Fitch affirmed long-term issuer default rating of Kazakhtelecom at “BB” and upgraded company national long-term rating to “A+(kaz)”; outlook positive
December 30. KASE. Fitch Ratings. Moscow
Fitch Ratings has revised the Outlook on Kazakhtelecom JSC’s (Kaztel) Long-Term Issuer Default Rating (IDR) to Positive from Stable and affirmed the IDR at ‘BB’. The agency has also upgraded the National Long-term rating to ‘A+(kaz)’ from ‘A(kaz)’ and assigned a Positive Outlook. A full list of rating actions is available at the end of this commentary.
The Outlook revision to Positive reflects the company’s improving liquidity, narrowing mismatch between predominantly domestic revenues and FX debt, improving cash flow, a successful launch of mobile operations and therefore lower execution risks associated with further mobile expansion.
Kaztel is a strong fixed-line incumbent, with a near monopoly position in the traditional telephony and high broadband market share, operating in a benign regulatory environment. The company re-entered the mobile mass market with its LTE service in 2014, providing it with a quad-play capability. Mobile roll-out and shareholder distributions have pushed funds from operations (FFO) adjusted gross leverage higher but we do not expect this to significantly exceed 2x.
KEY RATING DRIVERS
Strong Incumbent Positions
Kaztel is likely to maintain its dominant positions in the fixed-line segment, helped by benign regulation and a shortage of alternative networks. Kaztel estimated its fixed-line telephony market share at a high 93% at end-2013. Fixed-to-mobile substitution is a key threat, and this will drive modest fixed-line disconnections and pricing pressures in the voice segment, in our view. Expected interconnect rate cuts may exert additional pressure on traditional fixed-line revenue in the medium term but should not trigger any significant changes in the competitive environment.
Positive Broadband Prospects
The Kazakh broadband market still retains strong growth potential, driven by fairly low broadband penetration in the country (31% of households as of end-2013). The company remains an absolute broadband leader with over a 70% market share. Kaztel has completed its fibre infrastructure roll-out in key cities, strengthening its technological advantage over peers. Key large rival Vimpelcom significantly slowed down its broadband expansion in the country in 2014, which should lead to less aggressive competition for Kaztel.
Successful Mobile Entry
The company is facing reasonably positive prospects in the mobile market with its LTE service. Kaztel remains the only 4G operator in the country, which gives it a significant competitive advantage over peers in terms of broadband speed that it can offer to its customers. New subscriber additions in the data-only (dongles) segment have been strong, implying that the company has been able to convert its technological advantage into market share gains. An expected decline in low- ARPU CDMA voice subscribers has been largely offset by new higher-paying GSM customers.
Execution risks are notably higher in the mass mobile segment. The Kazakh market is well-penetrated with 3G data and GSM voice services and is highly competitive.
Capex Declines Drive Cash Flow Improvements
The end of Kaztel’s active fibre development project, the completion of the first stage of mobile roll-out and a strategic decision to smooth out further mobile investments will result in a substantial decrease in capex spend, both in absolute and relative terms. As a proportion of revenues, capex is expected to drop to approximately 20% in 2015-2017, compared with slightly above 30% in 2012-2014. Kaztel’s capex peaked in 2014.
We expect that 2015 cash flow generation would remain fairly depressed, reflecting the impact of continuing mobile development, one-off roll-out costs and sign-up subscriber promotions. We project pre-dividend free cash flow margin to recover to mid-high single digits in 2016-2017, from negative territory in 2014.
Leverage to Stabilise
Kaztel is likely see a peak in its FFO adjusted gross leverage at slightly above 2x, before stabilising below this level. The increase in leverage in 2015 will be driven by a decline of reported EBITDA and FFO margins, and by sluggish cash flow generation. EBITDA and FFO will be under pressure from substantial one-off mobile roll-out and promotional costs in 2015. We expect pre-dividend free cash flow to remain in a marginally negative territory during that year.
We project Kaztel’s deleveraging flexibility to improve from 2016. However, we expect that leverage to be managed in conjunction with shareholder remuneration needs. Although the company does not have public targets, leverage is likely to remain sustainably below 2x FFO adjusted gross leverage but above 1.5x, in our view.
Improving Liquidity; Lower FX Risks
Kaztel’s access to credit lines notably improved while FX risks subsided in 2014. Sustainably strong liquidity and further reduction in FX risks may result in moderate relaxation of our leverage triggers.
The company’s credit profile is likely to be resilient to potential foreign currency exchange rate volatility. By our estimates, stressing the metrics for a 50% tenge devaluation would only increase leverage by 0.4x total debt/EBITDA, which can be accommodated within the current rating level.
Fitch expects that FX debt as a share of total debt is likely to drop to approximately 68% by end-2014 from 87% at end-2013, and management has an intention to further reduce it. Arrangements with key vendors suggest that continuing large capex, including on imported telecom equipment, is unlikely to increase FX liabilities.
Kaztel has a few untapped credit lines from foreign banks, which provides it with access to substantial FX liquidity, in case of need. In addition, Development Bank of Kazakhstan (BBB/Stable) has a 10-year tenge credit line of approximately KZT37bn with Kaztel for funding mobile development. Kaztel’s debt profile is well spread with no medium-term debt redemption peaks.
Weak Domestic Banking System
The Kazakh domestic banking system is weak, implying scarcity of local funding, few committed credit facilities and potentially limited access to deposits. The company holds a significant amount of its cash liquidity with low-rated domestic banks. Consequently, our analysis primarily focuses on the company’s gross debt metrics.
Weak Parent-Subsidiary Linkage
Kaztel’s ratings reflect its standalone credit profile. Kaztel is of only limited strategic importance for Kazakhstan, while operating and legal ties with its controlling shareholder, government-controlled Samruk-Kazyna, are weak. Although indirect government control is a positive credit factor, it does not justify a rating uplift, in our view.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
– A protracted rise in gross leverage to above 2.5x total debt/EBITDA and 3x funds from operations (FFO)-adjusted leverage (end-2013: 1.4x), and/or a material increase in refinancing risks
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
– A sustained decrease in gross leverage to below 1.0x total debt/EBITDA and 1.5x FFO-adjusted leverage and successful development of the mobile segment demonstrating strong operating and financial performance
FULL LIST OF RATING ACTIONS:
Long-Term IDR: affirmed at ‘BB’, Outlook revised to Positive from Stable
Short-Term IDR: affirmed at ‘B’
Local currency Long-Term IDR: affirmed at ‘BB’, Outlook revised to Positive from Stable
National Long-Term Rating: upgraded to ‘A+(kaz) from A(kaz)’, Outlook Positive
Senior unsecured debt in foreign and local currency: affirmed at ‘BB’
Senior unsecured debt in local currency: upgraded to ‘A+(kaz)’ from ‘A(kaz)’
Proposed KZT 90bn programme including the first KZT 21bn tranche: affirmed at ‘BB(EXP)’; upgraded to ‘A+(kaz)(EXP)’ from ‘A(kaz)(EXP)’