OREANDA-NEWS. Fitch Ratings has affirmed Russian utility company PJSC Inter RAO's Long-term Issuer Default Ratings (IDR) at 'BBB-'. The Outlook is Negative. A full list of rating actions is below.

The affirmation reflects Inter RAO's strong credit metrics and Fitch's expectations that the company will maintain a robust financial profile over 2016-2019, despite our expectation of higher dividend payments and capex. The company's strong market position, and solid contribution to cash flow stability of operations under capacity supply agreements (CSA) are also supportive. At the same time, Fitch expects weak growth of the Russian economy in 2016-2017 and the government's social responsibilities might continue to exacerbate the regulatory and political risks, which constrain the rating.

Inter RAO's rating continues to incorporate the relatively strong operational and strategic and to a lesser extent legal ties between the company and its ultimate majority indirect shareholder, Russian Federation (BBB-/Negative). The Negative Outlook mirrors that on the sovereign.

KEY RATING DRIVERS

Strengthening Standalone Profile

Inter RAO's ratings are underpinned by the company's robust financial profile. We anticipate contraction in Russia's GDP of 0.7% in 2016 and 8.2% inflation which we do not expect to be fully reflected in electricity price increases. However, Inter RAO's financial profile remains strong for the rating and we expect funds from operations (FFO) net adjusted leverage around 0.7x on average for 2016-2019 (0.16x for 2015) and FFO interest coverage of around 8x (7.0x) on average for the same period. A stronger operational and regulatory environment, for example, a longer track record of a supportive CSA framework with the expected strong credit metrics would support a higher standalone profile for the company.

Moderate Capex

The near-term completion of expansion capex should contribute to Inter RAO's ability and financial flexibility to adapt to potential external economic or regulatory shocks. Inter RAO has an investment programme of about RUB66bn to be spent over 2016-2018. However, in our forecast we continue to rely on the historical average level, which is above the company's guidance.

Higher Dividends

We consider the company's current dividend policy, which envisages a payout ratio of 25% of IFRS net income over 2016-2018 as moderate. However, the risk of dividend payments being increased is high as it is currently in place for other state-owned companies. We thus assume 50% payout ratio for Inter RAO. Nonetheless, we believe it would be manageable for the company due to its strong cash flow generation.

Non-Core Assets Disposal

In 2012-1Q16 the company followed a prudent financial policy using asset disposals for non-debt funding of its acquisition-focused and capital intensive strategy. Inter RAO sold equity stakes in utilities, which it received from the state as assets contributions, for about RUB127bn (USD2.0bn) during 2011-2016. In May 2016 Inter RAO signed an agreement for 40.29% stake sale of Irkutskenergo shares to Deripaska's company Evrosibenergo (Telmamskaya GRES LLP) for RUB70bn (USD1.1bn). Inter RAO has already received RUB45bn and the remaining amount will be paid by instalments through to May 2018.

Taking into consideration the completion of the company's mandatory capex under the CSAs, the sale of the Irkutskenergo stake might result in a dividends increase or M&A.

Single-Notch Uplift for State Support

Inter RAO's rating benefits from a one-notch uplift for state support as we continue to assess the strategic, operational, and to a lesser extent legal ties between the company and its ultimate majority shareholder, the Russian Federation, as fairly strong. This is due to the strategic importance of Inter RAO to the country's electricity production and supply as well as the track record of tangible state support, provided largely in kind.

Regulatory Environment

Inter RAO mainly operates in non-regulated markets, so we expect regulatory changes to have a more limited impact compared with Russian regulated network utilities. Nevertheless, any tariff changes in the regulated segment may have an indirect adverse impact on competitive markets as in 2012 and 2014.

The favourable economics of projects operating under CSAs along with their long-term nature provides visibility and stability to Inter RAO's cash flow. The newly commissioned units operating under the CSAs contributed around 35% of Inter RAO's 2015 EBITDA and they will contribute above 40% of company's EBITDA by 2017 once all new capacity under the CSA framework is commissioned. The track record of the CSA framework is positive, but remains relatively short.

Strong Business Profile

Inter RAO's strong market position as the third-largest power generation company in Russia and among the largest utilities in Europe by installed electric capacity and the largest domestic power retail company as well as by its virtual monopoly in cross-border power trading supports its business profile.

Inter RAO accounted for 14% of the Russian electricity generation market and 16% of the Russian electricity supply market in 2015. It operates multiple assets, which should reduce the risk of cash flow volatility due to, for example, unexpected outage. We assess the efficiency of the group's assets as being above the Russian average.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Domestic GDP decline of 0.7% and inflation of 8.2% in 2016

- Electricity tariffs and power prices increase below CPI over 2016-2019

- Dividend payout ratio of 50% for 2016-2019

- Capex over 2017-2019 to remain in line with the average over 2011-2015

RATING SENSITIVITIES

Positive: Future developments that could lead to positive rating action include:

- A revision of the sovereign's Outlook to Stable.

- A more transparent and predictable regulatory framework, coupled with the company's strong financial profile, could be positive for the standalone rating.

Negative: Future developments that could lead to negative rating action include:

- Evidence of weaker state support and/or Russia's downgrade.

- Aggressive debt-funded acquisitions and/or more ambitious capex programme resulting in deterioration of the financial profile (eg FFO net adjusted leverage above 2.5x and FFO fixed charge cover below 5x on a sustained basis), which could be negative for the standalone rating.

LIQUIDITY AND DEBT STRUCTURE

Sufficient Liquidity

Inter RAO's cash position of RUB83.6bn at end-2015 was sufficient to cover its short-term maturities of RUB31.5bn, which accounted for about 43% of total debt. Its debt repayment schedule is not onerous and is relatively balanced, except for the hike in maturities of about RUB34bn in 2016. The company also has access to uncommitted credit facilities of RUB114.7bn for the whole group and RUB40bn at Inter RAO's level. We also consider RUB70bn cash from the recently announced sale of equity stake in a non-core asset as an additional cushion for capex funding or debt repayment. However, there is still no final strategy from the management regarding the proceeds from this deal.

Manageable FX Exposure

We assess Inter RAO's currency risk as manageable due to the company's generation of a reasonable portion of revenue in foreign currency and strong financial profile, which has significant headroom to absorb FX shocks. Inter RAO remains exposed to foreign currency fluctuations as about 26% of its total debt at end-2015 was denominated in US dollars and euros. Although only around 9% of revenues are foreign currency-linked or denominated, this amounted to RUB72bn in 2015, which is largely sufficient to cover its foreign currency-denominated debt of RUB19.4bn.

FULL LIST OF RATING ACTIONS

Long-term foreign and local currency IDRs: affirmed at 'BBB-', Outlook Negative

Short-term foreign and local currency IDRs: affirmed at 'F3'

National Long-term rating: affirmed at 'AA+(rus)', Outlook Stable