2020 tariffs, excluding investment costs, resulting in a 10%-14% yoy decrease. The company has resubmitted its request for tariff caps and investment programme approval and expects new tariffs to be approved and come into force from May 2021. In our rating case we assume tariffs to decline by 10%-14% in 2021 yoy, and to increase annually slightly below inflation in 2022-2024. Weaker 2021 EBITDA Expected: We expect 2021 EBITDA to fall by about 25% due to lower tariffs and the effect of the capacity market. We expect the company to earn around KZT2.4 billion in 2020 as a capacity market operator and to make losses in 2021-2024 of about KZT5 billion on average. This is mainly driven by the return of profits received in 2019-2020 to consumers through capacity tariff reductions. Sound Credit Metrics: Fitch expects KEGOC to continue to generate healthy cash flow from operations of about KZT56 billion on average over 2021-2024 based on our assumptions. However, free cash flow (FCF) is likely to be negative in 2021-2024 due to expected average capex of about KZT49 billion annually, and an average 89% dividend pay-out ratio annually over the same period. This will add to funding requirements. We expect KEGOC's funds from operations (FFO) gross leverage to average around 2.7x and FFO interest coverage to average 4.4x in 2021- 2024, which is within our guidelines for the SCP.
FX Exposure Decreasing: KEGOC remains exposed to FX fluctuations as around 41% of its debt at end-2020 was denominated in foreign currencies (mainly US dollars and euros). KEGOC has significantly reduced the share of FX debt from 72% at end-2016, although it remains one of the largest among Fitch-rated corporates in Kazakhstan. KEGOC does not use any hedging arrangements, except for holding a portion of cash and deposits in US dollars (around 48% at end2020). In 2020, KEGOC registered a bond programme of KZT80 billion and placed KZT9.7 billion in May 2020 and KZT8.6 billion in January 2021. The company has strong access to the local market and plans to attract new debt in local currency. Combined with the gradual amortisation of FX loans from ERBD and IBRD, this will further decrease FX exposure. 'bb+' SCP: The SCP benefits from KEGOC's monopoly position, solid financial profile and large size relative to Kazakh peers. It is constrained by the company's FX exposure, evolving regulatory framework and the relatively weak operating environment in which it operates. The SCP also considers large capex and dividends, which are likely to result in negative FCF. We see limited scope for SCP improvement, given the current regulatory framework and operating environment. Strong Links with the State: We assess status, ownership and control as strong because the Kazakh state is its ultimate dominant shareholder and approves KEGOC's strategy and capex through the board of directors. We also view the support track record from the Kazakh state as strong, as it provided guarantees for 27% of KEGOC's debt at end-2020 (30% at end-2019). KEGOC has also previously received equity injections to fund capex and Kazakhstan's national pension fund is a large investor in KEGOC's local bonds. Incentive to Support: We assess the socio-political impact of a theoretical default as strong, as KEGOC is a large employer and a natural monopoly. It also runs the country's major energy infrastructure, with significant development capex plans. KEGOC is funded indirectly by the state and by loans from the development banks, but there are no cross-default provisions with the state. Therefore, we view the financial implications of its theoretical default on the state or other government-related entities as moderate.
Rating Derivation Relative to Peers
KEGOC's business profile is similar to that of Public Joint Stock Company Rosseti Moscow Region (BB+/Stable), the principal electricity distribution company in Moscow and the wider Moscow region. It is 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 lower exposure to volume risk. KEGOC is exposed to higher regulatory risks than FedGrid. KEGOC's financial profile is similar to that of FedGrid and stronger than that of Rosseti Moscow Region. The investment programmes of all three companies are usually large, although they have some flexibility.
