OREANDA-NEWS. Fitch Ratings has assigned Russia-based electricity generator Public Joint-Stock Company The Second Generating Company of Wholesale Power Market's (OGK-2) RUB10bn 11.5% domestic bonds due in 2020 a final local currency senior unsecured 'BB' rating.

The rating is in line with OGK-2's Long-term local currency Issuer Default Rating (IDR) of 'BB'/Stable, as the bonds represent direct and unsecured obligations of the company. The proceeds of the bond are being used by the company for funding its investment programme, refinancing and general corporate needs. A full list of OGK-2's ratings is available below.

The 'BB' rating incorporates a one-notch uplift to the company's 'BB-' standalone rating for parental support from the ultimate majority shareholder, PAO Gazprom (BBB-/Negative). Its standalone rating is underpinned by the company's position as one of the largest power generators in Russia and cash flow generation from capacity sales under the Capacity Supply Agreements (CSA). We expect the postponement of commissioning of certain new units under the CSA and therefore leverage metrics are unlikely to improve to below 4x before end-2016. The standalone rating is constrained by high regulatory risk and the company's exposure to price and volume risk.

The Stable Outlook reflects our view of the company's ability to commission its new units and transfer the 420MW unit of Serovskaya GRES to PJSC Inter RAO (BBB-/Negative), in line with the updated schedule.

KEY RATING DRIVERS
One-Notch Uplift for Parental Support
OGK-2's 'BB' IDR benefits from a one-notch uplift, reflecting our view of likely support from PAO Gazprom, which indirectly owns 77.24% of OGK-2 through OOO Gazprom Energoholding (GEH). The strength of the ties is supported by OGK-2's integral role within Gazprom's operations and its substantial share in GEH's operations.

OGK-2's installed capacity covered about 48% of GEH's total installed capacity at end-2014. Its gas-fired power plants are reliant on Gazprom's gas supplies, which accounted for 76%-92% of the company's gas consumption over 2012-2014. Additionally, 94% of OGK-2's total outstanding debt at end-1H15 was loans from Gazprom.

Strong Market Position
The 'BB-' standalone rating is underpinned by the company's market position as one of the largest power generating companies in Russia covering 7% of Russia's installed capacity and electricity generation in 2014. The operation of multiple assets should moderate the risk of cash flow volatility (i.e driven by unexpected outage). The company is mainly involved in the production and sale of electricity on the wholesale market. In contrast to its large international peers that are involved in various power generation types, OGK-2 is focused on thermal power generation.

CSAs Support EBITDA
Similarly to rated Russian peers, capacity sales under the CSA - which contributed 35%-40% to EBITDA over 2012-2014 - mitigate the company's exposure to market risk, support stable cash flow generation and enhance its business profile. The company expects the share of CSA sales to increase to 50%-55% of EBITDA over 2016-2020 once all new capacity under the CSA framework is commissioned. We assume that OGK-2 will commission new capacities as per the revised schedule, including new units of Ryazanskaya GRES from 1 January 2016 and Troitskaya GRES and Novocherkasskaya GRES from 1 April 2016. According to the company a new unit of Serovskaya GRES was commissioned on 22 December 2015.

Deleveraging Unlikely Before 2017
We expect funds from operations (FFO) net adjusted leverage to increase to above 7x in 2015 from 2.8x in 2014. In addition to high capex, we expect OGK-2's EBITDA margin to weaken to 8% in 2015 due to the rise in fuel costs and decline in revenue from electricity sales. The high leverage is also driven by the acquisition of a 45.5046% share in OGK-Investproekt from PJSC Mosenergo for RUB2.8bn in December 2015 (previously expected to be acquired in 1H16) plus outstanding debt of RUB11bn to be consolidated in OGK-2's accounts at end-2015, and additional external acquisition funding. However, we expect that 2016 EBITDA will be boosted by the expected commissioning of new units under the CSA with a combined capacity of 1,410MW in January-April 2016 and the consolidation of OGK-Investproekt that operate Cherepovetskaya GRES under the CSA.

The company expects to acquire the remaining 45% stake in OGK-Investproekt for RUB2.8bn in 1H16.

