Fitch rates Kazakhstan’s KEGOC’s local-currency bond ‘BBB-‘

Fitch Rates Kazakhstan's Real Estate Fund Samruk-Kazyna 'BB+'; Outlook Stable

The International Rating Agency Fitch Ratings has assigned a local-currency senior unsecured rating of ‘BBB-‘ to Kazakhstan Electricity Grid Operating Company (KEGOC) and its domestic bond program for 84 billion tenges and the 47.5 billion tenges bonds issued under it, the rating agency reported on March 31.

KEGOC plans to use the proceeds of the bond issue to finance its investment program and reduce its FX exposure.

“KEGOC’s ratings reflect the overall strong links with the state, namely government guarantees for some of KEGOC’s debt, and the company’s Long-Term IDRs are one notch lower than the sovereign’s,” the rating agency said.

In mid-2016 KEGOC placed 47.5 billion tenges of local unsecured bonds with the National Pension Fund. The interest rate was set at CPI+2.9 percent. The first coupon rate was set based on CPI in March 2016 at 18.6 percent, which is high given the modest economic growth in Kazakhstan. The company may issue an additional 36 billion tenges of local bonds in 2017 for business needs. Fitch expects the interest rate to decrease to 10-13 percent in 2017-2019 following the slowdown in inflation in Kazakhstan.

KEGOC is exposed to currency risk as about 76 percent of the company’s 205 billion tenges debt at 30 September 2016 was in foreign currencies (51 percent in US dollars and 25 percent in euros) with only a marginal portion of revenue denominated in US dollars (related to transnational electricity flows). KEGOC does not have any hedging arrangements, although the currency mismatch risk is mitigated by its holding most of its cash and bank deposits in US dollars.

Fitch noted that vulnerability to FX risk would be reduced if KEGOC issues further local bonds or decides to repay some of its loans early. Nevertheless, the rating agency expects the FX exposure to remain significant.

Fitch noted that KEGOC continues to benefit from favourable long-term tariffs set by the Committee on Regulation of Natural Monopolies and Protection of Competition until 2020. The tariffs for transmission, dispatching and balancing increased by an average 12 percent in 2016 and the company expects them to rise on average by 6.5 percent in 2017-2020. Long-term tariffs provide earnings visibility, although they remain subject to revision in the case of a macroeconomic shock or further tenge devaluation, Fitch said. The rating agency forecasts tariffs will rise on average by 2 percent below the approved levels over 2017-2020.

KEGOC’s capex program of 236 billion tenges for 2016-2020 remains high, although it was scaled down in September 2016 from 268 billion tenges with the postponement of some development projects. The share of maintenance capex is low at an average of 14 percent for 2016-2020, providing the scope for cuts to total capex. However, Fitch does not expect substantial reductions in capex since the approved high tariff growth is contingent on certain investments being realized. The rating agency also expects KEGOC to rely on new unguaranteed borrowings to finance its large capex program.

Fitch assesses KEGOC’s standalone profile as commensurate with a high ‘BB’ rating category given the company’s monopoly position in electricity transmission in the country and its sound financial profile. However, the company’s standalone profile is constrained by large capex, which is likely to result in continued negative free cash flow (FCF), and by a high exposure to FX.

The company’s financial profile improved significantly in 2015, and Fitch expects its funds from operations (FFO) adjusted leverage and FFO fixed charge cover to average 2.5x and 6.9x in 2016-2020, respectively. If the company repays some of its FX-denominated loans, its leverage metric may improve further.

Positive sovereign rating action; strengthening of legal ties (eg the share of guaranteed debt rises steadily above 40 percent); or enhancement of the business or financial profile, possibly as a result of stronger regulation and higher equity funding, which would be positive for the unguaranteed debt profile of KEGOC and its standalone rating, may, individually or collectively, lead to positive rating action on the company.

Negative sovereign rating action; or if the state tolerates deterioration of the company’s credit profile eg through an increased capex program without sufficient funding or downward revision of tariffs, leading to FFO adjusted gross leverage persistently higher than 4x and FFO fixed charge coverage below 4, may, individually or collectively, lead to negative rating action.