- We expect the financial performance of Kazakhstan Electricity Grid Operating Co. (KEGOC) will continue improving on the back of favorable tariffs.
- We now see a high likelihood that KEGOC would receive timely and sufficient extraordinary support from its ultimate owner, the Kazakh government, if necessary.
- We are therefore revising our outlook on KEGOC to positive from stable,and affirming our 'BB' rating.
- The positive outlook reflects the increased likelihood that KEGOC can sustainably exceed our upgrade thresholds through solid performance and continued debt reduction.
On Nov. 23, 2017, S&P Global Ratings revised its outlook on Kazakhstan Electricity Grid Operating Co. (JSC) to positive from stable. The 'BB' long-term corporate credit rating was affirmed.
At the same time, we affirmed our 'BB' issue rating on KEGOC's senior unsecured bank loan from the European Bank For Reconstruction And Development (EBRD).
The outlook revision reflects our view that KEGOC's credit ratios could strengthen in the next 12 months, owing to the favorable tariffs set for 2016-2020 and efficient cost management. We expect the company will continue generating stable operating cash flows that suffice for gradual debt repayment. We forecast funds from operations (FFO) to debt will increase to more than 30% in 2017 and to 33%-35% in 2018, from about 26% in 2016.
We also note that the appetite for dividends of KEGOC's parent, 100%
state-owned national welfare fund Samruk-Kazyna, is likely to increase to up to 100% of net income--in line with the existing dividend policy--compared with moderate 40% payouts on average in the past. This, together with still-significant capital expenditure (capex) needs, will lead to negative discretionary cash flow in the next few years.
The company is gradually changing the structure of its debt portfolio by repaying old U.S. dollar- and euro-denominated loans with Kazakhstan tenge (KZT) instruments issued on the local market. As of June 30, 2017, about half of the debt portfolio was denominated in dollars and euros, versus 100% at the end of 2015. We view this as a positive trend that reduces the risk of a negative impact from foreign currency fluctuations, albeit without removing it completely. We factor this risk into our assessment of KEGOC's stand-alone credit profile (SACP) at 'b+'.
We continue to regard KEGOC's business risk profile as constrained by the tariff system, which lacks transparency and does not guarantee either full or timely cost recovery. We do not consider that the mechanism allows for full pass-through of costs. In addition, the regulator's lack of independence from the government aggravates this risk because the government often uses utilities' tariffs as a social or macroeconomic instrument (as is the case with tariff caps, for example).
Still, we note that the current tariffs set for 2016-2020 enable the company to generate cash flows sufficient to cover operating costs and capex, and to gradually repay its debt and reduce leverage.
We regard KEGOC as a government-related entity (GRE). We now think there's a high likelihood of extraordinary government support. KEGOC's continues to hold a very important role for Kazakhstan's government, given the company's strategic importance as the monopoly provider of essential electricity infrastructure and its status as a system operator. Still, we think the Kazakh government generally tolerates relatively high leverage at various GREs. Moreover, support mechanisms via Samruk-Kazyna are relatively complex and time consuming, as we have seen with other Kazakh GREs, and we cannot rule out negative interventions from higher-than-expected dividends or regulatory pressures.
In our base case for KEGOC, we assume:
·About 9% average growth in transmission volumes to 43 kilowatts per hour (kWh) in 2017, reflecting a peak in exports to Russia, and moderating to 41 kWh in 2018.
·Average transmission tariff increases of 8%, 11%, and 13% in 2017, 2018, and 2019 respectively, in line with the regulator's resets, which will support the company's revenues and EBITDA growth.
·No further tenge devaluations.
·Capex of about KZT55 billion in 2017, KZT35 billion in 2018, and KZT21 billion in 2019, in line with the approved investment program, albeit with some flexibility in the capex timelines.
·Dividends at 70%-100% of net income, in step with the dividend policy.
Based on these assumptions, we arrive at the following credit measures in 2017-2018:
·Adjusted FFO to debt exceeding 30% in 2017 and at 33%-35% in 2018; and
·An EBITDA margin of 40%-45%.
We assess KEGOC's liquidity as adequate, based on our estimate that the company's liquidity sources will comfortably exceed its funding needs by about 2x in the 12 months started Sept. 30, 2017, and that sources will exceed uses even if EBITDA declines by 15%. We believe that KEGOC has adequate access to financing from local banks. Still, we view the local banking system as relatively weak. Like other midsize emerging market issuers, access to international capital markets for KEGOC may fluctuate going forward, in our view. Therefore, we assess the company's liquidity as adequate rather than strong.
We estimate principal liquidity sources for the 12 months started Sept. 30, 2017, as:
·About KZT109 billion in available cash and deposits.
· Cash flow from operations of KZT53 billion-56 billion.
We estimate principal liquidity uses for the same period as:
·Capex of about KZT40 billion.
·Maturing bank debt of KZT10 billion.
·Dividends at 70%-100% of net income, matching the dividend policy.
KEGOC is subject to certain financial covenants contained in the EBRD and International Bank for Reconstruction and Development loan facilities, notably a net debt-to-EBITDA ratio of below 4.0x. We expect KEGOC will comply with all covenants in 2017 and 2018.
The positive outlook on KEGOC reflects the increased likelihood that KEGOC can sustainably exceed our upgrade thresholds through solid performance and continued debt reduction. We think the current favorable tariffs can support KEGOC's cash flow generation and enable the company to gradually reduce its debt, with FFO to debt sustainably above 30% in the absence of negative regulatory or dividend pressures.
We could raise the ratings if we saw that KEGOC's financial metrics improved, with FFO to debt comfortably above 30% on a sustainable basis. An upgrade would also hinge on KEGOC maintaining adequate liquidity, and no downward changes in our assessment of a high likelihood of extraordinary state support for KEGOC, or lowering of our sovereign rating on Kazakhstan.
We could revise the outlook to stable if KEGOC failed to achieve stronger results and leverage ratios, or if, in contrast with our base case, higher capex or excessive dividends mitigated the positive developments in tariffs.
Ratings Score Snapshot
Corporate Credit Rating: BB/Positive/--
Business risk: Weak
· Country risk: High
· Industry risk: Very low
· Competitive position: Weak
Financial risk: Significant
· Cash flow/Leverage: Significant
Anchor: bb- Modifiers
·Diversification/Portfolio effect: Neutral (no impact)
·Capital structure: Neutral (no impact)
·Liquidity: Adequate (no impact)
·Financial policy: Neutral (no impact)
·Management and governance: Fair (no impact)
·Comparable ratings analysis: Negative (-1 notch)
Stand-alone credit profile: b+
·Likelihood of government support: High (+2 notches from SACP)
·Criteria - Corporates - General: Reflecting Subordination Risk In Corporate Issue Ratings, Sept. 21, 2017
· General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
·\General Criteria: Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015
·Criteria - Corporates - General: Methodology And Assumptions: Liquidity
Descriptors For Global Corporate Issuers, Dec. 16, 2014
·General Criteria: Methodology: Industry Risk, Nov. 19, 2013
·General Criteria: Group Rating Methodology, Nov. 19, 2013
·General Criteria: Country Risk Assessment Methodology And Assumptions,Nov. 19, 2013
·Criteria - Corporates - Utilities: Key Credit Factors For The Regulated
Utilities Industry, Nov. 19, 2013
·Criteria - Corporates - General: Corporate Methodology, Nov. 19, 2013
·Criteria - Corporates - General: Corporate Methodology: Ratios And Adjustments, Nov. 19, 2013
· General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012
·General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010
·General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009