Fitch Rates KEGOC's Local-Currency Bond 'BBB-'

English

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. 

DERIVATION SUMMARY 

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. 

KEY ASSUMPTIONS 

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. 

RATING SENSITIVITIES 

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. 

LIQUIDITY 

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. 

Contact: 

Principal Analyst

Dmitry Doronin, CFA

Analyst

+7 495 956 9984

 

Supervisory Analyst

Elina Kulieva

Director

+7 495 956 2402

Fitch Ratings CIS Ltd

26 Valovaya Street

Moscow 115054

 

Committee Chairperson

Josef Pospisil, CFA

Managing Director

+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. 

Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: julia.belskayavontell@fitchratings.com. 

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

 

Applicable Criteria

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)

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

Solicitation Status

Endorsement Policy 

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.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. DIRECTORS AND SHAREHOLDERS RELEVANT INTERESTS ARE AVAILABLE AT HTTPS://WWW.FITCHRATINGS.COM/SITE/REGULATORY. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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