OREANDA-NEWS. Fitch Ratings has assigned Kazakhstan-based electricity and heat generator and distributor Joint Stock Company Pavlodarenergo (Pavlodarenergo) a Long-Term Foreign Currency Issuer Default Rating (IDR) of 'B+' with Stable Outlook. A full list of ratings actions is available at the end of this commentary. 
The ratings of Pavlodarenergo are aligned with those of its sole shareholder, Joint Stock Company Central-Asian Electric-Power Corporation (CAEPCo, B+/Stable; see 'Fitch Downgrades CAEPCo to 'B+'; Outlook Stable'), reflecting its position as the largest operating subsidiary of CAEPCo, with 55% of group EBITDA.

The ratings also reflect Pavlodarenergo's vertical integration, stable regional market share, and a benign regulatory regime in the distribution segment. However, the ratings are constrained by an unfavourable tariff environment in the generation segment, and a significant capex programme, which Fitch expects to be partially debt-funded.

We assess CAEPCo, Pavlodarenergo and another 100% subsidiary, Sevkazenergo, on a consolidated basis, since there is no ring-fencing, treasury is centrally managed and debt is located at both holdco and opco levels.

The Kazakhstan tenge devaluation of more than 90% in 2015 weakened Pavlodarenergo's credit profiles due to a currency mismatch between the company's debt and revenues and the absence of hedging to reduce foreign exchange risk exposure. As a result the company's funds from operations (FFO) adjusted gross leverage increased to 2.9x at end-2015 from 2.0x at end- 2014, and  FFO interest coverage weakened to 7.1x from 9.6x during the same period.

At end-2015, 60% of company's outstanding debt was denominated in US dollar,  versus all local currency-denominated revenue. We expect the pressure to  continue, even with no further tenge devaluation. At end-2015, Pavlodarenergo  had 48% of cash and deposits in US dollars.

As a result of the tenge devaluation Pavlodarenergo breached its assets/liabilities  ratio covenant as per its loan agreements with EBRD in 2015, for which the company received a waiver. We expect Pavlodarenergo to breach this covenant in  2016 even with no further tenge depreciation. Failure to obtain a waiver or revise  the covenant may lead to a rating downgrade. EBRD indirectly owns 22.6% of  Pavlodarenergo.


Capex is expected to remain significant despite the completion of the so-called  mandatory investment programme, which the company agreed with the  government in 2009-2015 when tariff caps were in place. Fitch expects  Pavlodarenergo to generate solid cash flow from operations (CFO) of KZT11.5bn  on average over 2016-2019, although FCF is likely to remain negative at an average KZT1bn per year over the same period.

The negative FCF will be mainly driven by the company's significant investment programme of KZT10.4bn on average annually for 2016-2019 as well as dividend payments of about 50% of net profit over the medium term. We have assumed lower capex due to our lower-than-management forecast revenue to reflect that most of the investment is discretionary in nature. Fitch expects Pavlodarenergoto rely on new borrowings to finance cash shortfalls.

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

- Electricity volume growth in line with Fitch GDP forecasts of 2% p.a. over  2017-2019

- Tariffs growth as approved by the government for distribution at 8% CAGR over 2016-2020 and 0% for generation for 2016-2018.

- Capex in line with the company's adjusted capex/revenue ratio

- Inflation-driven cost increase

- No further tenge depreciation

- Dividend payments of 50% of IFRS net income over 2017-2019.

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

- A negative rating action on CAEPCo as Pavlodarenergo's ratings are aligned with the parent's IDR

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

- A positive rating action on CAEPCo

The sensitivities may change if the links with CAEPCo weaken. For the rating of  CAEPCo, Pavlodarenergo's ultimate parent, Fitch outlined the following  sensitivities in its rating action commentary of 27 July 2016:

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.