OREANDA-NEWS. Fitch Ratings has downgraded Ukraine-based DTEK Energy B.V.'s (DTEK) Long-term Issuer Default Rating (IDR) to 'RD' (Restricted Default) from 'C', following the company's disclosure of the result of the eurobonds distressed exchange offer. The rating is then upgraded to 'C' as repayment risk is still considered to be imminent. A full list of rating actions is provided at the end of this commentary.

DTEK issued new bonds on 28 April 2015 pursuant to an exchange offer and scheme of arrangement in respect of the company's maturing USD200m 2015 notes. We view this as a Distressed Debt Exchange (DDE) and this is reflected in the downgrade to 'RD'. The subsequent upgrade to 'C' indicates that the repayment risk remains imminent as post-restructuring liquidity profile may not be sufficient to cover bank loans repayments due by end-3Q15 and as DTEK continues negotiating further extensions of remaining debt maturities.

KEY RATING DRIVERS

Imminent Refinancing Risk
DTEK faces imminent liquidity risk as its cash position is not sufficient to cover onerous short-term maturities in 2015. Fitch notes, that the successful restructuring of 2015 notes had significantly helped DTEK to extend its short-term bank debt due in 2Q15, but significant maturities remain in 3Q15. The longer-term solution to extend repayments with main lenders is expected to be achieved no earlier than mid-2015. This should help align the company's repayment schedule with its cash generation ability. However, a further restricted default is likely.

Despite the exchange offer completion, which include the replacement of the remaining USD200m portion of its USD500m eurobonds due on 28 April 2015 with USD160m new notes due in March 2018 and a cash and early tender consideration of USD45m, the company's cash position remains well below its short-term maturities due in 2015-2016.

Distressed Debt Exchange
Under Fitch's criteria, the exchange offer launched on 23 March 2015 constituted a DDE. This is because, in Fitch's view, the exchange offer imposed a material reduction in terms of the April 2015 bond compared with the original contractual terms and the restructuring was to avoid a payment default. Fitch believes that alternative options were limited and failure to place new bonds could have led to insolvency proceedings. Fitch recognises the incrementally positive impact that the successful exchange has had on the group's liquidity and debt service.

Foreign Currency Exposure
DTEK is exposed to high foreign currency fluctuations risk, as most of its debt is denominated in foreign currencies, i.e. US dollar (63% of total debt at end-2014), euro (27%) and rouble (2%). This contrasts with less than 10% of its revenue in US dollar in 2014, while most of its remaining revenue is denominated in hryvna. An increase of the economic and political uncertainty in Ukraine has led to significant hryvna devaluation against major currencies. The company does not fully hedge its FX risks. However, more than 70% of its cash as of end-2014 was kept in US dollar and euro.

High Exposure to Local Banks
DTEK's liquidity position is weakened by its high exposure to domestic banks. In our analysis we assumed a portion of cash held at the Ukrainian banks as restricted, due to the banks' low credit quality, and estimated unrestricted cash was UAH5.4bn (USD341m) at end-2014. In addition, a significant portion of cash is kept at First Ukrainian International Bank, which is owned by SCM, DTEK's parent company.

Political Instability
The on-going political and economic uncertainty - Fitch is forecasting a 5% decline in Ukraine's GDP and a 26% inflation for 2015 - is likely to continue to have a material adverse impact on DTEK's credit metrics. Fitch notes that assets located in the conflict zones - Donetsk and Lugansk regions - account for a significant part of DTEK's EBITDA and revenue.

On 21 January 2015, Crimea authorities passed a resolution to expropriate the property of DTEK's subsidiary Krymenergo located in the region. However, DTEK's exposure to Crimea is limited as its electricity distribution in Crimea accounted for less than 3% of revenue and around 2% of EBITDA in 2014.

Profitability Continues to Deteriorate
Despite economic deterioration in Ukraine, DTEK managed to demonstrate almost stable financial performance in hryvna, with 2014 revenue up 0.2% yoy and EBITDA down only 4% yoy, based on Fitch estimates. However, EBITDA margin in 2014 declined further to 15%, from almost 16% in 2013 and 20% in 2012. We expect margins to remain under pressure in 2015 as the recently approved tariff increase is likely to be offset by forecasted cost pressures.

Ukraine's Leading Utilities Company
DTEK remains the leading coal mining, power and heat generation, electricity distribution and sales company in Ukraine. With an installed electric capacity of around 19 gigawatts at end-2014, DTEK ranks among the largest Fitch-rated CIS power utilities. Fitch believes that DTEK will continue to occupy the leading position among private Ukrainian utility companies for at least the medium term. Its vertical integration in coal mining, power generation and distribution supports its profitability.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for DTEK include:
- Domestic GDP decline of 5% and inflation of 26% in 2015
- Electricity consumption to decline faster than GDP contraction
- Electricity tariffs to increase well below inflation, with export electricity tariffs to increase as a result of further UAH devaluation
- Refinancing of USD200m eurobond and expected maturity extension of bank debt thereafter
- Debt split by FX assumed to be in line with 2014 breakdown
- Capital expenditure broadly at 2014 levels

RATING SENSITIVITIES

Negative: Future developments that could lead to negative rating action include:
- Failure by the company to successfully extend the maturities of its bank debt
- Actions which constitute a DDE

Positive: Future developments that could lead to positive rating action include:
-Successful refinancing of short-term bank maturities
-Achievement of a more sustainable liquidity profile with manageable short-term debt levels
-Improvement of the macro-economic environment and the company's accounts receivables management

FULL LIST OF RATING ACTIONS

DTEK Energy B.V.
Long-term foreign and local currency IDRs: downgraded to 'RD' from 'C' and subsequently upgraded to 'C'
Short-term foreign and local currency IDRs: downgraded to 'RD' from 'C' and subsequently upgraded to 'C'
National Long-term rating: downgraded to 'RD(ukr)' from 'C(ukr)' and subsequently upgraded to 'C(ukr)'
Foreign currency senior unsecured rating: downgraded to 'RD' from 'C' and subsequently upgraded to 'C'; Recovery Rating 'RR5'
National senior unsecured rating: downgraded to 'RD(ukr)' from 'C(ukr)' and subsequently upgraded to 'C(ukr)'

DTEK Finance plc.
Foreign currency senior unsecured ratings including USD750m and USD160m bonds: downgraded to 'RD' from 'C' and subsequently upgraded to 'C'; Recovery Rating 'RR5'.