Fitch Ratings-Moscow/London-30 March 2017: Fitch Ratings has assigned a local-currency senior unsecured rating of 'BBB-' to Kazakhstan Electricity Grid Operating Company (KEGOC) and its domestic bond programme for KZT84 billion and the KZT47.5 billion bonds issued under it.
The senior unsecured rating is aligned with KEGOC's Long-Term Local-Currency Issuer Default Rating (IDR, BBB-/Stable), reflecting that all of company's debt is equal ranking, unsecured and issued directly by KEGOC. KEGOC plans to use the proceeds of the bond issue to finance its investment programme and reduce its FX exposure.
KEGOC's ratings reflect the overall strong links with the state, namely government guarantees for some of KEGOC's debt, and the company's Long-Term IDRs are one notch lower than the sovereign's.
KEY RATING DRIVERS
High Coupon Bonds: In mid-2016 KEGOC placed KZT47.5 billion of local unsecured bonds with the National Pension Fund. The interest rate was set at CPI+2.9%. The first coupon rate was set based on CPI in March 2016 at 18.6%, which is high given the modest economic growth in Kazakhstan. The company may issue an additional KZT36bn of local bonds in 2017 for business needs. We expect the interest rate to decrease to 10%-13% in 2017-2019 following the slowdown in inflation in Kazakhstan.
High FX Exposure: KEGOC is exposed to currency risk as about 76% of the company's KZT205 billion debt at 30 September 2016 was in foreign currencies (51% in US dollars and 25% in euros) with only a marginal portion of revenue denominated in US dollars (related to transnational electricity flows). KEGOC does not have any hedging arrangements, although the currency mismatch risk is mitigated by its holding most of its cash and bank deposits in US dollars.
Vulnerability to FX risk would be reduced if KEGOC issues further local bonds or decides to repay some of its loans early. Nevertheless, we expect the FX exposure to remain significant.
Favourable Tariffs: KEGOC continues to benefit from favourable long-term tariffs set by the Committee on Regulation of Natural Monopolies and Protection of Competition until 2020. The tariffs for transmission, dispatching and balancing increased by an average 12% in 2016 and the company expects them to rise on average by 6.5% in 2017-2020. In our view long-term tariffs provide earnings visibility, although they remain subject to revision in the case of a macroeconomic shock or further tenge devaluation. In our rating case, we forecast tariffs will rise on average by 2% below the approved levels over 2017-2020.
Capex Remains High: KEGOC's capex programme of KZT236 billion for 2016-2020 remains high, although it was scaled down in September 2016 from KZT268 billion with the postponement of some development projects. The share of maintenance capex is low at an average of 14% for 2016-2020, providing the scope for cuts to total capex. However, we do not expect substantial reductions in capex since the approved high tariff growth is contingent on certain investments being realised. We also expect KEGOC to rely on new unguaranteed borrowings to finance its large capex programme.
Strengthening Standalone Profile: We assess KEGOC's standalone profile as commensurate with a high 'BB' rating category given the company's monopoly position in electricity transmission in the country and its sound financial profile. However, the company's standalone profile is constrained by large capex, which is likely to result in continued negative free cash flow (FCF), and by a high exposure to FX.
The company's financial profile improved significantly in 2015, and we expect its funds from operations (FFO) adjusted leverage and FFO fixed charge cover to average 2.5x and 6.9x in 2016-2020, respectively. In Kazakhstan we usually look at gross metrics due to a weak local banking system. If the company repays some of its FX-denominated loans, its leverage metric may improve further.
KEGOC is an electricity transmission company in Kazakhstan. Its closest peers are PJSC Federal Grid Company of Unified Energy System (FedGrid, BBB-/Stable), Russian electricity transmission operator, PJSC Moscow United Electric Grid Company (MOESK, BB+/Stable), the principal electricity distribution company in Moscow and the wider Moscow region, and Mangistau Electricity Distribution Network Company (MEDNC, BB/Negative), an electricity distribution company in western Kazakhstan. KEGOC and its peers are subject to regulatory uncertainties, the risk of macroeconomic shocks, and possible political interference. Their investment programmes are usually sizeable.
KEGOC, MEDNC and MOESK are also 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 top-down minus one notch, while FedGrid and MOESK are rated based on a standalone basis plus uplift for state support. MEDNC is rated three notches below the sovereign.
Fitch's key assumptions within our rating case for the issuer include:
- tariff growth of 2% below the approved long-term tariffs;
- transmission volumes to grow in line with GDP over 2016-2020;
- KZT236 billion of total capex in 2016-2020;
- 80% dividend payout ratio in 2017-2020, which is higher than the company's forecast of 40%;
- interest rate for local bonds at 13.4% in 2017, 12.4% in 2018 and 10.4% in 2019-2020.
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
- Positive sovereign rating action
- Strengthening of legal ties (eg 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 deterioration of the company's credit profile eg 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.
Adequate Liquidity: At 30 September 2016 KEGOC's readily available cash position stood at KZT140 billion, which was sufficient to cover short-term maturities of KZT26 billion. The company has a fairly balanced debt maturity profile with a KZT23 billion average annual repayment. However, Fitch expects negative FCF to average KZT6 billion annually over 2016-2020, driven by a substantial investment programme.
Dmitry Doronin, CFA
+7 495 956 9984
+7 495 956 2402
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.
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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
Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017)
Parent and Subsidiary Rating Linkage (pub. 31 Aug 2016)
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 21 Nov 2016)
Recovery Ratings and Notching Criteria for Utilities (pub. 04 Mar 2016)
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