Fitch affirms Central Asian Electric Energy Corporation ratings; outlook Stable

30.06.14 17:47
/Fitch Ratings, Moscow, June 26, 14, heading by KASE/ – Fitch Ratings has affirmed Joint Stock Company Central-Asian Electric-Power Corporation's (CAEPCo) Long-term foreign currency Issuer Default Rating (IDR) at 'BB-'. The Outlook is Stable. A full list of ratings actions is at the end of this comment. The rating reflects CAEPCo's vertical integration, benign regulatory regime and stable regional market position (despite overall small size) with access to cheap regulated coal supplies. However, CAEPCo's ageing assets require significant renewal and the planned investment programme will likely result in negative free cash flow (FCF) and elevated funds from operations (FFO) gross adjusted leverage of about 2.8x on average over 2014-2016 based on Fitch's conservative assumption. KEY RATING DRIVERS Generation Dominates Despite Integration CAEPCo is one of the largest privately owned electricity generators in Kazakhstan. It is integrated across the electricity value chain with the exception of fuel production and transmission, which gives the company access to markets for its energy output and limits customer concentration. CAEPCo's revenue and EBITDA are dominated by generation services, which accounted for about 46% and 91%, respectively, in 2013. Electricity and heat distribution represents about 18% of revenue and 6% EBITDA, while low marginal sales makes 36% of revenue and only 3% of EBITDA in 2013. Loss Making Heat Business The heat distribution business is loss-making due to high heat loss and regulated end user tariffs, which Fitch assumes are kept low for social reasons (heat generation is reported within overall generation and cash flow accretive), a situation that we assume will persist but with gradual improvement. Solid CFO, Negative FCF Expected Fitch expects CAEPCo to continue generating solid cash flow from operations (CFO) of around KZT18bn on average over 2014-2016 following volumes and tariff increase. However, FCF is likely to remain negative at around KZT8bn on average over 2014-2016 but may turn positive in 2017. The negative FCF will be mainly driven by the ambitious investment plans of about KZT82bn over 2014-2016 as well as dividend payments of about 30%-50% of net profit in the medium term. Fitch expects CAEPCo to rely on new borrowings to finance cash shortfalls. Elevated Leverage Expected Fitch expects CAEPCo's intensive investment programme over 2014-2016 to be partially debt funded, therefore we anticipate FFO gross adjusted leverage will slightly increase to about 2.8x on average over the same period from 2.5x at end-2013. The capex programme is aimed at modernising over 60% of CAEPCo's ageing 1960s and 1970s generation capacity by 2018, as well as upgrading its distribution network. Capacity expansion will be moderate at around 13% in total to 2018 but additional benefits will be reduced losses in production and distribution of heat and electricity. Cheap Fuel Supports EBITDA Kazakh coal prices are significantly below international market rates, reflecting their regulated nature, low calorific content and high ash content of coal used domestically as well as low transport costs. Additionally, to protect energy affordability, the coal price charged to utilities is regulated annually and reflected in power tariff caps. An unexpected and significant increase in the price of coal above Fitch's current inflationary estimates of 6.5%-9.0% annually would have a negative impact on EBITDA, although this is considered unlikely and is expected to be reflected in higher tariffs. Supportive Tariffs At Present Fitch views positively the switch to medium-term distribution tariffs approval. Since 2013, CAEPCo's distribution segment companies have been operating under three-year tariffs that were approved until 2016 and are determined based on 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 operational performance. Fitch notes that generation tariffs are currently approved until 2015. The post-2015 electricity generation tariff regime is uncertain, particularly for existing capacities. However, we assume that fuel and other cost inflation will continue to be reflected in energy prices. 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. No Parent Uplift or Constraint Unlike most Fitch-rated utilities in CIS, CAEPCo is privately owned and therefore not affected by sovereign linkage. The company is run as a standalone enterprise with two foreign institutional shareholders and as such we do not assume any impact on the ratings based on the credit profile of the controlling parent, Central- Asian Power-Energy Company JSC (CAPEC). The ratings therefore reflect CAEPCo's standalone credit profile. Dividends to Delay Debt Reduction CAEPCo's financial policy is to pay dividends and this could delay de-leveraging in the long term. However, we believe that should tariffs and volumes underperform, CAEPCo retains the flexibility to lower dividends to preserve cash, as demonstrated in 2011 when the dividend payout ratio was decreased to 15% upon the 