Fitch maintains Samruk-Energy ratings in Negative list of Rating Watch

/Fitch Ratings, London/Moscow, August 8, 14, heading by KASE/ – Fitch Ratings is maintaining Kazakhstan-based JSC Samruk-Energy's (Samruk-Energy) ratings, including its Long-term foreign currency Issuer Default Rating of'BBB', on Rating Watch Negative (RWN). The full list of rating actions is provided at the end of this commentary. The RWN reflects uncertainty regarding the state's willingness to support the company's credit metrics while encouraging its acquisitive and capital-intensive strategy. Fitch will re-assess the ties between Samruk-Energy and its ultimate sole shareholder, the Kazakh State, following the determination of the final funding structure for the recent large acquisition of LLP Ekibastuzskaya GRES-1. Any weakening of ties may result in a widening of notches between the State's (BBB+/A-/Stable) and the group's ratings. Currently the company's Long-term foreign currency Issuer Default Rating (IDR) of 'BBB' is one notch below the sovereign's (BBB+/Stable). KEY RATING DRIVERS Acquisition Financing Samruk-Energy's recent acquisition of a 50% stake in LLP Ekibastuzskaya GRES-1 was mostly debt-funded and led to a deterioration of credit metrics. However, the final funding structure may include substantial equity funding as half of the acquisition debt may be converted into equity. Samruk-Energy has purchased a 50% stake in LLP Ekibastuzskaya GRES-1 from Kazakhmys for KZT221bn (USD1.3bn) provided by its sole direct shareholder JSC Sovereign Wealth Fund Samruk-Kazyna (S-K, BBB+/Stable), which is 100% state-owned. Samruk-Energy funded this transaction with a KZT200bn loan and KZT21bn of equity, all from S-K. However, the company expects that half of the KZT200bn of debt will be converted into equity and the remaining half into subordinated bonds, the final details of which are not disclosed yet. Fitch will resolve the RWN taking into account the impact of the final funding structure on the credit metrics once the details of the transaction are available. Top-Down Rating Approach Fitch continues to apply a top-down rating approach to Samruk-Energy with its Long-term IDRs being notched down from the Kazakh sovereign's ratings. This notching reflects strong strategic, operational and, to a lesser extent, legal ties between the State and the group, according to Fitch's Parent and Subsidiary Rating Linkage methodology. The strength of the ties is underpinned by the company's strategic importance to the Kazakh economy and by equity injections provided by the state for funding its investment projects. Fitch will re-assess the strength of the ties following the determination of the final funding structure of the acquisition and taking into account provision of other forms of state support. A weakening of ties may result in a widening of notches between the company's and the sovereign's ratings. We view Samruk-Energy's standalone profile as commensurate with a mid 'B' rating category (assuming a mostly debt-funded acquisition). Legal Ties Weaken While Samruk-Energy continues to benefit from tangible state support, including equity injections and asset contributions, the strength of the legal ties (e.g. state guarantees for debt), which are the key driver for the current one notch difference between the company's and State's ratings, is diminishing. The share of fully state-guaranteed debt (directly by the State or via S-K) in Samruk-Energy's gross debt declined to 13% at end-2013 from 19% in 2012, due to an increase in total debt. The most recent guarantee provided by S-K was in 2010 for the loans of one of Samruk-Energy's JVs. The company also received equity injections from the State of KZT111bn over 2008-2013 and expects to receive around KZT103bn over 2014-2018, for the modernisation of the Almaty and Balkhash power stations and for funding the Ekibastuzskaya GRES-1 acquisition. S-K plans to offer minority stake in Samruk-Energy to the local public in a so- called 'People's IPO' over 2015. However, S-K and thereby the government, are expected to retain a majority stake in Samruk-Energy and continue to support Samruk-Energy, at least within the rating horizon. Strategic Importance The strength of strategic links is underpinned by Samruk-Energy's dominant market position. It controls 47% of total installed capacity in Kazakhstan, about one third of total electricity production in the country, operates 70 thousand km of transmission lines and extracts 38% of total coal output in Kazakhstan. Credit Metrics under Pressure Fitch expects Samruk-Energy's funds from operations (FFO) adjusted gross leverage to remain high, at above 6x over 2014-2018 (5x in 2013) and its FFO fixed charge cover to deteriorate to below 3x by 2015 (6x in 2013). This is due to an intensive capex programme of KZT494bn (USD2.7bn) over 2014-2018. The forecast also assumes the impact of a mostly debt-funded acquisition of Ekibastuzskaya GRES-1. While we expect the company to continue generating solid and stable cash flow from operations over 2014-2018 due to tariff increases and stable dividends flow from its JVs, we forecast free cash flow to remain negative over the same period, due to the capital intensity of operations. We view the company's dividend policy