S&P affirmed Samruk-Energy (Kazakhstan) ratings and revised outllok from “Stable” to “Negative”

November 13.KASE

S&P affirmed Samruk-Energy (Kazakhstan) ratings and revised outllok from "Stable" to "Negative"Standard & Poor’s Ratings Services said today it revised its outlook on Kazakhstan-based state-owned vertically integrated electric utility Samruk-Energy JSC to negative from stable. At the same time, we affirmed our ‘BB+/B’ long- and short-term corporate credit ratings and ‘kzAA-‘ national scale rating.

We affirmed the issue rating on Samruk-Energy’s $500 million notes at ‘BB+’. The recovery rating on these notes is unchanged at ‘4’, indicating our expectation of average (30%-50%) recovery in the event of a payment default.

The outlook revision reflects our opinion that Samruk-Energy’s 2013-2014 investment levels-including acquisitions-might be higher than we previously anticipated and that the group could struggle to sustainably maintain credit metrics commensurate with the current ‘b+’ stand-alone credit profile (SACP). Our current base-case scenario assumes that the Standard & Poor’s-adjusted debt-to-EBITDA ratio will remain below 4.0x in 2013-2014.

We incorporate a significant positive contribution from the commissioning of the Moinak hydropower plant, completed in 2012, to the group’s results from 2013. We forecast revenues of around Kazakhstani tenge (KZT) 140 billion (about $930 million) and EBITDA of around KZT40 billion this year, compared withKZT95 billion and KZT22 billion in 2012. Nevertheless, we believe Samruk-Energy has an appetite for new investments, as highlighted by a number of large-scale expansion projects and potential acquisitions being considered. We believe that, if realized, additional investments could lead to a higher debt-to- EBITDA ratio than in our base-case projections and prompt us to consider a  negative rating action.

We have revised our assessment of Samruk-Energy’s management and governance score to “weak” from “fair.” This reflects existing uncertainties around the group’s strategic and financial planning processes and risk tolerance, as well as weak governance. This includes poor transparency around future investments and acquisitions, which we believe is largely dictated by Samruk-Energy’s main shareholder, Samruk-Kazyna, and the government, restricting the group’s autonomy. Our assessment also incorporates planning deficiencies, highlighted by sudden changes in planned capital expenditure (capex) and debt funding.

Samruk-Energy is a vertically integrated group of companies with business segments including coal mining and electricity generation, distribution, and supply. The group controls about 47% of installed capacity and 38% of total electricity production in Kazakhstan, including its share in joint ventures, or 17% and 15%, if excluding them.

The business risk profile assessment reflects our view of Samruk-Energy’s evolving corporate structure, with a limited track record of operations in their current form, an aged asset base, uncertainties over regulatory framework after 2015, and the transitional features of domestic power market. Supporting factors include the group’s solid domestic market position and high vertical integration through its long position in coal, electricity generation, distribution,  and supply operations.

The financial risk profile assessment incorporates our view of Samruk-Energy’s ambitious investment program, over which it has limited flexibility, as it has been approved by the regulator, and its relatively high debt to EBITDA. The group carries significant exposure to foreign currency and interest-rate risk, since about 64% of its total debt is dollar-denominated and around 35% bears floating rates.

Samruk-Energy’s financial risk profile is supported by its favorable long-term debt maturity profile, adequate liquidity backed by cash proceeds from a $500 million, five-year term bond placement, and strong track record of ongoing financial government support.

We consider Samruk-Energy to be a government-related entity (GRE), according to our criteria, based on our belief that there is a “high” likelihood that the Kazakh government would provide timely and sufficient extraordinary financial support to Samruk-Energy in the event of financial distress. Our assessment factors in our opinion of Samruk-Energy’s:

– “Important” role for the government, given its strategic position as a leading provider of electricity in Kazakhstan; and

– “Very strong” link with the government, given its 100% ownership of the group through its investment vehicle Samruk-Kazyna, our expectation that the government will maintain majority ownership for at least the next two years, the government’s involvement in strategic decision-making, and the risk to the sovereign’s reputation if Samruk-Energy was to default. This is supported by historically strong financial support from the government in the form of equity injections, asset transfers, low interest-rate loans, debt guarantees, and the provision of financial aid and tax benefits.

We assess the group’s SACP at ‘b+’, based on our view of its “fair” business risk profile and “aggressive” financial risk profile.

The negative outlook reflects our opinion that Samruk-Energy might struggle to maintain financial ratios and performance adequate for the current ratings over the rating horizon.

We might lower the ratings if Samruk-Energy demonstrated more aggressive financial policies than we anticipate by proceeding with a higher level of debt-financed investment or acquisition, leading to deterioration in credit metrics. We currently deem a Standard & Poor’s-adjusted debt-to-EBITDA ratio of below 4.0x as commensurate with our “aggressive” financial risk profile and SACP of ‘b+’. A one-notch downward revision of the group’s SACP would result in a one-notch lowering of the long-term rating, provided that the likelihood of extraordinary government support remained unchanged.

We could revise the outlook to stable if the group implemented less aggressive financial policies on investments and debt management-including greater clarity on investments to be undertaken-and improved the transparency and certainty of its financial plans and group structure development. In addition, ratings stability would depend on operating and financial results leading to credit metrics remaining commensurate with the current ratings and maintenance of adequate liquidity and maturity profiles.