Fitch Affirms KEGOC at ‘BBB-’; Outlook Stable

English

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.

Rating Sensitivities 

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.

Key Assumptions

 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.

Ratings 

Long-Term IDR affirmed at «BBB-» Stable Outlook

Long-Term Local Currency IDR affirmed at «BBB-» Stable Outlook

Short-Term IDR affirmed at «F3»

Analysts

Dmitry Doronin, CFA

Associate Director

Secondary Rating Analyst

+7 495 956 9984

dmitry.doronin@fitchratings.com

Oxana Zguralskaya 

Director

Primary Rating Analyst

+7 495 956 7099 

oxana.zguralskaya@fitchratings.com

 

Antonio Totaro

Senior Director

Committee Chairperson

 +39 02 879087 297

Media Contacts

Adrian Simpson

London

+44 20 3530 1010

adrian.simpson@thefitchgroup.com

Fitch Ratings CIS Ltd 

26 Valovaya Street 

Moscow 115054

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR WHICH THE LEAD ANALYST IS BASED IN AN ESMA- OR FCA-REGISTERED FITCH RATINGS COMPANY (OR BRANCH OF SUCH A COMPANY) CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE. Copyright © 2021 by Fitch, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, New York, 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. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion is based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating. 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 anytime 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 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.