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TEXT-S&P:RusHydro outlook revised to negative; 'BB+/B/ruAA+' Rtgs Afrmd
We also affirmed the issue rating on the Russian ruble (RUB) 20 billion ($676 million) 7.875% loan participation notes due 2015 issued by orphan special-purpose vehicle RusHydro Finance Ltd. (not rated) at 'BB+'. We also affirmed the 'BB+' issue rating on the RUB20 billion proceeds loan lent on by RusHydro Finance Ltd. to RusHydro. Our recovery rating on this loan is unchanged at '3', reflecting our expectation of meaningful (50%-70%) recovery in the event of a payment default.
The outlook revision reflects our view that RusHydro could struggle to restore its financial risk profile to levels we would consider commensurate with the long-term rating. This is a result of our revised financial projections that forecast increasing debt leverage for RusHydro, which is primarily a result of:
-- The acquisition of a 69.3% stake in RAO ES of East (not rated) in late 2011 and the effects of the consequent debt consolidation;
-- Regulatory pressure, including the unexpected removal of the special investment component from RusHydro's revenues and maintenance of price caps, which limit RusHydro's earnings potential; and
-- Our expectations of negative free operating cash flow (FOCF) generation stemming from a large-scale investment program.
We estimate that, following the acquisition of RAO ES of East, the company's adjusted debt-to-EBITDA ratio will be about 1.8x in 2011 and 2.8x-2.9x in 2012. We think that this is a temporary deviation and that RusHydro should be able to restore its financial risk profile as of 2014 and thereafter. In our opinion, an adjusted debt-to-EBITDA ratio of 2.5x is commensurate with the current long-term rating, all else being equal.
We view the unanticipated RAO ES of East transaction as an example of negative intervention by the government and a sign of weak corporate governance. We think the government imposed this transaction on RusHydro to help develop the infrastructure in Russia's Far East, and, although this reinforces the company's close links with the government, it also highlights the limited autonomy of the company's management.
It also highlights an unexpectedly aggressive financial policy, which weighs on our financial risk profile assessment. Furthermore, we see the acquisition as dilutive for the company's business risk profile, as the acquired thermal generation assets are less profitable, old, and in need of upgrading, and fall outside of RusHydro's core strategy of producing electricity from renewable sources.
We note that because of the government's recent decision, the company is unlikely to exercise the sale of 11% of its treasury shares to Vnesheconombank (BBB/Stable/A-3; BBB+/Stable/A-2) for RUB64 billion, which we viewed as a funding source for the company's investment program. In our base-case scenario, however, we assume RusHydro will scale down its investment program for 2012-2014 accordingly, in order to restore its key credit metrics to levels commensurate with the current long-term rating.
We do not incorporate the potential inflows related to a future sale of Far East Distribution Co. (not rated), because the pricing and timing of the deal is uncertain. However, if realized, this transaction might reduce RusHydro's need for new debt to finance its investments.
The ratings on RusHydro reflect the company's low production costs, given that 75% of RusHydro's generating capacities relate to hydrogenation; stronger-than-industry-average profitability, even after consolidation of RAO ES of East; a geographically diverse generation portfolio in Russia; and good access to capital markets.
These strengths are offset in our opinion by RusHydro's exposure to the volatile spot electricity market, aging assets, significant investment needs, and a massive capital-spending program that we think will result in negative FOCF, and weather risks related to hydrological conditions.
We assess RusHydro's stand-alone credit profile (SACP) at 'bb' on the basis of the company's "fair" business risk profile and "significant" financial risk profile as our criteria define those terms. We analyze RusHydro using our criteria for government-related entities. Our expectation of a "moderately high" likelihood of extraordinary government support is based on our assessment of RusHydro's "important" role for and "strong" link with the government.
The short-term rating is 'B'. We consider RusHydro's liquidity to be "adequate" under our criteria, and calculate that liquidity sources will exceed liquidity uses by about 1.2x over the next 12 months. As of Dec. 31, 2011, we estimate the company had liquidity sources of about RUB84 billion. These include:
-- Unrestricted cash and equivalents of RUB31 billion, although some of it is tied to operations;
-- A RUB8 billion available credit line from the European Bank for Reconstruction and Development (AAA/Stable/A-1+) maturing in 2021 and EUR128 million from UniCredit Bank Austria AG (A/Negative/A-1) with maturity in 2026; and
-- Our projections for funds from operations of about RUB40 billion for 2012.
