Fitch affirms Kazakhtelecom (Kazakhstan) ratings, outlook Stable

April 7. KASE

Fitch affirms Kazakhtelecom (Kazakhstan) ratings, outlook StableFitch Ratings has affirmed Kazakhtelecom JSC’s (Kaztel) Long-term foreign and local currency Issuer Default Ratings (IDR) at ‘BB’, Short-term foreign currency IDR at ‘B’ and National Long-term rating at ‘A(kaz)’. The Outlooks on the Long-term ratings are Stable.

The affirmation reflects the improvement in Kaztel’s cash flow generation and credit metrics in FY10 following the sale of a 51% stake in its GSM-standard mobile subsidiary, Mobile Telecom-Service LLP (MTS) as well as its reduced refinancing risk following the refinancing of its USD350m syndicated loan due in July 2010 with long-term (five to 10-year) borrowings in late-2009.

The ratings reflect Kaztel’s strong market position and financial performance, modest leverage, improved cash flow generation and maturity profile. However, they also reflect the significant regulatory uncertainty and the strategic challenges it faces to stabilise its profitability margins and retain competitiveness in the most profitable urban areas.

The Stable Outlook is underpinned by Kaztel’s strong EBITDA generation, albeit lower in 2010, with an organic EBITDA margin (adjusted for MTS) down to 35.3% at FY10 from 40.1% at FY09 after the completion of cost-cutting measures. However, Fitch remains concerned that operating margins may decline further in the mid term as the tariffs on Kaztel’s fixed-line business may continue to come under pressure due to regulatory intervention and the mobile segment may also face more competition. Furthermore, broadband growth may come from ruralareas, where pricing and operational profitability is expected to be lower. Therefore, Fitch believes that the company’s ability to maintain margins at this level is unproven.

The company’s current gross leverage, if sustained at approximately 1x, is strong for the current rating level and may warrant positive rating action. Furthermore, a reduction in foreign currency risk (nearly all of its debt is denominated in or linked to foreign currencies), sustainable high organic EBITDA margin of above 30% and healthy free cash flow (FCF) generation – on the back of a lower capex to sales ratio would be considered a rating positive. Factors constraining the ratings may include potential liquidity constraints as a result of possible restrictions to Kaztel’s access to cash in local banks, as well as steep margin erosion, combined with an excessive ramp-up in capex. Fitch remains concerned about a rise in future capex due to regulatory pressures to expand network coverage in sparsely-populated regions.

Fitch rates Kaztel on a standalone basis and does not factor in any support due to indirect government ownership, although there is evidence that the government has provided indirect support through state-owned banks in the past.

Kaztel’s total debt/EBITDA (including associate dividends) dipped to 1.2x at FY10 from 1.4x at FY09, due to the MTS disposal and rising EBITDA due to significantly higher associate dividends (KZT23,026 at FY10 versus KZT12,740 at FY09). Following capex reduction to 23% in 2010 and 26% of revenue in 2009 from 42.3% in 2008, Kaztel’s historically negative FCF turned positive, reporting KZT38.9bn in 2010 and KZT23.2bn in 2009. The MTS disposal also generated USD76m in cash for Kaztel, boosting cash balances.

At end-2010, liquidity (cash of KZT58.4m), deposits and the next 12 months’ forecast positive FCF was strong, and comfortably covered short-term maturities, if not constrained by possible restrictions of access to cash kept in local banks. Fitch further notes that Kaztel’s cash is mainly deposited with Kazakh banks that have substantially lower ratings than Kaztel. Although the risk that Kaztel’s cash would be blocked has reduced with the improvement of the banks’ liquidity since H208, Kaztel’s potential access to this cash remains a concern. As a result, in assessing Kaztel’s credit profile, Fitch placed greater emphasis on Kaztel’s gross rather than net leverage.

Fitch aims to visit and review the company by July 2011 at the latest after it has received a detailed management update on the company’s overall strategy following the MTS disposal, the regulatory scheme, Kaztel’s forecasted revenues, operating margins, cash generation performance and expected key financial metrics at end-FY11.