as conservative, although the dividend payout ratio was increased to 20% for 2013 from 15% in 2012. Potential Assets Disposal In April 2014 Kazakhstan's government approved a list of 106 companies for privatisation within 2014-2016. The sale of assets is approved by the State and intended to increase competition in the power industry in Kazakhstan. The terms and any pricing of these assets sale are not disclosed yet. Nine of these companies are owned by Samruk-Energy, which are JSC Mangistau Electricity Distribution Company (MEDNC, rated BB+/Stable), JSC Aktobe TPP, JSC Zhambylskaya GRES, JSC VK REK, LLP Shygysenergotrade, JSC Alatau Zharyk Company, LLP AlmatyEnergoSbyt, JSC Almaty Power Station and TOO Tegis Munay. Based on Fitch estimates, these assets are expected to account for 68% of group's revenue and 31% of EBITDA in 2014-2018. The assets represented 6.3% of total debt at end-2013. Prior Ranking Debt The foreign currency senior unsecured debt rating is notched down a level from Samruk-Energy's Long-term foreign currency IDR, due to the structural and contractual subordination in the group's debt structure. The share of secured and prior-ranking debt at the operating company level in total debt as well as the ratio of prior ranking debt to group EBITDA have decreased so far in 2014, due to the acquisition of Ekibastuzskaya GRES-1, which was funded at the holding company level. In addition to the reduction of prior ranking debt, Fitch will consider aligning the senior unsecured rating with the IDR if the group achieves further clarity and consistency in its financial policy and group debt management. LIQUIDITY AND DEBT STRUCTURE Fitch views Samruk-Energy's liquidity as adequate. At end-2013 Samruk-Energy's unrestricted cash and cash equivalents stood at KZT54.2bn (excluding cash held at Alliance Bank JSC rated RD), which was sufficient to cover short-term maturities of KZT11.3bn. The company has a fairly balanced debt maturity profile with a maturity peak only in 2017 of around KZT93bn, which is the repayment of a USD500m eurobond. Fitch expects negative free cash flow driven by substantial investment programme to continue to add to funding requirements. Almost all of the group's cash position is held at domestic banks. While we believe that the company's access to liquidity for daily operations is likely to be adequate, its full access to all the cash held at Kazakh banks may be limited. In addition, Samruk-Energy is exposed to foreign currency risk as 29% of its debt as of 1H14 was USD-denominated whereas most of its revenue and costs are based in local currency. The recent devaluation of tenge will contribute to pressure on the company's credit metrics. RATING SENSITIVITIES Negative: Future developments that could lead to negative rating action include: - Negative sovereign rating action - Diminishing state support The ratings are on Rating Watch Negative. As a result, Fitch's sensitivities do not currently anticipate developments with a material likelihood, individually or collectively, of leading to an upgrade. Future developments that could, nonetheless, lead to a positive rating action include: - Positive sovereign rating action - Increase of state support (e.g. state guarantees for a larger portion of the company's debt) - Material reduction in the structural and contractual subordination in the group's debt structure along with adherence to a clearly defined debt management policy, which would be positive for the senior unsecured ratings For the sovereign rating of Kazakhstan, Samruk-Energy's ultimate parent, Fitch outlined the following sensitivities in its rating action commentary of 9 May 2014: The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently well balanced. The main factors that individually or collectively might lead to rating action are as follows: Positive: - Substantial strengthening of the sovereign balance sheet over the medium term - Effective restructuring of bank balance sheets - Entrenching low and stable inflation under a more flexible exchange rate regime - Improvements in governance and institutional strength Negative: - A departure from prudent policy that leads to a sustained decline in sovereign assets - A severe, sustained commodity price shock that negatively affects the balance of payments and public finances - Excessive lending growth and inadequate risk management in the banking sector - A political risk event FULL LIST OF RATING ACTIONS Long-term foreign currency IDR of 'BBB'; maintained on RWN Long-term local currency IDR of 'BBB+'; maintained on RWN Short-term foreign currency IDR of 'F3'; maintained on RWN National Long-term rating of 'AAA(kaz)'; maintained on RWN Foreign currency senior unsecured rating of 'BBB-'; maintained on RWN Local currency senior unsecured rating of 'BBB'; maintained on RWN National senior unsecured rating of 'AA+(kaz)'; maintained on RWN. Contacts: Principal Analyst Elina Kulieva Associate Director +7 495 956 9901 Supervisory Analyst Angelina Valavina Senior Director +44 20 3530 1314 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chair Arkadiusz Wicik Senior Director +48 22 338 62 86 Media Relations: Julia Belskaya von Tell, Moscow, tel. + 7 495 956 9908/9901, julia.belskayavontell@fitchratings.com [2014-08-11]