OREANDA-NEWS. Fitch Ratings has downgraded Kazakhstan-based Joint Stock Company Central-Asian Electric-Power Corporation's (CAEPCo) Long-Term Foreign Currency Issuer Default Rating to 'B+' from 'BB-'. The Outlook is Stable. A full list of ratings actions is available at the end of this commentary.
The downgrade reflects our expectation that CAEPCo is unlikely to reduce its consolidated funds from operations (FFO) adjusted gross leverage to below 3x (3.8x in 2015) and to increase FFO interest coverage above 4.5x (4.9x in 2015) over 2016-2019. The weakening of CAEPCo's credit profile follows Kazakh tenge's sharp devaluation in 2015, given the company's high exposure to foreign currency risk. Fifty-four per cent of its debt at 1H16 was denominated in US dollar versus all revenue generated in local currency.

The ratings reflect CAEPCo's solid consolidated business profile, strong 1H16 financial results, vertical integration, and stable regional market position (despite overall small size). The ratings also take into account a currently fairly benign regulatory regime in the dist ibution sector, although theratings are constrained  by an unfavourable regulatory environment in the generation segment with tariffs  kept at 2015 levels for 2016-2018. CAEPCo's capex remains significant, which  Fitch expects to be partially debt-funded, resulting in further negative free cash  flow (FCF) in 2016-2018.

We assess CAEPCo, and 100% subsidiaries - Pavlodarenergo JSC and Sevkazenergo JSC - on a consolidated basis, since there is no ring-fencing, treasury is  centrally managed, debt is located at both holdco and opco levels. The debt of CAEPCo is primarily serviced by dividends from its opcos and we rate its notes without opco's guarantees one notch below the IDR.

The Kazakhstan tenge devaluation by more than 90% in 2015 weakened CAEPCo's credit profile due to a currency mismatch between the company's debt and revenues and the absence of hedging to reduce the company's foreign  exchange exposure. At end-2015, 54% of CAEPCo's outstanding debt was  denominated in US dollar, versus all local currency-denominated revenue.

We expect this pressure to continue, even with no further tenge depreciation. However, CAEPCo has some flexibility in dividend payments as well as in capex, as committed capex for 2016-2020 amounts to 61% of forecast total capex.

CAEPCo also maintains a portion of cash in US dollars. At end-2015, CAEPCo had 25% of cash and deposits in US dollars. The company is also exposed to interest rate risk since about half of its outstanding loans are drawn underfloating  interest rates.

As a result of the tenge devaluation CAEPCo breached its debt/equity covenant as per its loan agreement with EBRD in 2015, for which the company received a waiver. We expect CAEPCo to breach this covenant again in 2016-2019 even  with no further tenge depreciation. Failure to obtain a waiver or revise the  covenant may lead to further rating downgrade. EBRD owns 22.6% of CAEPCo.

Capex is expected to remain significant despite the completion of the so-called mandatory investment programme agreed with the government in 2009-2015 when tariff caps were in place. Fitch expects CAEPCo to continue generating solid consolidated cash flow from operations (CFO) of KZT19bn on average over 2016-2019, although FCF is likely to remain negative at KZT5bn over same period.

The negative FCF will be mainly driven by the company's significant investment programme of KZT22bn on average annually for 2016-2019 as well as dividend  payments of about 15% of net profit over the medium term. We have assumed  lower capex, in line with our lower-than- management revenue forecast, reflecting  that most of the investment is discretionary in nature. Fitch expects CAEPCo to  rely on new borrowings to finance cash shortfalls.

CAEPCo's financial policy to pay dividends could delay de-leveraging in the long term. However, CAEPCo retains the flexibility to lower dividends to preserve cash,  as demonstrated in 2011 when it cut dividend to offset higher capex. In 2015 CAEPCo tightened its dividend payout range to 15% from 30%. Our rating case assumed the 15% payout from 2017, following the payment of KZT933m in January 2016. Nevertheless, we expect FCF to remain negative since FFO will not be sufficient to cover the high capex and dividends.

CAEPCo is one of the largest privately-owned electricity generators in the highly  fragmented Kazakh market, responsible for only 7.2% of electricity generation in  2015. Consequently, it is somewhat smaller than its rated CIS peers. It is vertically  integrated across electricity generation, supply and distribution, which gives the  company access to markets for its energy output and limits customer  concentration.

CAEPCo covers electricity and heat generation, distribution and supply in the Pavlodar and Petropavlovsk regions through its 100% subsidiaries Pavlodarenergo JSC (4.1% of Kazakhstan electricity production) and Sevkazenergo JSC (3.1%), and  electricity transmission and supply in Akmola Region through Akmola EDC and  Astanaenergosbyt LLP. Electricity and heat generation services dominate CAEPCo's  EBITDA, accounting for about 96% in 2015.

CAEPCo demonstrated strong operational and financial results in 2015 and 1H16. The company commissioned three new turbines ahead of time and increased its modernised capacity to 542MW from 289MW. The share of modernised capacity reached 49%, up from 27% in 2014. Electricity production rose 7.4% during the same period, compared with a 3.3% decline in Kazakhstan and a further 11.6% yoy in 1H16 versus a 0.4% decline in Kazakhstan.

Despite our forecasts of Kazakhstan GDP declining by 1% and inflation increasing 14% in 2016, we expect the company's financial profile to remain strong with an average EBITDA margin of about 23% over 2016-2019, which will support CAEPCO's ratings. This is based on our assumptions of approved tariff  growth for the distribution segment, and 0% tariff growth for the generation  segment for 2016-2018.

RATING SENSITIVITIES

- Negative: Future developments that could lead to negative rating action include:

- Sustained slowdown of the Kazakh economy, further tenge devaluation, increase in coal prices that is substantially above inflation or tariffs  materially lower than our forecasts, leading to FFO-adjusted gross leverage  persistently higher than 4x and FFO interest coverage below 3.5x.

- Committing to capex without sufficient available funding, and worsening  overall liquidity.

Positive: Future developments that could lead to an upgrade include:

- A stronger financial profile than forecast by Fitch supporting FFO adjusted gross leverage below 3x and FFO interest coverage above 4.5x on a sustained basis.