S&P downgrades ratings of Samruk-Energy from “ВВ+” to “ВВ”; outlook “Stable”

February 19. KASE. Standard & Poor’s

S&P downgrades ratings of Samruk-Energy from "ВВ+" to "ВВ"; outlook "Stable"Standard & Poor’s Ratings Services said today that it had lowered its long-term corporate credit rating on Kazakhstan-based energy group Samruk-Energy JSC to ‘BB’ from ‘BB+’ and the Kazakhstan national scale rating to ‘kzA+’ from ‘kzAA-‘. The outlook is stable. At the same time, the ‘B’ short-term corporate credit rating was  affirmed.

We also lowered the issue rating on the group’s US$500 million senior unsecured notes due 2017 to ‘BB’ from ‘BB-‘. The recovery rating on the notes remains unchanged at ‘4’ .

That rating action is in line with our methodology for government-related entities (GREs) and follows our lowering of the sovereign rating on Kazakhstan by one  notch. It also reflects our view that there is a high likelihood that Kazakhstan’s  government would provide timely and sufficient extraordinary financial support to Samruk-Energy in the event of financial distress. This is underpinned by the group’s market position, which consolidates 47% of installed power generation capacity in the country. The rating also reflects our assessment of the group’s stand-alone credit profile (SACP) at ‘b+’, based on our view of its business risk  profile as “weak” and its financial risk profile as “aggressive.”

Samruk-Energy is a vertically integrated group of companies with business segments including coal mining and electricity generation, distribution, and supply. Our assessment of Samruk-Energy’s business risk profile as “weak” reflects our view of its evolving corporate structure, with a limited track record of  operations in their current form, an aged asset base, limited visibility at this stage  over the regulatory framework after 2015, and the transitional features of the domestic power market. Supporting factors include the group’s solid domestic  market position, average profitability (which is higher than peers in the Commonwealth of Independent States), and high vertical integration through its long position in coal, electricity generation, distribution, and supply operations.

Our assessment of Samruk-Energy’s financial risk profile as “aggressive” incorporates our view of the group’s ambitious investment program (over which it has limited flexibility as it has been approved by the regulator) and its fairly high debt-to-EBITDA ratio.

Our view that there is a “high” likelihood of extraordinary financial support from  the government reflects 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, giventhe 100% ownership of the group through government 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 were 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.

The stable outlook reflects our view that the risks associated with Samruk-Energy’s ambitious investment program, pressure on the group’s credit metrics, and high debt leverage are balanced by our view of the high likelihood that the group would receive timely and sufficient extraordinary support from the government of Kazakhstan if needed. This is underpinned by Samruk-Energy’s strategic importance for and strong track record of receiving financial aid from the government of Kazakhstan, as well as its solid market position and benefits of vertical integration.

According to our methodology for rating GREs, if the sovereign rating is further lowered to ‘BBB-‘, it would not automatically result in a similar rating action on Samruk-Energy, provided that Samruk-Energy’s SACP and likelihood of extraordinary state support remain unchanged.

Downward pressure on the ratings might arise if the group adopts more aggressive financial policies that aren’t commensurate with our current expectations, for example, if increased investments led to leverage exceeding 5x debt to EBITDA or FFO to debt below 12%, or if the liquidity and maturity profiles  weakened. Credit metrics could also deteriorate from Samruk-Energy not receiving sufficient ongoing government aid via such supportive measures as conversion of shareholder debt to equity, favorable price caps, and equity injections. We could then change our comparable ratings modifier to neutral from positive, which would trigger a downward revision of the group’s SACP to ‘b’.

However, according to our methodology for rating GREs, Samruk-Energy’s SACP would have to fall to ‘b-‘ to result in a one-notch downgrade, all else being equal.

If we revised the likelihood of extraordinary state support to “moderately high,” it would also lead us to lower our rating on Samruk-Energy, if the SACP and sovereign ratings remain unchanged. Such a revision might stem from a demonstrated weaker willingness of the government to provide financial support to the group, a revision of government strategies regarding development of the private sector, or enhanced privatization above our expectations during the “People’s IPO.”

If we revised up our assessment of Samruk-Energy’s SACP to ‘bb-‘, and the group’s credit metrics sustainably improved to a level commensurate with a “significant” financial risk profile, including debt to EBITDA of 3x-4x and FFO to debt in the 20%-30% range, it could trigger an upgrade of Samruk-Energy. We think that these factors could occur in case of further conversion of loans to equity, further equity contributions, or lower investments implemented by the group, with Samruk-Energy’s liquidity and maturity profiles also remaining adequate.