OREANDA-NEWS. Fitch Ratings has affirmed Saudi Electricity Company's (SEC) Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'AA-'. The Outlook on the Long-term IDR is Stable. Fitch has also affirmed SEC's outstanding Sukuk issues, including issues under Saudi Electricity Global Sukuk Company, Saudi Electricity Global Sukuk Company 2, and Saudi Electricity Global Sukuk Company 3, at 'AA-'.

The affirmation reflects the continued strength of SEC's links with Saudi Arabia (KSA; AA/Stable).

KEY RATING DRIVERS
Sovereign Support Critical
SEC's current ratings are one notch lower than the KSA's 'AA' ratings, based on the strong operational, strategic links, whilst the legal links are moderate (in the absence of an explicit sovereign guarantee) in accordance with Fitch's Parent and Subsidiary Rating Linkage methodology. KSA directly owns 74% of SEC (and indirectly owns another 7% through Saudi Aramco, a state-owned enterprise). Fitch views SEC against the broader global electric utility peer group, where it is currently among the highest-rated entities, the residual risks and opportunities inherent in the sector; and the scale of the current investment programme, which will weigh on SEC's balance sheet over the next four years.

Historically, state financial support has been strong and we assume this will continue. At end-September 2014 SEC had SAR69bn (USD18bn) available under the SAR130.5bn (USD35bn) of soft loans provided by KSA, which are interest free and drawn down in instalments. SEC is drawing down the soft loans of SAR51bn (USD14bn) announced in June 2011 and SAR49.4bn (USD13bn) announced in March 2014 by the KSA to partially finance its capital projects. Since its inception in 1999, SEC has not paid for fuel provided by Saudi Aramco. SEC transferred a total of SAR57bn in 2007, 2011 and 2013 of Saudi Aramco payables to the Ministry of Finance, converting them to long-term government payables. At FYE13 this amounted to SAR82.6bn (FYE12 SAR58.5bn). 100% of the long-term payables are direct to Ministry of Finance. The KSA has waived all dividend payments from SEC since inception, with the last 10-year waiver running through till 2020. The KSA appoints five of SEC's nine board members, including the chairman.

Integrated Business Profile
SEC is a monopolistic, vertically integrated utility in KSA. The utility regulator, Electricity and Cogeneration Regulatory Authority (ECRA), has licensed SEC to generate, transmit, and distribute electricity in its designated service territory. The company remains dominant in KSA's electricity generation sector even with the emergence of independent power producers (IPPs), holding 78.5% of KSA's total generation capacity at FYE13. SEC retains up to 50% equity positions in five IPPs, sources their fuel and purchases all electricity produced. Utilising generating capacity at IPPs ahead of its own plants is expected to result in some EBITDA margin compression in coming years, particularly in light of seasonal swings in electricity demand in KSA.

Efficiency Study
SEC is currently undertaking a study as part of the government's initiative to derive greater efficiencies in the electricity sector, which subject to the approval of stakeholders may see SEC's business units reorganised and its corporate structure evolve. SEC's transmission activities were transferred in 2012 and sit within a separate wholly-owned subsidiary National Grid Co. Similar subsidiaries could be established to house generation and distribution operations with the entities controlled by SEC. SEC's reorganisation may further evolve. Despite the intended efficiency gains, this may also pose some risks to SEC, in Fitch's view, for example, if we believed that the links with the sovereign would be weaker as a result.

Commitment to Growth
SEC is instrumental in meeting the country's growing electricity demand and executing the state policy of providing subsidised electricity within Saudi Arabia along with developing a robust, reliable, and stable electricity infrastructure. SEC's current capital spending plan of about SAR212bn (USD57bn) over the next four years (2014-2017) includes investment in electricity generation capacity, transmission infrastructure, and distribution assets. Historically, the maximum annual capital investment by SEC has been around SAR41bn. Delivery of an even larger capex programme, on time and on budget, while simultaneously managing other construction-related risks could be challenging.

