Fitch Affirms Samruk-Energy at 'BBB-'; Outlook Stable
The affirmation reflects strong strategic and operational ties with the Kazakh state and our expectation that the government would provide timely support to Samruk-Energy to meet and service its liabilities, if required. We expect the company's standalone credit profile to be under pressure from substantial capex, continued tenge depreciation and potentially adverse tariff developments.
KEY RATING DRIVERS
Top-Down Minus Two Notches
We apply a two-notch differential between the rating of Samruk-Energy and the state (BBB+/Stable). We continue to view the operational and strategic links between Samruk-Energy and ultimately the state as strong, which supports the application of the top-down rating approach. The strength of the ties is underpinned by the company's strategic importance to the Kazakh economy as the company controls about 38% of total installed electricity generation capacity and 36% of total coal output in the country. The strength of ties is also supported by the state's approval of the company's strategy and capex programme, and by tangible financial support in the form of equity injections, asset contributions, subordinated loans and subsidies.
The government demonstrated its support in November 2015. Wholly state-owned sovereign wealth fund Samruk-Kazyna (BBB+/Stable) reduced the interest rate on the KZT100bn loan it provides to Samruk-Energy from 9% to 1%. The loan will also be subordinated to all other unsecured obligations of Samruk-Energy. This measure will help the company meet the 5.0x debt/EBITDA covenant set in the EBRD agreement at the end-2015 test date. We understand that Samruk-Kazyna is also considering the possibility of converting the KZT100bn loan into equity in 2016 as a measure of extraordinary support.
Tenge Depreciation Negative for Credit Metrics
The tenge depreciation by around 85% since August 2015 has had a negative effect on the company's credit metrics, as around 40% of its debt is denominated in US dollars and euros, with almost all revenues generated in local currency. Samruk-Energy does not have any hedging mechanisms other than keeping a portion of its cash in dollars (72% at end-November 2015). The tenge is now floating and the company plans to reduce its exposure to FX risk by issuing tenge-denominated debt.
Tight Leverage Covenant
The company's debt/EBITDA covenant set in the loan agreement with the EBRD is tight due to Samruk-Energy's weak financials. The bank has reset the covenant from 4.5x to 5.0x for 2015, which Samruk-Energy expects to meet at end-2015. We expect covenant pressure to persist in the following years. This will be more reflective of the company's standalone mid 'B' category profile than of an investment-grade rating.
Potential Tariff Freeze
The introduction of the capacity market in Kazakhstan, initially planned for 2016, was postponed until 2019 to ease the pressure on industrial producers. This adds uncertainty to the 2016-2019 tariff regulation as capacity payments were meant to supplement wholesale electricity prices. A freeze of generation tariffs for Kazakhstan's northern zone is being considered by the authorities. This would affect Samruk-Energy's largest operating subsidiary Ekibastuz GRES-1 (BB+/Stable). Fitch expects the final tariff decisions and capex programme to be approved by end-2015 or early 2016.
The impact on Samruk-Energy's financial profile is unclear because the tariff freeze may lead to higher price competitiveness for producers and ultimately be compensated for by higher generation volumes. Fitch assumes 0% generation tariff growth for 2016-2018 and lower capex spending in 2018-2019.
Asset Privatisation
Samruk-Energy is privatising its nine subsidiaries. The company has so far sold its 50% stake in Zhambylskaya GRES for KZT2.4bn. Under the state privatisation programme, in 2016 the company should sell its power distribution assets (MEDNC and VK REK including supply company Shygysenergotrade), and a generation power plant (Aktobe CHP). It also plans to privatise one more distribution company, Alatau Zharyk Company, power supply company AlmatyEnergosbyt, Tegis Munay and the large Almaty generation plant in 2H16-2017. The company expects to use privatisation proceeds for a Eurobond repayment in December 2017.
The rating impact of asset privatisation would depend on the sale prices achieved. Nine assets earmarked for privatisation contributed around 68% to revenue and 30% to EBITDA in 2014. They had a relatively low debt burden of KZT14bn. Samruk-Energy's profitability should improve after the disposals as it will retain its highly profitable hydro power plants and Ekibastuz GRES-1. The leverage impact will be neutral if the company achieves at least 50% of the expected price.