2011 results due to the decision of shareholders to accelerate implementation of the investment programme. CAEPCo's dividend policy provides for a 30%-50% dividend payout ratio. For 2013 CAEPCo declared dividends of KZT2.3bn that will be paid in 2H14. Further Potential Acquisitions CAEPCo is likely to continue consolidating the Kazakh electricity market. At end-2013 CAPEC agreed to contribute its 51.59% stake in AEDC to CAEPCo as an equity and the company expects to acquire another 48.41% in 2H14 for KZT8.9bn (USD40m) through a mixture of equity and debt. CAEPCo expects to consolidate AEDC from 2014, an electricity distribution network that previously distributed electricity largely supplied to CAEPCO's subsidiary, Astanaenergosbyt (AESbyt). AEDC has an EBITDA margin of about 25% compared with AESbyt's EBITDA margin of about 2%. Fitch views positively the consolidation of EBITDA margin enhancing assets that will likely result in a revenue and EBITDA increase of about 8% and 29%, respectively. However, we note that certain investments of about KZT19.6bn over 2014-2018 will be required that are currently included in CAEPCo's investment programme. Non-completion, or completion with higher debt and capital expenditure requirement than our forecasts could push CAEPCo towards guidance for negative rating action. RATING SENSITIVITIES Positive: Future developments that could lead to positive rating action include: - A stronger financial profile than forecast by Fitch due to, among other things, higher than expected growth in electric and heat tariffs and/or generation electricity supporting FFO gross adjusted leverage below 2x and FFO interest coverage above 7x on a sustained basis would be positive for the ratings. - Increased certainty regarding the post-2015 regulatory framework could also be supportive of the ratings. Negative: Future developments that could lead to negative rating action include: - A substantially above inflation increase in coal price and/or tariffs materially lower than our forecasts, leading to FFO gross adjusted leverage persistently higher than 3x and FFO interest coverage below 4.5x would be negative for the ratings. - Committing to capex without sufficient available funding, worsening overall liquidity position may also be rating negative. LIQUIDITY AND DEBT STRUCTURE - Adequate Liquidity Fitch views CAEPCo's liquidity as adequate. At end-2013 cash and cash equivalents stood at KZT2.3bn, which together with short-term bank deposits with a maturity up to one year of KZT9.3bn are sufficient to cover short-term debt maturities of KZT9.3bn. However, negative FCF over 2014-2016 driven by the ambitious investment programme and continued dividend payments continue to add to funding requirements and Fitch believes that CAEPCo will need to rely on new borrowings to finance cash shortfalls. CAEPCo has proven access to domestic and some international lenders. Fitch notes that CAEPCo has some flexibility in capex implementation as well as in dividend payments. CAEPCo's committed capex amounted to about KZT38bn to be spent over 2014-2016 and management anticipates maintenance capex of about KZT8bn on average over 2014-2016. At end-2013 the majority of CAEPCo's debt was secured bank loans (KZT26.6bn or about 62%) and three unsecured local bonds maturing in 2017, 2020 and 2023 (KZT14.7bn in total or 34%). All current debt facilities (both secured and unsecured) are largely at the operating company level. Fitch rates KZT1bn notes a one notch below CAEPCo's local currency IDR of 'BB-' as the notes are issued by CAEPCo and do not benefit from upstream guarantees from the operating subsidiaries, and also because the notes have no security over operating assets and no cross defaults with other facilities. - Foreign Currency Exposure The recent tenge devaluation of about 20% affects CAEPCo's credit metrics given about 30% of CAEPCO's debt at end-2013 was denominated in US dollars. The proportion of foreign currency-denominated debt is likely to increase over the coming years. CAEPCo does not have any specific hedging policies in place. Fitch believes that a lack of hedging could increase leverage by about 0.1x-0.2x in 2014-2015. Additionally the majority of US dollar denominated debt is raised under variable interest rates exposing the company to interest rate fluctuations risks. FULL LIST OF RATING ACTIONS Long-term foreign currency Issuer Default Rating (IDR) affirmed at 'BB-', Outlook Stable Long-term local currency IDR affirmed at 'BB-', Outlook Stable National Long-term Rating affirmed at 'BBB+(kaz)', Outlook Stable Short Term foreign currency IDR affirmed at 'B' Local currency senior unsecured rating affirmed at 'B+' National senior unsecured rating affirmed at 'BBB-(kaz)' Contact: Principal Analyst Elina Kulieva Associate Director +7 495 956 99 01 Supervisory Analyst Oxana Zguralskaya Director Fitch Ratings CIS Ltd +7 495 956 70 99 26 Valovaya Street Moscow 115054 Committee Chairperson Angelina Valavina Senior Director +44 20 3530 1314 Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, julia.belskayavontell@fitchratings.com [2014-06-30]