OREANDA-NEWS. Fitch Ratings has assigned Baskent Elektrik Dagitim A. S. (Baskent) a National Long-Term Rating of 'AA(tur)' with a Stable Outlook.

The rating is supported by the regulated nature of the company's operations, predictable operating cash flows and experienced shareholders. Fitch views the current regulatory regime as favourable for investments but uncertainty remains about profitability once capex slows down. Baskent does not own the infrastructure assets, and its investments in the grid are treated as financial assets, recoverable in 10 years, with an attractive real rate of return. Under the current regulatory period, investments should continue until 2020, meaning that financial returns will continue until at least 2029. Although typical for Turkey, we view the liquidity management and debt maturity profile as aggressive.

KEY RATING DRIVERS

Regulatory Visibility

Electricity distribution in Turkey is in its third regulatory period, which started in 2016, offering good visibility until 2020. The regulation includes regulatory asset base (RAB) concept, and investments are remunerated at a real rate of return of 11.91% (regulatory period two 9.97%), with capital fully reimbursed in 10 years. Baskent may also outperform through opex efficiencies, higher than the targets set by the regulator, capex outperformance and lower technical losses than those allowed. Overall, we find the current regulatory regime to be supportive and transparent, despite the lack of asset ownership and low visibility beyond the 10-year capital return period.

Experienced Shareholders

Baskent is part of the Enerjisa Enerji group, an integrated utility active in generation, trading and supply and distribution whose ultimate parent companies are Sabanci Holding (50%) and E. ON SE (50%). The expansion capex programme for the generation group has been completed, with 3.5 gigawatts in mostly hydro and gas generation capacity. The retail and trading business consisting of 40 terawatt hours of sales and 10 million subscribers is currently cash flow positive, providing liquidity support though intercompany loans to the other subsidiaries. Next to Baskent, the distribution arm of Enerjisa operates two other networks in the Istanbul area and in Southern Turkey. We view Enerjisa's overall credit quality as stronger than Baskent. We do not provide any notching uplift for the shareholders' support but highlight that the good reputation and experience of both E. ON and Sabanci allow Enerjisa good access to capital and provide operational knowledge.

Returns Driven by Investments

The majority of Baskent's EBITDA comes from financial income, which represents the return allowed on investments while the remaining 10%-15% of EBITDA comes from various incentives and outperformance on regulatory targets. It is unclear how regulation will treat maintenance and repair capex once capex requirements slow down, as these costs are currently not remunerated by any additional allowed return. However, the Turkish distribution infrastructure requires investments for expansion, strengthening and renewing of the grid and the high investment capex cycle is likely to continue well into the next decade. While we note the uncertainty related to regulated returns after the initial 10-year investment return period, the changes are too far in the future (after 2029 on the current capex plan) to be considered in our current rating case forecast (i. e. it is not a limiting factor financially, but it is limiting our business profile assessment).

Moderate Financial Policy

Management's current strategy targets maximum net debt/EBITDA of 5.0x for the distribution businesses which include Baskent and two other networks. We assess this policy as moderate, and highlight that EBITDA does not account for some of the reimbursed regulated cash flows which on average for 2016-2020 amount to TRY340m/year, increasing as the investments occur. This target compares with funds from operation (FFO) adjusted net leverage of 3.1x-3.4x, post the reimbursement adjustment. We expect that leverage would be managed down in a possible future phase where return of and on investment capital decreases.

Enerjisa Elektrik Dagitim A. S. (the intermediate between Baskent and its ultimate shareholders) runs a conservative dividend policy in which the targeted net debt / EBITDA ratios for any of its subsidiaries are taken into consideration before any dividends are paid. Target leverage is for generation 4.0x, distribution and sales consolidated 4.0x and distribution 5.0x net debt/EBITDA.

Limited Forex Risk

With the exception of a EUR3.5m EIB loan, Baskent's debt is TRY-denominated and thus facing immaterial forex exposure. We assess the lack of forex exposure as positive for the rating, particularly in the context of the depreciating local currency and corporate peers in Turkey.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Baskent include:

- Allowed real WACC of 11.91%, as communicated by the regulator.

- Slightly declining inflation from 8% in 2017 to about 7% in 2020.

- Capital expenditures for the current price control as allowed by the regulator.

- Net collections from financial assets related to service concession agreements added to FFO, in order to reflect Baskent's true cash generation position.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

- FFO adjusted net leverage below 3.0x, net debt/EBITDA below 4.0x and FFO fixed charge cover above 3.0x, all on a sustained basis.

- Better clarity on regulation after the high intensity investment ends.

- Improvement in liquidity position and debt maturity profile.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- FFO adjusted leverage above 4.0x, net debt/EBITDA above 5.0x, and FFO fixed charge cover below 2.0x, all on a sustained basis.

- Any adverse regulation effects including delays in recoveries of investments.

- Deterioration of available liquidity.

- Unhedged foreign currency debt exposure.

LIQUIDITY

The Turkish market operates with a heavy use of spot/overnight loans. At the end of March 2016, Baskent had TRY1.2bn of available liquidity lines from six different Turkish banks (eight in total but two have already been utilised). The facilities are available but not committed and the only covenant applicable is that Enerjisa Elektrik Dagitim should maintain at least a 51% stake in Baskent. The loans are utilised without any security or obligations from the shareholders and there are no fees charged, since the amounts are not committed. Cash balances are minimal and share of short term debt is high with relatively short average maturity profile. We view liquidity and debt management as rating constraints.