2015 Negative Free Cash Flow
Fitch expects OGK-2 to generate cash flow from operations of RUB11.4bn on average over 2015-2018 following commissioning of new capacity under the CSA, which stipulated that tariffs be 3.0x-3.5x higher on average than those for existing facilities. However, we expect negative free cash flow (FCF) in 2015 due to ambitious investment plans of RUB23bn. Fitch expects OGK-2 to rely on new borrowings to finance cash shortfalls. FCF may turn positive in 2016 if the new 420MW unit at Serovskaya GRES is transferred to Inter RAO and therefore will not require any capex in 2016 and beyond.

Volume and Price Risk Exposure
OGK-2 generates most of its revenue from electricity and capacity sale (about 70%) on the free market, exposing the company to volume and price risks with the remaining sales from the regulated market. Price risk may be exacerbated by regulatory changes affecting tariffs. We believe volumes and price risks are moderated by cash flow generation from new capacity sales under the CSA given their favourable economics.

Unpredictable Regulatory Regime
Like other Russian utilities, OGK-2 is exposed to regulatory risk, reflected in frequent modifications of the regulatory regime and political interventions. Guaranteed payments under the CSAs are currently considerably higher than capacity payments for the old capacity, although they have not been significantly altered so far. Any significant revision of the CSAs will weigh heavily on utilities' financial profiles and increase cash flow risk. Our projections for OGK-2 are based on the assumption that the fundamentals of the CSA framework will remain unchanged.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Domestic GDP decline of 4% and inflation of 15.5% in 2015.
- GDP growth of 0.5% and CPI of 9% in 2016
- Electricity consumption to decline slower than GDP contraction in 2015
- Electricity tariffs to increase below inflation
- Inflation-driven gas price increase
- Capital expenditure in line with management's expectations
- Acquisition of a 45.5046% share in OGK-Investproekt from PJSC Mosenergo for RUB2.8bn in December 2015 and the remaining 45% stake for RUB2.8bn in 1H16
- Dividend payments of 15%-20% of IFRS net income over 2016-2018
- Penalties for later commissioning of power units to be paid over November 2017-2019

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-Improvement in financial profile due to, among other things, higher-than-expected growth in tariffs and/or volumes supporting FFO net adjusted leverage below 3x and FFO interest coverage above 6.5x on a sustained basis.
-Stronger parental support.
-Increased predictability of the regulatory and operational framework in Russia.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Inability to improve credit metrics such that FFO net adjusted leverage remains above 4x and FFO interest coverage stays below 3x on a sustained basis due to, among other factors, failure to commence operations at the new units in line with schedule, lower volumes of electricity and capacity sales, lower tariffs or margin squeeze driven by the rise of fuel prices not fully compensated by electric prices growth, weak working capital management, M&A transaction resulting in higher debt and/or intensive capex programme.
- Weakening of parental support, which may result in a removal of the one-notch uplift to OGK-2's standalone rating.
- Deterioration of the regulatory and operational environment in Russia.

LIQUIDITY
Fitch assesses OGK-2's liquidity as manageable within the Gazprom group. At end-1H15 OGK-2's cash and cash equivalents were RUB6.7bn, sufficient to cover upcoming short-term debt maturities of RUB6.6bn. The majority of debt at end-1H15 (about 94%) was capex-related loans from Gazprom. OGK-2 has access to uncommitted credit lines of RUB24bn due over 2015-2020, mainly from major Russian banks. OGK-2's investment programme has limited flexibility which increases short-term funding needs.

FX exposure is limited to capex projects that contain a foreign currency component. The company estimates that RUB5.8bn of capex over 2015-2016 relating to purchases of equipment are denominated in foreign currencies or 14% of total capex. At end-1H15 OGK-2 held a portion of cash in US dollars (about RUB2bn).

FULL LIST OF RATING ACTIONS
Long-term foreign currency IDR: 'BB', Outlook Stable
Long-term local currency IDR: 'BB', Outlook Stable
Short-term foreign currency IDR: 'B'
Short-term local currency IDR: 'B'
National Long-term Rating: 'AA-(rus)', Outlook Stable
Local currency senior unsecured rating: 'BB'