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Jan 10 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned Mangistau Electricity Distribution Company JSC’s (MEDNC) KZT2.4bn 8% domestic bond due 2024 a ‘BBB-(EXP)’ expected local currency senior unsecured rating. The final rating is contingent upon the receipt of final documentation conforming materially to information already received.
The rating is in line with MEDNC’s Long-term local currency Issuer Default Rating (IDR) of ‘BBB-', which has a Stable Outlook, as the bond will constitute a direct and unsecured obligation of the company. MEDNC will use the proceeds of the bond issue to finance its investment programme until 2015. A full list of MEDNC’s ratings is below.
Three Notches below Sovereign
MEDNC’s ratings are notched down from those of Kazakhstan (BBB+/Stable) by three notches, reflecting the moderate strength of the links between the company and ultimate parent. MEDNC’s direct parent, indirectly fully state-owned JSC Samruk-Energy (S-E; BBB/Stable), has not provided tangible financial assistance to MEDNC since we widened the notching from the sovereign rating to three notches from two in 2011. Although S-E does not view MEDNC as strategic, it is not actively pursuing a reduction of its stake in the company. MEDNC’s ratings are based on the assumption that S-E will retain at least majority ownership over the rating horizon and we do not expect significant changes to the relationship in the near term. We view MEDNC’s standalone profile as commensurate with a ‘BB-’ rating.
Near-Monopoly Position in the Region
MEDNC’s credit profile is supported by its near-monopoly position in electricity transmission and distribution in the Region of Mangistau, one of Kazakhstan’s strategic oil and gas regions. It is also underpinned by prospects for economic development and expansion in the region, in relation to both oil and gas and transportation, and by favourable three-year tariffs. MEDNC further benefits from limited foreign exchange risks and from the absence of interest rate risks.
Small Scale, Concentrated Customer Base
The ratings are constrained by MEDNC’s small scale of operations, which limit its cash flow generation capacity, its high exposure to a single industry (oil and gas) and, within that, high customer concentration (the top-four customers represented over 67% of 2012 revenue). The latter is somewhat mitigated by the state ownership of some customers, and by prepayment terms under transmission and distribution agreements.
Between 2012 and 9M13 MEDNC’s revenue growth was mainly driven by a transmission and distribution tariff increase to KZT3.1 per kWh in 2013 from KZT2.39 in 2012 and KZT1.95 in 2011. Further tariff increases have been approved at about 5% on average for 2014 and 2015. The tariff increase in 2012 was partly driven by an increase of MAEK-Kazatomprom’s electricity prices.
Since 2013, MEDNC’s tariffs are approved by Kazakstan’s Agency on Regulating Natural Monopolies and Competition Protection for a three-year period, rather than the one-year period previously, in conjunction with the capex programme. MEDNC expects its 2016 tariffs to be approved in 2H14. Fitch positively views the switch to medium-term tariff approval. The tariff system for transmission and distribution segments, which is predominantly based on benchmarking with the intention to increase the company’s efficiency, should result in favourable tariffs for MEDNC.
Capex Will Increase Leverage
MEDNC’s ratings are constrained by its large prospective investment programme relative to the small scale of its operations. At end-2012 MEDNC reported funds from operations (FFO) adjusted leverage of 1.5x, down from 2.2x at end-2011. The company’s ambitious capex programme of about KZT27.8bn over 2013-2017 will likely result in negative free cash flow over the same period and require significant debt funding. Fitch expects that it may result in FFO-adjusted leverage increasing to around 3x by end-2015 and towards 4x by end-2016 under our conservative assumptions.
Capex will consist of KZT13.5bn on the construction of two new electricity transmission lines, KZT4.6bn on the reconstruction of current transmission lines and substations, and some on other projects. The currently approved capex programme is KZT12bn for 2013-2015. At end-2012 FFO interest cover slightly improved to around 4x from 3.6x at end-2011 and we expect that it will remain in the single digits over 2013-2016.
Stable CFO, Negative FCF Expected
Fitch expects MEDNC to continue generating solid and stable cash flow from operations (CFO) over 2013-2016. However, free cash flow is likely to turn negative in 2013 and onwards, mainly driven by substantial capex plans. For 2013, Fitch estimates MEDNC’s CFO at KZT2.2bn, before capex (KZT3.4bn) and dividends (KZT250m). Fitch expects MEDNC to rely on new borrowings to finance cash shortfalls.
Elevated Dividend Payout
Fitch notes that for 2012 MEDNC’s dividend payout ratio increased to 75% (or KZT250m) from 50% (or KZT88m) for 2011. However, management expects it to decrease to around 50% over the medium term. If dividends remain elevated at a time of increasing capex, Fitch may view it as a sign of weakening links with the ultimate parent and may revise its rating approach to one of bottom-up from one of top-down.
The Stable Outlook reflects Fitch’s assessment that upside and downside risks to the rating are currently balanced. The main factors that may individually or collectively lead to rating action are as follows:
- Positive rating action on Kazakhstan provided the links between MEDNC and the sovereign do not weaken.
- Stronger links with the ultimate parent.
- Enhancement of the business profile, such as diversification and scale with only modest increase in leverage would be positive for the standalone profile.
- Negative rating action on Kazakhstan.
- Weaker links with the ultimate parent, such as a reduction of S-E’s stake in MEDNC to less than 50% or an elevated dividend payout, insufficient tariffs and increased capex contributing to weaker credit metrics. This may result in Fitch reconsidering its rating approach to one of bottom-up from the top-down that is being currently applied.
- Deterioration in MEDNC’s FFO adjusted leverage to 4x or above and FFO interest cover to 2.0x or below on a sustained basis would be negative for the standalone profile.
Fitch views MEDNC’s liquidity as manageable, comprising solely cash as the company does not have any available credit lines. At end-3Q13, MEDNC’s cash balance of KZT2.9bn was sufficient to cover short-term maturities of KZT962m. Cash balances are mostly held in local currency with domestic banks including Halyk Bank of Kazakhstan (BB-/Rating Watch Evolving) and Nurbank, which is a risk.
At end-3Q13, most of MEDNC’s debt was represented by two unsecured fixed-rate bonds of KZT800m and KZT1.7bn maturing in 2014 and in 2023, respectively. The rest of the debt is represented by interest-free loans with maturity up to 2036 from MEDNC’s customers to co-finance new network connections. MENDC’s ambitious capex programme will likely require additional debt funding over the medium term. MEDNC has proven access to the domestic bond market. During 2013, MEDNC issued KZT1.7bn of bonds to partly finance its substantial capex need (KZT3.4bn) for the year. The remainder is expected to be financed by MEDNC’s own funds.
FULL LIST OF MEDNC’s RATINGS
Long-term foreign currency IDR ‘BB+', Outlook Stable
Long-term local currency IDR ‘BBB-', Outlook Stable
National Long-term rating ‘AA(kaz)', Outlook Stable
Short-term foreign currency IDR ‘B’
Foreign currency senior unsecured rating ‘BB+’
Local currency senior unsecured rating, including that on KZT1.7bn and KZT800m bonds, ‘BBB-'