OREANDA-NEWS. S&P Global Ratings said today that it had placed its 'B' long-term corporate credit rating on Bulgarian electricity utility Natsionalna Elektricheska Kompania EAD (NEK) on CreditWatch with negative implications.

The CreditWatch placement reflects potential pressures on NEK's credit quality if the company's profits and cash flow generation remain weak, or if it doesn't obtain sufficient financial support from the government and from the parent Bulgarian Energy Holding (BEH) to cover external debt payments and the payment due to Atomstroyexport after NEK abandoned construction of a nuclear plant it had agreed Atomstroyexport was to build.

We continue to believe that NEK's financial position remains unsustainable in the long term and its stand-alone capacity to meet its financial obligations mainly depends on how quickly the recent changes in regulatory conditions will translate into positive cash flow generation. NEK's losses have reduced, but the company's EBITDA and funds from operations remained negative in the first half of 2016. Our 'ccc+' assessment of NEK's stand-alone credit profile (SACP) therefore includes ongoing support from the parent. In particular, we understand most of NEK's debt is due to the parent. On June 30, 2016, NEK had Bulgarian lev (BGN) 2.4 billion debt to the parent versus BGN157 million debt to external banks. We understand that, in the coming weeks, NEK will complete the replacement of a €535 million short-term shareholder loan with a long-term loan from BEH, after BEH successfully issued €550 million bonds in August 2016.

Following the Swiss arbitration court's award to Atomstroyexport in June 2016, NEK faces paying Atomstroyexport a large sum of €550 million for the abandoned nuclear power plant construction. The exact amount of interest payable is yet to be clarified. We understand that the Bulgarian parliament has voted to provide financial support to NEK for this payment, but that such support is subject to the European Commission's approval, and the amount, timing, and terms are uncertain at this stage. If financial support from the government comes in the form of debt, rather than equity, we expect NEK's leverage to increase compared with year-end 2015. We understand that, at this stage, the arbitration court decision has not triggered any cross-default or debt acceleration, and that it didn't affect the ability of NEK's immediate parent, Bulgarian Energy Holding (BEH), to successfully issue €550 million bonds in August 2016.

We continue to regard NEK as a strategically important subsidiary of BEH. We consequently factor in two notches of uplift from NEK's 'ccc+' SACP. Our rating on NEK is capped at one notch below the 'b+' group credit profile (GCP). Although we do not rate BEH, we factor its credit quality into our rating on NEK. We regard BEH as a government-related entity with moderate likelihood of extraordinary state support. Our assessment of BEH's GCP is 'b+', factoring in potential extraordinary state support. That said, in our view, BEH's future credit quality could be affected if NEK's performance remains weak, or if NEK's liquidity issues erode BEH's standing on financial markets.

In our view, NEK should avoid default on its minimal external debt obligations over the next 12 months if it obtains timely financial support from BEH and from the government. If NEK fails to obtain such support, we may reassess our view on NEK's status in the group and with regard to the government.

The CreditWatch placement reflects continued pressures on the rating if NEK's profitability and cash flow do not return to positive in 2016, despite the recent regulatory reforms and improving supplier terms. In our view, this could affect NEK's stand-alone credit quality, as well as our view of the parent's credit quality and BEH's ability to continue to provide ongoing liquidity support to NEK. The CreditWatch also reflects risks to liquidity if NEK doesn't receive sufficient financial support from the government or BEH to cover NEK's ongoing payments on external debt and the Atomstroyexport payable, or if the Atomstroyexport payable affects NEK's or BEH's external debt obligations. We will reassess the situation within the next three months.

We would likely lower the rating if NEK accumulates new power tariff deficits and continues to accumulate mounting overdue payables, or if NEK fails to obtain sufficient long-term funding from the government to cover its Atomstroyexport payable. We could also lower the rating in case of continuing liquidity pressures, or if parental support from BEH diminishes.

We could affirm the rating if NEK demonstrates sustainable profits and cash flows, receives sufficient long-term financial support to cover the Atomstroyexport payable and its external debt, and continues to enjoy group support.