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 the terms. We analyze RusHydro using our criteria for government-related entities (GREs). Our expectation of a "moderately high" likelihood of extraordinary government support is based on our assessment of RusHydro's:
-- "Important" role for the government, given its role as a mainly profit-oriented enterprise in a competitive environment, dominant position in the energy sector, key role in supporting power-intensive industries, and capacity regulation reserve function; and
-- "Strong" link with the state, owing to Russia's 60.5% ownership, our expectation that the government's stake will not fall to less than 50% plus one share over the medium term (supported by a recent government decision to include RusHydro in a list of strategic entities), ongoing state support in the form of asset and capital injections, the state's intention to continue providing support on a temporary and exceptional basis, and the risk to the sovereign's reputation if RusHydro were to default.
S&P base-case operating scenario
Our base-case scenario assumes that RusHydro's 2012 revenues from electricity generation are likely to be hindered by regulatory constraints. As a result, we expect revenues in that segment to remain flat in 2012. Overall, we project that the company's revenues will reach Russian ruble (RUB)300 billion--the company reported RUB151 billion of revenues in the first half of 2012, below the RUB372 billion generated in 2011--explained by the disposal of several supply companies in March 2011. For 2013 we anticipate a moderate single-digit percentage growth in RusHydro's revenues.
In 2011, RusHydro acquired the RAO Energy System of the East group of entities via a noncash transaction, thereby consolidating 8.8 gigawatts of thermal generation capacity in eastern Russia. We view this transaction as an example of negative intervention by the government and a sign of weak corporate governance. We think the government imposed the transaction on RusHydro to help develop infrastructure in eastern Russia, and, although this reinforces the company's close links with the government, it also highlights the limited autonomy of the company's management.
We also see the acquisition as dilutive of the company's business risk profile, as the acquired thermal generation assets are less profitable, old, in need of upgrading, and fall outside RusHydro's core strategy of producing electricity from renewable sources. The deal resulted in a weakening of RusHydro's margins--in 2011 RAO Energy System of the East reported a 10.6% EBITDA margin compared with 67% from hydrogeneration and 21% overall. Under our base case, we expect no major improvements in RusHydro's profitability in 2012 due to existing industry price caps. That view is also supported by RusHydro's first half 2012 results, as the company reported a 21% EBITDA margin.
S&P base-case cash flow and capital-structure scenario
Under our base-case scenario, we envisage that the company's adjusted consolidated debt to EBITDA will rise to 2.9x in 2012 from 2x at the end of 2011. We think that this will be a temporary deviation and that RusHydro should be able to restore its financial risk profile from 2014. In our opinion, adjusted debt to EBITDA of 2.5x is commensurate with the current long-term rating, all other things being equal. We note that the government recently announced it would provide about RUB50 billion in cash to RusHydro through an equity injection aimed at financing RAO Energy System of the East's investment programme. We see this as a good indication of state support probability, which we have incorporated into the rating. It also decreases RusHydro's need for new borrowings.
We also assume that RusHydro has some flexibility over its anticipated RUB250 billion spending for 2012-2014, and might scale it down to restore its key credit metrics to levels commensurate with our current long-term rating.
We expect the company to generate heavily negative FOCF until at least 2014, which is likely to be financed by a combination of internal funding, new debt issuance, and financial injections by the state.
The short-term rating is 'B'. We consider RusHydro's liquidity to be "adequate" under our criteria, and calculate that sources will exceed uses by about 1.8x over the next 12 months. As of June 30, 2012, we estimated that the company had liquidity sources of about RUB170 billion.
-- Unrestricted cash and equivalents of RUB60 billion, although some of this is tied to operations;
-- A RUB8 billion available credit line from the European Bank for Reconstruction and Development (EBRD; AAA/Stable/A-1+) maturing in 2021 and EUR85 million from UniCredit Bank Austria AG (A/Negative/A-1) maturing in 2026;
-- Our projection of funds from operations (FFO) of about RUB47 billion in 2012; and
-- Equity injections from the state of about RUB50.3 billion, which we expect to be received by the end of 2012.
We estimate RusHydro's liquidity needs over the next 12 months to be about RUB100 billion, comprising:
-- Debt maturities of about RUB25 billion;
-- Capital spending of at least RUB65 billion, excluding value-added tax and the construction of the Boguchanskaya Hydro Power Plant and the BEMA aluminum plant, although we believe that actual spending will depend on availability of funding and that RusHydro has some flexibility in its capital spending; and
-- Dividend payments of about RUB2.6 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 likely to remain compliant with all of its covenants in 2012-2013, although with little headroom. According to the documentation, a covenant breach would not lead to acceleration of the related loans and therefore we would not consider it a default.
For our full recovery report, see "RusHydro (OJSC) Recovery Rating Profile," published Aug. 30, 2011, on RatingsDirect on the Global Credit Portal.
The negative outlook reflects our opinion that RusHydro could struggle to consistently maintain cash flow ratios that we would consider commensurate with the ratings.
We might lower the long-term rating on RusHydro if its consolidated adjusted debt exceeded 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 Energy System of the East, weaker financial performance due to higher regulatory pressure than we expect, or deterioration in the company's liquidity and maturity profiles. Any 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 credit rating.
At the current long-term rating level, we expect adjusted consolidated debt to EBITDA of 2.5x-3x in 2012-2013, recovering to below 2.5x from 2014. We think RusHydro has the potential to strengthen its financial profile because it has some flexibility in its capital-spending program and might benefit from low-cost electricity generation. However, we note that the company's earnings potential is being negatively affected by regulatory actions, including imposed price caps and the removal of a special investment component from its revenues.
We could revise the outlook to stable if RusHydro demonstrated prudence and financial discipline by keeping its debt continuously below 2.5x EBITDA and showing capacity to scale down its investments and exercise successful cost controls. This would also require the 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 other things 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
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- RusHydro (OJSC) Recovery Rating Profile, Aug. 30, 2011
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008