OREANDA-NEWS. More-->S&P Global Ratings today affirmed its 'BB-' long-term corporate credit rating and 'ruAA-' Russia national scale rating on Russia-based electricity utility Moscow United Electric Grid Co. (MOESK). The outlook is stable.

The affirmation reflects our expectation of MOESK's resilient operating performance in the coming years. We think the company's expected performance will largely offset the recent increase in dividend distributions and still-high capital expenditures (capex).

We factor in that MOESK will maintain or moderately grow EBITDA in 2016-2017, on the back of tariff increases broadly in line with inflation and despite somewhat lower electricity transmission volumes that suffer from the weak economic backdrop in Russia. We expect the company will maintain its S&P Global Ratings-adjusted ratio of funds from operations (FFO) to debt comfortably above 30% (above 20% excluding connection fees), which we see as commensurate with the current rating. This is despite the negative discretionary cash flow we anticipate, owing to still-high capex and dividends. The latter have increased following the government's decision to increase dividends to 50% of net income under International Financial Reporting Standards (IFRS), at least in 2015, for government-owned companies including MOESK. We currently anticipate that these high dividend distributions may continue in the future. Highly volatile cash flows, related notably to the high share of revenues from connection fees (24% of EBITDA in 2015) that depend on economic growth, further constrain our assessment of MOESK's financial risk profile as aggressive.

MOESK's fair business risk profile remains constrained by a tariff regime that lacks protection from political interventions, a track record of government attempts to manually control electricity tariffs, a somewhat concentrated customer base, and an above-industry-average level of losses in grids.

These constraints are mitigated by MOESK's role as the major distribution grid operator in Moscow and Moscow Oblast (which we consider to be the most lucrative areas in the country) and its relatively stable earnings base derived from regulated power distribution. A portion of revenues is generated by the new connections segment, which we consider to be more volatile.

We also continue to believe that there is a moderate likelihood that MOESK would receive timely and sufficient extraordinary support from the Russian government (Russian Federation; foreign currency BB+/Negative/B, local currency BBB-/Negative/A-3), its ultimate owner, if needed. We view the role of the company as important and link as limited. In particular, we think that privatization risk is low in the next 12 months, given the current economic environment, but it might again increase when economic conditions stabilize.

In our base case, we assume: A marginal decline in volumes of electricity distributed in 2016, then almost flat in 2017.A 6%-8% rise in tariffs in 2016-2017.Flat EBITDA margin of 31.5%-32.5% in 2016-2017, on the back of a moderate tariff rise and effective operating costs management. Capex of about Russian ruble (RUB) 36 billion-RUB 38 billion ($0.5 billion) in 2016-2017.A higher dividend payout of RUB5.5 billion-RUB6 billion (50% of net income under IFRS). Based on these assumptions, we arrive at the following credit measures for MOESK in 2016-2017: A debt-to-EBITDA ratio of about 2x. FFO to debt in the 33%-42% range.

The stable outlook reflects our opinion that MOESK will maintain moderate leverage over the next 12 months, with adjusted FFO-to-debt in the 30%-45% range (20%-30% excluding connection fees from EBITDA) despite continued negative discretionary cash flow generation, and continue to prudently manage its liquidity. This would correspond to debt to EBITDA in the 2x-3x range (3x-4x excluding connection fees from EBITDA). Our outlook, in particular, factors in continued tariff increases in line with inflation and no substantial decline in collection of receivables. The outlook also takes into account that if we lower our local currency long-term sovereign rating on Russia by one notch, all else remaining equal, we are unlikely to take a similar rating action on MOESK.

We might lower our rating on MOESK if the FFO-to-debt ratio fell below 30% (below 20% excluding connection fees), for example, as a result of further weakening in the economy and problems with collecting of receivables. Metrics may also deteriorate as a result of the government's reluctance to continue raising tariffs to compensate for the company's high capex and dividends. Alternatively, downward pressure might arise if the company starts to rely excessively on short-term financing.

Although not anticipated in the next 12 months, we could raise the rating if Russia's economic stabilizes and MOESK's financial risk profile strengthens, with FFO to debt above 45% on a consistent basis (above 30% excluding connection fees from EBITDA). Also, we would raise our rating on MOESK if we raise the local currency sovereign rating on Russia as we would then incorporate a notch for extraordinary government support in our rating on MOESK to reflect the government's increased ability to intervene. We view an upgrade of Russia as unlikely at this stage, however, giver our negative outlook on the long-term rating.