KEGOC, FedGrid and Rosseti Moscow Region are rated under our GRE Criteria. KEGOC has an SCP of 'bb+' and is rated one notch below the sovereign. FedGrid's rating incorporates a singlenotch uplift to the SCP of 'bbb-' to the same level as Russia. Rosseti Moscow Region is rated under a bottom-up plus-one notch approach with an SCP of 'bb'. The wider peer group includes Romanian distribution operator Electrica SA (BBB/Negative), which benefits from a more predictable regulatory framework and lower risk of political interference. This is only partly offset by more risky distribution operations compared with transmission. Electrica's financial profile is also stronger than that of KEGOC. Other peers are REN - Redes Energeticas Nacionais, SGPS, S.A. (BBB/Negative), Red Electrica Corporacion S.A. (A-/Stable) and Terna S.p.A. (BBB+/Stable), electricity transmission operators in Portugal, Spain and Italy, respectively. Their SCPs are higher due to more predictable and transparent regulation and operating environment, despite higher leverage.
Developments That May, Individually or Collectively, Lead to Positive Rating Action - Positive sovereign rating action - Significant strengthening of legal ties, for example if the share of guaranteed debt rises above 75%, which we view as unlikely Developments That May, Individually or Collectively, Lead to Negative Rating Action - Negative sovereign rating action - Weaker links with the state - If the state tolerates a deterioration of the company's SCP, for example through an increased capex programme without sufficient funding or downward revision of tariffs, leading to FFO gross leverage persistently higher than 4x and FFO interest coverage below 4x, it could be negative for the SCP, but not necessarily the rating. For the sovereign rating of Kazakhstan, KEGOC's ultimate parent, Fitch outlined the following sensitivities in its rating action commentary of 21 August 2020:
The main factors that could, individually or collectively, lead to positive rating action/upgrade are: - Structural: Strengthening of the economic policy framework and institutional capacity to further enhance policy predictability and effectiveness. - Macro: Improvement in the resilience of the economy and public finances to commodity price shocks, for example through economic diversification and a further building of fiscal and external buffers. The main factors that could, individually or collectively, lead to negative rating action/downgrade: - Public Finances: Failure to reduce the consolidated fiscal deficit materially or a faster than expected erosion of the sovereign's balance sheet strengths. - Macro: Policies that undermine the credibility of monetary policy or confidence in the flexibility of the exchange rate to respond to external shocks. - Public Finances: Materialisation of significant contingent liabilities from the banking sector and SOEs on the public sector balance sheet.
Liquidity and Debt Structure
Adequate Liquidity: At end-3Q2020, KEGOC's readily available cash and deposits (Fitchcalculated) of about KZT69 billion were sufficient to cover short-term debt of KZT15 billion and expected negative FCF. Cash and deposits were mainly held at domestic banks, namely JSC Halyk Bank (BB+/Stable), ATF Bank JSC (B-/Rating Watch Positive), ForteBank JSC (B/Stable) and Bank Center Credit Joint Stock Company. In addition, KEGOC had KZT26 billion invested in notes of National Bank of Kazakhstan. We believe that the company's access to liquidity for daily operations is adequate, but full access to all cash held at Kazakh banks may be limited. 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.
Fitch's Key Assumptions Within Our Rating Case for the Issuer - Kazakh GDP to fall by 2.8% in 2020, then grow at 3.8%-4.1% and CPI at about 6%-7.5% over 2020-2024; -transmission, dispatch and balancing volumes to grow at 2%-5% in 2020 and around 1.6% annually thereafter; -tariffs for transmission, dispatch and balancing to decrease by 12% on average in 2021 as per management expectations, then to grow at around 4% on average over 2022-2024; - capex of around KZT47 billion annually on average over 2020-2024; - 89% dividend pay-out ratio on average over 2021-2024.
Long-Term IDR affirmed at «BBB-» Stable Outlook
Long-Term Local Currency IDR affirmed at «BBB-» Stable Outlook
Short-Term IDR affirmed at «F3»
Dmitry Doronin, CFA
Secondary Rating Analyst
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Primary Rating Analyst
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Fitch Ratings CIS Ltd
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