Fitch Downgrades Samruk-Energy to ‘BBB-‘; Outlook Stable
November 07. Fitch Ratings. London/Warsaw
Fitch Ratings has downgraded Kazakhstan-based JSC Samruk-Energy’s ratings, including its Long-term foreign currency Issuer Default Rating (IDR) to ‘BBB-‘ from ‘BBB’ and foreign currency senior unsecured rating to ‘BB+’ from ‘BBB-‘. The Outlooks on the Long-term ratings are Stable. The full list of rating actions is provided at the end of this commentary.
The downgrade reflects the weakened legal ties between Samruk-Energy and its sole, indirect shareholder – the Kazakh State (BBB+/Stable) – due to a decline in the share of state- guaranteed debt. The share of state-guaranteed debt had been the key driver of the previous one-notch differential between their ratings. Following the downgrade, the company’s Long-term IDRs are two notches lower than the sovereign’s.
We continue to apply a one-notch difference between the senior unsecured ratings and the Long-term IDRs, due to evolving financial and debt management policies and expected changes to the group structure, as a result of planned asset disposals and the company’s acquisitive strategy.
KEY RATING DRIVERS
Weakened Legal Ties
The downgrade reflects the widening of rating differential to two notches from a single notch between Samruk-Energy and its sole direct shareholder JSC Sovereign Wealth Fund Samruk-Kazyna (BBB+/Stable) and, ultimately, the State that owns 100% of Samruk-Kazyna. This reflects our reassessment of the strength of legal, operational and strategic ties between the company and its sole shareholder.
While we continue to view the operational and strategic ties as strong, the legal ties have weakened as the share of fully state-guaranteed debt (directly by the state or via Samruk-Kazyna) in Samruk-Energy’s gross debt declined to 9% as of October 2014 from 19% as of end-1H12, due to an increase in unguaranteed debt, including debt from Samruk-Kazyna. Furthermore, the company’s debt does not carry any cross default provisions. We view robust legal ties as a key factor for either aligning the company’s rating with, or rating it one notch lower than, that of its shareholder.
State Support Underpins Top-Down Approach
We continue to view the operational and strategic links between Samruk-Energy and Samruk-Kazyna 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 a half of total installed electric power capacity in the country, by the State’s approval of its strategy and capex programme as well as by sizeable tangible financial support from the State in the form of equity injections, assets contribution, subordinated loans and subsidies. Samruk-Energy received equity injections from the State of KZT111bn over 2008-2013, KZT121bn in 2014 for funding the Ekibastuzskaya GRES-1 acquisition and expects to receive around KZT82bn over 2015-2018 for the modernisation of the Almaty and Balkhash power stations. It also received about KZT134bn over 2008-2013 in the form of assets contribution.
Limited Impact from Planned IPO
Samruk-Kazyna plans to offer a minority stake in JSC Samruk-Energy to the local public in a so-called People’s IPO over 2015. However, Samruk-Kazyna and thereby the government, are expected to retain a majority stake in Samruk-Energy and continue to support Samruk-Energy, at least within rating horizon.
The recent acquisition of a 50% stake in LLP Ekibastuzskaya GRES-1 for KZT236.7bn (USD1.3bn) by Samruk-Energy was initially financed via a shareholder loan received from Samruk-Kazyna for the total consideration. The company is in the process of refinancing this shareholder loan through an equity contribution for KZT121bn received from the State by October 2014 and an issue of subordinated bonds for KZT100bn by the end-2014 – early 2015 to be purchased by Samruk-Kazyna. As documentation for subordinated bonds has not yet been finalised, we are currently treating them as 100% debt in our financial analysis. We expect a substantial contribution of Ekibastuzskaya GRES-1 to the group’s EBITDA from 2014 and the conversion of about half of the acquisition loan into equity to result in a largely neutral effect on group’s credit metrics.
‘B’ Category Standalone Profile
We view Samruk-Energy’s standalone profile to be commensurate with the mid-‘B’ rating category, which is reflective of its weak credit metrics that are balanced with a solid business profile. We forecast Samruk-Energy’s funds from operations (FFO) adjusted gross leverage in 2015 to be in line with 2013’s 5.2x and to remain well above 5x over 2015-2018, and its FFO fixed charge cover to deteriorate to below 3x by 2016 (6.3x in 2013). This is due to an intensive capex programme of KZT486bn (USD2.7bn) over 2014-2018. The forecast is also based on our treatment of the planned subordinated bond issue for the Ekibastuzskaya GRES-1 acquisition as 100% debt.
Tight Leverage Covenant
We consider the financial covenant of debt/EBITDA below 4.5x from 2014 set in the loan agreement with EBRD as tight given Samruk-Energy’s weak financials. We estimate that its EBITDA-based leverage metrics are likely to test this covenant in 2014, before breaching it during 2015-2018. Therefore, if the covenant level is not reset or if the company does not receive additional financial support from the State to improve its financial profile, Samruk-Energy is likely to be in a recurring breach of this leverage covenant. This will be more reflective of the company’s standalone mid-B category profile than of an investment grade rating.