We estimate that RusHydro's liquidity needs over the next 12 months to be about RUB68 billion, comprising:
-- Debt maturities of about RUB9 billion in 2012;
-- Capital expenditures of at least RUB58 billion (excluding value-added-tax and the construction of the Boguchanskaya Hydro Power Plant and an aluminum plant [BEMA project]), although we believe that the actual spending will depend on the availability of funding and RusHydro has some flexibility in its capital expenditures; and
-- Dividend payments of about RUB1 billion in 2012.
The company is subject to several covenants under its existing financial obligations. For example, it must keep total debt under a maximum of 3x EBITDA. We understand that the company is compliant with all the covenants in 2012-2013, although with little headroom. According to the documentation, a breach of covenant would not lead to an acceleration of the loans and therefore we would not consider it to be an event of default.
The issue rating on the RUB20 billion 7.875% loan participation notes due 2015 issued by orphan special-purpose vehicle RusHydro Finance Ltd. is 'BB+', the same as the issue rating on the RUB20 billion proceeds loan lent on by RusHydro Finance Ltd. to RusHydro. The recovery rating on the proceeds loan is '3', indicating our expectation of meaningful (50%-70%) recovery in the event of a payment default.
The recovery and issue ratings are supported by our valuation of the business as a going concern in the context of our hypothetical default scenario, but mitigated by the unsecured nature of the rated instruments; the Russian insolvency regime, which we view as unfavorable for creditors; and the potentially negative impact that the Russian government stake could have for recovery prospects.
To calculate recovery, we simulate a hypothetical default scenario, based on a combination of plant outages or unfavorable weather leading to a requirement to purchase power in the open market to fulfill contracts, in turn leading to reduced earnings. In addition, we have assumed that RusHydro would raise additional debt to fund its investment program.
We note that the increasing leverage resulting from the acquisition of RAO ES of East may have a dilutive effect on recovery prospects, although we still see recovery prospects in the 50%-70% range.
For more information, please see "RusHydro (OJSC) Recovery Rating Profile", published Aug. 30, 2011, on RatingsDirect the Global Credit Portal.
The negative outlook reflects out opinion that RusHydro could struggle to consistently maintain cash flow ratios that we would consider commensurate with the ratings.
We could lower the long-term rating on RusHydro if its consolidated adjusted debt exceeds EBITDA by 3x or more, even if only temporarily. A downgrade could also be triggered by higher-than-expected investments, including the need to invest in RAO ES of East; weaker financial performance, due to higher regulatory pressure than we expect; or deterioration in liquidity and maturity profiles. Lastly, any further negative intervention by the government is likely to lead to a revision of our business risk profile assessment to "weak", which could lead to a revision of RusHydro's SACP and consequently to a lower long-term rating.
At the current long-term rating level, we expect adjusted consolidated debt to EBITDA to be 2.5x-3.0x in 2012-2013, but to recover to below 2.5x in 2014 and thereafter. We think RusHydro has the potential to strengthen its financial profile because it has some flexibility in its capital-spending program and may benefit from low-cost electricity generation. However, we note that the company's earnings potential is pressured by adverse regulatory actions in the industry, including imposed price caps and the removal of a special investment component from RusHydro's revenues.
We could revise the outlook to stable if RusHydro demonstrates prudence and financial discipline by keeping its debt below 2.5x EBITDA continuously and showing capacity to scale down its investments and exercise successful cost control initiatives. This would also require implementation of less-aggressive financial policies.
The long-term rating assumes there will be no change in relations between RusHydro and the Russian government within the next two years that could affect our view of a "moderately high" likelihood of timely and sufficient extraordinary state support, if required. All else being equal, we would have to revise our assessment of this likelihood to "low" for it to result in a one-notch downgrade.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Ratings Affirmed; CreditWatch/Outlook Action
Corporate Credit Rating BB+/Negative/B BB+/Stable/B
Russia National Scale Rating ruAA+
Senior Unsecured (1 issue) BB+
Recovery Rating 3
RusHydro Finance Ltd.
Senior Unsecured (1 issue) BB+
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