Ambitious Debt-Funded Capex
Samruk-Energy has a substantial capex programme of KZT266bn for 2015-2018. As a result, we expect its free cash flow to remain significantly negative for 2015-2018. However, if the tariffs for Samruk-Energy's generation subsidiaries are frozen for 2016-2018 the government may revise the company's capex programme downward.
Weak Standalone Profile
We view Samruk-Energy's standalone profile as commensurate with the mid 'B' rating category, significantly below the government-supported IDR. The main constraints on its credit profile are its operating and regulatory environment, with exposure to FX resulting in weakening of its credit metrics. In view of the tenge depreciation, ambitious capex plans, 30% dividend pay-out and a potential tariff freeze for 2016-2018, we expect Samruk-Energy's funds from operations (FFO) adjusted gross leverage to remain at around 6.7x on average in 2015-2019, and its FFO fixed charge cover to deteriorate to below 3x by 2017.
Prior-Ranking Debt
The ratio of secured and prior-ranking debt at operating company level is below Fitch's threshold of 2x of EBITDA, at around 1.8x of the group's 2015 EBITDA projected by Fitch. However, we continue to notch the foreign- and local-currency senior unsecured ratings down by one level from Samruk-Energy's Long-term Foreign- and Local-Currency IDRs, respectively, due to the lack of clarity and consistency in its financial policy and group debt management, and uncertainties associated with planned asset disposals.
KEY ASSUMPTIONS
Fitch's key assumptions in its rating case for Samruk-Energy include:
- 0% tariff growth for 2016-2018
- Electricity production to increase below GDP growth rate
- Inflation-driven cost increase (including coal)
- Interest rate of 1% for KZT100bn subordinated loan from Samruk-Kazyna
- 30% dividend payout ratio
- Part of capex postponed from 2016-2017 and higher than management forecasts for 2018-2019
- 40% haircut to expected proceeds from privatisation of non-core subsidiaries in 2016
- second-wave privatisation (Almaty power station and Alatau Zharyk Company) excluded from forecasts due to high level of uncertainty
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Positive sovereign rating action
- Strengthening of legal ties (eg state guarantees for a larger portion of the company's debt and/or cross default provision)
- A clearly defined debt-management policy that provides for a centralised debt-management function, which would be positive for senior unsecured ratings
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Negative sovereign rating action
- Diminishing or irregular state support
Fitch outlined the following sensitivities for the sovereign rating of Kazakhstan, Samruk-Energy's ultimate parent, in its Rating Action Commentary of 30 October 2015:
The following risk factors individually, or collectively, could trigger negative rating action:
- Policy mismanagement and/or prolonged low oil prices leading to a weakening in the sovereign external balance sheet
- Renewed weakness in the banking sector, which leads to contingent liabilities for the sovereign
- A political risk event
The following factors, individually or collectively, could result in positive rating action:
- Moves to strengthen monetary and exchange rate policy
- Steps to reduce the vulnerability of the public finances to future oil price shocks, for example by reducing the non-oil deficit, currently estimated at more than 9% of GDP
- Substantial improvements in governance and institutional strength
LIQUIDITY AND DEBT STRUCTURE
At end-November 2015 Samruk-Energy's available cash and cash equivalents were KZT54bn, comfortably covering December 2015 maturities of KZT10.1bn. Maturities in 2016 of KZT52.5bn would be covered by a mix of cash balances and operating cash flow. However, the investment programme for 2016 is not yet fully funded: around KZT17.7bn of new debt would need to be raised to cover planned projects. The company's USD500m Eurobond matures in December 2017, and Samruk-Energy is working on various refinancing strategies.
Almost all the group's cash position is held at domestic banks. Although we believe the company's access to liquidity for daily operations is likely to be adequate, its full access to all the cash held at Kazakh banks may be limited. We therefore focus on gross leverage ratios in our analysis rather than net figures. At end-November 2015, 60% of the group's cash was held at the holding company level.
FULL LIST OF RATING ACTIONS
Long-term Foreign-Currency IDR affirmed at 'BBB-'; Outlook Stable
Long-term Local-Currency IDR affirmed at 'BBB'; Outlook Stable
Short-term Foreign-Currency IDR affirmed at 'F3';
Long-term National Rating affirmed at 'AA+(kaz)'; Outlook Stable
Foreign-currency senior unsecured rating affirmed at 'BB+'
Local-currency senior unsecured rating assigned at 'BBB-'
National senior unsecured rating assigned at 'AA(kaz)'.
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