The ratio of secured and prior-ranking debt at the operating companies level improved to below Fitch’s threshold of 2x of EBITDA, at above 1x of group’s 2014 EBITDA. 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 as these policies are currently under review along with the company’s long-term strategy as well as expected changes in the group structure due to planned assets disposals and the company’s acquisitive strategy.
Generation Dominates Despite Integration
Samruk-Energy’s standalone ratings benefit from the company’s gradual shift towards vertically integrated operations, with activities ranging from coal mining to generation, transmission and distribution of power and heat. Fitch expects the generation segment to remain the main cash flow driver for the group. The Ekibastuzskaya GRES-1 acquisition is expected to increase the share of generation in Samruk-Energy’s EBITDA to 84% (excluding income from associates) in 2014, from around 60% in 2013.
Potential Assets Disposal
In April 2014 Kazakhstan’s government approved the list of 106 companies earmarked for privatisation over 2014-2016. The terms and pricing details of these assets sales are not yet disclosed. Nine of these companies are owned by Samruk-Energy. Based on Fitch’s estimates, these assets contribute on average 68% to the group’s revenue and 31% to EBITDA annually in 2014-2018 while they accounted for 6.3% of total group debt at end-2013. Our financial forecasts do not take into account potential disposals.
Supportive Tariffs at Present
Since 2013 electricity grid companies in Kazakhstan have been operating under three-year tariffs that are approved until 2016 and are determined by a benchmarking mechanism. We believe that longer-term tariffs establish a foundation for clearer rules and a more stable operating environment, and the introduction of a benchmarking mechanism should motivate companies to increase efficiency, supporting their operational performance. A shift to the competitive, de-regulated market for generating companies is unlikely to happen before 2016. The Kazakh authorities expect to implement an electricity capacity market, which should ensure economically sound returns on investments and provide incentives for the construction of new generation assets or for expanding current capacity.
LIQUIDITY AND DEBT STRUCTURE
At end-1H14 Samruk-Energy’s readily available cash position stood at KZT59.2bn (excluding cash held at Alliance Bank (RD)), which was sufficient to cover short-term maturities of KZT28bn. The company has a fairly balanced debt maturity profile with a repayment peak only in 2017 of around KZT93bn, which is the repayment of USD500m eurobond. However, Fitch expects negative free cash flow over 2014-2018, driven by a substantial investment programme.
Almost all of the group’s cash position is held at domestic banks. While we believe that 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. As a result, we focus on gross leverage ratios in our analysis rather than on net figures. At end-2013, 98% of the group’s cash position was held at the holding company level.
Samruk-Energy is exposed to currency risk as about 29% of total debt at 1H14 was raised in USD, while the remaining debt is denominated in KZT. Samruk-Energy’s revenue and operating expenses are mainly denominated in KZT.
Positive: Future developments that could lead to positive rating actions include:
-Positive sovereign rating action
-Strengthening of legal ties (e.g. 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 could lead to negative rating action include:
-Negative sovereign rating action
-Diminishing State support
For the sovereign rating of Kazakhstan, Samruk-Energy’s ultimate parent, Fitch outlined the following sensitivities in its rating action commentary of 7 November 2014:
The Stable Outlook reflects Fitch’s assessment that upside and downside risks to the rating are currently well-balanced. The main factors that individually or collectively might lead to rating action are as follows:
-Steps to reduce the vulnerability of public finances to oil price shocks, for example by narrowing the non-oil fiscal deficit
-Effective restructuring of bank balance sheets
-Entrenching low and stable inflation under a more flexible exchange rate regime
-Substantial improvements in governance and institutional strength
-Policy management leading to a sustained decline in sovereign assets or reduced economic or financial stability
-A sustained commodity price shock
-Renewed weakness in the banking sector and crystallisation of contingent liabilities–A political risk event
FULL LIST OF RATING ACTIONS FOR JSC SAMRUK-ENERGY
Long-term foreign currency IDR: downgraded to ‘BBB-‘ from ‘BBB’; removed from RWN, Outlook Stable
Long-term local currency IDR: downgraded to ‘BBB’ from ‘BBB+’; removed from RWN, Outlook Stable
Short-term foreign currency IDR: affirmed at ‘F3’; removed from RWN
National Long-term rating: downgraded to ‘AA+(kaz)’ from ‘AAA(kaz)’; removed from RWN, Outlook Stable
Foreign currency senior unsecured rating: downgraded to ‘BB+’ from ‘BBB-‘; removed from RWN
Local currency senior unsecured rating: downgraded to ‘BBB-‘ from ‘BBB’; removed from RWN
National senior unsecured rating: downgraded to ‘AA(kaz)’ from ‘AA+(kaz)’; removed from RWN