Subsidised Electricity Tariff
The Council of Ministers, responsible for setting electricity tariffs, has authorised ECRA to set electricity tariffs for commercial, government, and industrial customers. The Council of Ministers has set the maximum electricity tariff that ECRA can approve at SAR0.26 per kilowatt-hour of electricity. However, the tariff charged to residential consumers is solely determined by the Council of Ministers, as it remains heavily subsidised.

Weakening Standalone Credit Metrics
Fitch-calculated leverage, measured by funds from operations (FFO) net adjusted leverage, is expected to rise above 4x by 2017 from 3x at end-2013. These ratios take into account the soft loans from KSA. Fitch assumes that the company will supplement cash from operations with debt to fund its capital programme and that it will continue to defer fuel costs payable to Saudi Aramco. Nonetheless, SEC's standalone credit profile is significantly lower than the current state support- driven rating.

Adequate Liquidity
At end-September 2014, SEC had approximately SAR34bn in total liquidity, including SAR6.3bn in cash, SAR1bn committed overdraft facility, SAR7.5bn committed loan facility and the remainder comprising committed government soft loans disbursements for FY14. This compares with around SAR2.3bn of maturities due in 2015, and expectations of significantly negative free cash flow (FCF).

SEC completed three capital market fundraising in 2014, issuing a fourth local Sukuk in January for SAR4.5bn, and a two tranche 10-year and 30-year international Sukuk raising USD2.5bn (SAR9.375bn) in April. SEC repaid the SAR7bn domestic Sukuk issued in 2009 on its first purchase date in July 2014. SEC has no significant debt maturities until 2017, when the domestic Sukuk for SAR7bn is expected to be refinanced. The soft loans provided by KSA for SAR51.1bn were granted in June 2011 with a draw down over five years, interest free and in March 2014 the KSA provided an additional SAR49.4bn soft loan with draw down over 5.25 years.

KEY ASSUMPTIONS
- Fitch expects revenue growth to range between 4% and 5%, mainly driven by population growth. In FYE13 SEC added 444,425 (6.1%) customers to its network.
- We expect a slight decrease in EBITDA margins. As SEC utilises the generating capacity of IPPs ahead of its own plants, this is expected to result in some EBITDA margin compression in coming years.
- SEC plans to invest around SAR212bn over 2014-2017 to meet growing electricity demand (average SAR53bn pa), which will result in significant negative FCF.
- Fitch expects this negative FCF will be funded with a combination of debt and additional government soft loans will be received and that further government funding will be provided in 2016 and 2017.
- We expect SEC to raise approximately SAR10bn pa of external (Sukuk) debt funding, between 2015 and 2017.
- We assume that SEC will continue to not pay for the fuel procured from Saudi Aramco for the foreseeable future or until regulatory environment changes to total cost recovery principle.
- The long-term government payables are excluded from debt.
- We do not expect negative credit implications from the corporate reorganisation given SEC's policy and importance to KSA.
- We assume no change in the implied support and commitment from, and ownership by KSA.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Explicit guarantees from the KSA in favour of SEC could likely result in positive rating action on SEC's IDR, providing that the remaining elements of the parent-subsidiary linkage do not weaken.
- A positive rating action on KSA could lead to a positive rating action on SEC.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- A negative rating action would result from a multi-notch downgrade of the sovereign.
- Any change in the implied support and commitment from, and ownership by KSA.
- A significant change in SEC's operational structure resulting in SEC's links with the sovereign diminishing would also prompt a review of the ratings.

SOVEREIGN RATING SENSITIVITIES
The main factors that, individually or collectively, could lead to positive rating action are:
- Progress in tackling weaknesses in structural indicators and the economic policy framework, relative to peers, and enhancing the business environment in ways conducive to further diversification of the economy and the revenue base.

The main factors that, individually or collectively, could lead to negative rating action are:
- The absence of an effective fiscal policy response to the lower oil price environment.
- An erosion of fiscal or external buffers, potentially stemming from a prolonged period of oil prices around the lows reached in 2015.
- Spillover from regional conflicts or a domestic political shock that threatens stability or affects key economic activities.