OREANDA-NEWS. Fitch Ratings has affirmed Korea District Heating Corporation's (KDHC) Long-Term Foreign Currency Issuer Default Rating (IDR) and foreign currency senior unsecured rating at 'A+' respectively. The Outlook on the IDR is Stable.

KDHC's ratings and Stable Outlook reflect the company's moderately strong ties with the South Korean government, and its position as the largest provider of district heating in Korea.

KEY RATING DRIVERS
One Notch Below Sovereign: KDHC is rated one notch below Korea (AA-/Stable). Fitch believes the strategic and operational ties with the sovereign, while moderately strong, are weaker than other Fitch-rated Korean state-owned enterprises (SOEs), whose ratings are equalised with the state. This is because, in Fitch's view, KDHC's business is less critical to the state and it does not have a dominant position outside greater Seoul.

Deterioration in Operating Performance: The company's revenue fell 14% y-o-y and EBIT declined nearly 60% in 9M14 declined mostly because volume fell from high bases in both the heating and electricity segment in the previous year and electricity selling prices decreased. Fitch expects the trend to continue for the full- year. Fitch expects revenue to fall further in 2015 as tariffs slide to reflect the recent fall in oil prices, but profitability is likely to improve with higher sales volume and because margins are also protected to a certain degree with the fuel cost adjustment mechanism in place.

Capex to Increase in 2015-2016: New major district heating projects, such as in Dongtan Hwasung, are likely to raise KHDC's annual capex to around KRW400bn-500bn in 2015-2016. As such we expect the company to post negative free cash flow over the next two to three years.

Weak But Stable Standalone Credit Profile: The company's standalone credit profile remains weak for its rating, similar to other Fitch-rated SOEs in Korea. Its credit metrics will likely deteriorate over the next two to three years due to higher capex, but Fitch believes the completion of the sale of its subsidiary Inchon Total Energy will cushion the decline in 2015. Fitch estimates the sale to result in net debt reduction of around KRW370bn. Overall, Fitch expects the company's FFO adjusted net leverage to deteriorate slightly but to remain at around 7x-8x for the next two to three years. (2013: 6.1x)

RATING SENSITIVITIES
The issuer rated at one notch below Korea's rating.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
- A negative rating action on the sovereign.
- The government's inability to curtail the rate of increase in public-sector entities' debt, resulting in deterioration in the state's ability to provide timely and adequate support to key public-sector entities.
- Weakening of linkages with the state.

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
- A positive rating action on the sovereign, provided that the rating linkages between KDHC and the state remain intact and that the state's ability to support key state-owned entities remains strong.
-Strengthening of linkage with the state.

For the sovereign rating of Korea, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 19 August 2014:

The main factors that, individually or collectively, could trigger positive rating action are:

-A significant reduction in general government indebtedness
-A sustainable decrease over time in the indebtedness of state-linked enterprises
-Evidence that the economy can grow over time, thereby narrowing the income gap with rating peers, without an ongoing rise in household indebtedness

The main factors that, individually or collectively, could trigger negative rating action are:

-A change of policy on the broader public sector's finances leading to tolerance for sustained rises in general government debt or broader public sector debt
-Crystallisation of risks in the financial sector leading to disruption of economic and financial stability, such as a sharp pick-up in defaults among households