Fitch Affirms KEGOC at ‘BBB-’; Outlook Stable

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Fitch Ratings has affirmed Kazakhstan Electricity Grid Operating Company's (KEGOC) Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB-'. The Outlook is Stable. A full list of ratings actions is available at the end of this commentary. 

Fitch rates KEGOC by applying a top down minus one notch approach under its "Government-Related Entities Rating Criteria". This reflects our assessment of KEGOC’s links with its ultimate dominant (90%) shareholder, the Republic of Kazakhstan (BBB/Stable) as the source of support including debt guarantees. 

KEY RATING DRIVERS 

Debt Partly Guaranteed by Government: Fitch views the linkage of KEGOC with the sovereign as strong since the group is majority state owned (90%), and the government approves the company’s strategy and capex through the board of directors. A record of state support includes state guarantees for about 35% of KEGOC’s debt at end-2017, equity injections to fund capex of KZT1.4 billion in 2012-2013, favourable tariff setting and the investment of the National Pension Fund’s funds in KEGOC’s local bonds. We thus see the support expectations factor as also strong. 

We assess the socio-political impact of a theoretical default as strong, as the company is a natural monopoly and runs the major energy infrastructure in the country, with significant development capex plans. KEGOC is funded indirectly by the state and international financial institutions (the EBRD and IBRD), but there are no cross-default provisions with Kazakhstan. Therefore, we view the financial implications of its theoretical default on the state or other government-related entities as moderate. 

Capacity Market Introduction from 2019 

From 2019, KEGOC, via one of its subsidiary, will be a single buyer of the capacity and will collect capacity payments from electricity consumers and redirecting them to generators. This will be a pass-through item for KEGOC, although it will increase its revenue and costs by the same amount of roughlyKZT250-270 billion annually over 2019-2022, based on our estimates. 

The cost of single buyers’ service will be included in capacity tariff, but it will compensate only the company’s administrative costs. Therefore, this should not affect the company’s EBITDA. We believe the new capacity market scheme may increases KEGOC’s business risks since the credit risk of non-payments will be borne by the company’s wholly owned subsidiary. At present it remains unclear how the new payment scheme will work, but we expect the company to receive support from the government in case of emergency. 

Favourable Tariffs: KEGOC continues to profit from favourable long-term tariffs for electricity transmission, dispatching and balancing, which are set until 2020. Tariffs increase is linked to the implementation of a certain capex programme, but the company has some flexibility in shifting capex spending between years. From 2021, KEGOC expects tariffs to be approved for the second five-year regulatory period with some downward pressure on tariffs. 

Long-term tariffs provide earnings visibility, although they may be subject to revision if there is a macroeconomic shock. The regulatory framework has been implemented well to date. In our rating case, we forecast tariffs to grow slightly below approved levels over 2019-2020 and to moderately decrease from 2021. 

Capex Remains High: We estimate that the company will continue to generate healthy cash flow from operations of about KZT60 billion on average over 2018-2022 under Fitch’s assumptions. However, its free cash flow (FCF) is likely to remain mostly negative over 2018-2022, driven by expected average investments of about KZT37 billion, and 80% dividend pay-out ratio over the same period, which may add to funding requirements. The share of maintenance capex is 40% of total capex on average for 2018-2022, 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. 

FX Exposure Remains: KEGOC continues to be exposed to foreign-exchange (FX) fluctuations as about 47% of its debt at end-2017 was denominated in foreign currencies, mainly US dollars and euros. The company generates only a marginal portion of revenue in USdollars, which is related to cross-border electricity flow. KEGOC does not have any hedging arrangements, although the currency-mismatch risk is partially mitigated by the fact that the company holds 29% of its cash and deposits in dollars. We expect the FX exposure to remain significant, although decreasing, due to amortisation of FX loans. Corporates RAC Template 

Fitch Affirms KEGOC at ‘BBB-’; Outlook Stable 3 August 2018 2 12ae05de12ae05de 

‘BB+’ Standalone Profile: We assess KEGOC's standalone profile as commensurate with a 'BB+' rating 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 2.1x over 2018-2022. We anticipate FFO fixed-charge coverage to be about 6x on average over 2018-2022, which is within our raring guidelines for the current rating. The standalone profile is constrained by large capex and dividends, which are likely to result in mainly negative FCF, and significant exposure to FX. 

DERIVATION SUMMARY 

KEGOC’s 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-/Positive), the Russian electricity transmission operator, due to the latter's larger scale of operations and lower exposure to volume risk. KEGOC and its peers are subject to the regulatory uncertainties, macroeconomic shocks and possible political interference. Their investment programmes are usually large, though they have some flexibility. KEGOC’s financial profile is similar to that of FedGrid and stronger than that of MOESK. 

KEGOC is rated one notch below the sovereign under the “Government-Related Entities Rating Criteria”, while we rate MOESK by applying a bottom-up plus one notch approach to its standalone rating of 'BB' under the same criteria. 

KEY ASSUMPTIONS 

Fitch's Key Assumptions Within Our Rating Case for the Issuer 

– Kazakh GDP to grow at about 3.5%-3.8% and CPI at about 6%-6.5% over 2018-2022; 

– transmission volumes to grow at GDP growth rate in 2018 and below GDP growth rate of 3.5% thereafter; 

– tariff growth as approved in 2018 and slightly below approved levels over 2019-2020; 

– capex of about KZT187 billion over 2018-2022; and 

– 80% dividend pay-out ratio in 2018-2022. 

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 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, it may be negative for the standalone profile, but not necessarily the rating 

LIQUIDITY 

Adequate Liquidity: At end-2017, KEGOC's readily available cash and deposits (Fitch-calculated) of about KZT70 billion were sufficient to cover short-term maturities of KZT13.9 billion and expected negative FCF. Cash and deposits were mainly held at domestic banks, namely ForteBank JSC (B/Stable), Halyk Bank of Kazakhstan (BB/Positive), Bank Centercredit (B/Stable), ATF Bank (B/Stable) and Tsesnabank. We treat KZT2.6 billion of deposits net of impairment charge in Eximbank, Delta Bank and Kazinvestbank as well as accrued interest on Batys-Transit bonds as restricted cash, and we do not rely on these funds in our liquidity analysis. 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. Corporates RAC Template 

Fitch Affirms KEGOC at ‘BBB-’; Outlook Stable 3 August 2018 3 12ae05de12ae05de 

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-’ 

Contact: 

Principal Analyst 

Dmitry Doronin 

Associate Director 

+7 495 956 9984 

Supervisory Analyst 

Oxana Zguralskaya 

Director 

+7495 956 7099 

Fitch Ratings CIS Ltd 

26 Valovaya Street 

Moscow, 115054 

Committee Chairperson 

Josef Pospisil 

Managing Director 

+44 20 3530 1287 

Summary of Financial Statement Adjustments 

Operating lease: We applied a multiple of 6x (relevant for Kazakhstan) to operating lease expenses. 

Cash and deposits: We reclassified KZT2.6 billion of short-term financial assets, including cash in the defaulted banks and bonds of associated company, to restricted cash. 

EBITDA: We excluded accrued reserve for impairment of accounts receivable and other current assets, impairment of PP&E from EBITDA calculation. 

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.