Fitch Affirms NamWater at 'BBB-'; Outlook Negative
The affirmation is supported by our view of the company's standalone credit profile as the national monopoly bulk water supplier in Namibia (BBB-/Negative), with a cost pass-through tariff framework and strong financial profile. Although we expect capex to lead to negative free cash flow (FCF) and increased leverage in the financial year ending March 2017, the forecast metrics will remain commensurate with the ratings. The Outlook on NamWater's ratings is constrained by the Outlook on Namibia's ratings.
KEY RATING DRIVERS
Delays in Tariff Implementation
In FY16 NamWater recorded an EBITDA of NAD249m (USD18m). The figure would have been NAD40m higher if the tariff increase was implemented at the start of the company's financial year rather than September 2015. Over the past five years, total revenue lost due to late tariff increases amounted to NAD154m. For FY17 tariffs were increased 10% on 1 May 2016, after a one-month delay, which is an improvement from the past two financial years.
Fitch believes a multi-year tariff adjustment will help alleviate the delays and in addition provide more visibility of revenues while improving transparency. NamWater plans to implement multi-year tariffs from April 2017 but this timescale is unlikely in our view given that both the Ministry of Finance and the Ministry of Agriculture, Water and Forestry (MAWF) are yet to agree on the process and policy. Instead Fitch believes the multi-year tariff could start by April 2018. We believe the track record for the tariff framework is still at a nascent stage and is exposed to political interference given the lack of an independent regulator.
Failure to Generate Adequate Reserves
NamWater operates on a full cost recovery basis as guided by the NamWater Act. The utility did not generate adequate reserves to refurbish and or replace its major infrastructure as tariffs charged based on the book value of assets were lower than the replacement value.
Fitch views NamWater's asset revaluation and call for recapitalisation as positive steps in trying to raise sufficient funds to address the infrastructure backlog. Ultimately, infrastructure funding, which cannot be funded by NamWater through increased tariffs, is expected to be funded through government capital contributions or the projects will be deferred. The government provides funding for projects that are not economically viable through capital contribution, and some commercial customers also contribute to capex in full in return for additional capacity needed by the customers themselves.
Credit Metrics Likely to Weaken
Fitch-adjusted capex (infrastructure master plan) for NamWater over the next four years is estimated at NAD3.4bn. The government - and customer-funded portion of the capex is about 50%, which is uncommitted and subject to confirmation of funding from both sources before the final investment decision. If the funding is not made available, capex will then be reduced or deferred accordingly, limiting the increase in leverage for the utility.
The Namibian government and the customers are each expected to fund about 25% of NamWater's total capex over the next four years. The remainder will be funded by NamWater from funds from operations (FFO), drawdown of short-term investments and issuance of bonds under its NAD1bn medium-term note programme (MTNP, of which NAD800m was available at FYE16). Fitch forecasts FFO-adjusted net leverage to increase to around 1.2x by FYE18 from 0.4x in FYE16.
Strong Shareholder Links
We view the utility's strategic and operational ties with the parent as strong, reflecting the objective of the utility to develop and manage Namibia's water resources on a sustainable basis. Support provided by the government is evident in a zero dividend policy, procurement of raw water from MAWF at zero cost and direct grants from MAWF for certain non-viable NamWater infrastructure projects.
Further, the NamWater Board of Directors are appointed by MAWF. The government's ownership of NamWater is entrenched through MAWF's approval of the utility's infrastructure master plan. In the absence of an independent regulator, MAWF regulates the tariff-setting for NamWater on the principle of full cost recovery basis. The MAWF also has a five-year performance contract with the NamWater Board of Directors where specific deliverables are highlighted. Fitch assumes that further tangible support would be provided, if needed.
However, the legal ties between the company and the government are deemed by Fitch as moderate, due to the lack of government guarantees of NamWater's debt and overall we view the links as supporting the company's ratings at one notch below the sovereign ratings. As a result, the IDRs are driven by the standalone profile of NamWater, which is stronger than the sovereign's, but are constrained by the sovereign's ratings as Fitch does not normally rate state-owned companies above the sovereign's.
As of 31 March 2016, NamWater held aggregate liquidity of NAD128m, comprising NAD111m of cash and cash equivalents and NAD17m of committed, undrawn bank facilities (expiring February 2017). This compares with short-term debt maturities of NAD8m. In addition, NamWater had short-term investments in securities, which could be accessed at short notice to support its liquidity.
-Stable volume growth in water sales for (treated & untreated) to continue at approximately 1% for 2017. More than 50% growth in desalinated water primarily driven by Husab uranium mine. More than 15% reduction in irrigation water primarily linked to drought conditions
-Annual high single-digit tariff increases per annum for 2018-2020
-Some pressure on EBITDA margins in FY17, mainly attributed to a 16.71% increase in electricity tariff
-Fitch-adjusted capex for 2017-2020 at NAD3.4bn. In the rating case, we have only assumed that NAD1.7bn will be funded from internally generated funds, monetisation of short-term investments and debt. The remainder will be funded by MAWF and customer contributions.
-No dividends declared in our rating case.
-Negative FCF from 2017 onwards as the utility implements its capex master plan
Positive: Future developments that could lead to positive rating action include:
- The revision of the Outlook on Namibia sovereign rating to Stable would be replicated in NamWater.
- The rating impact of any improvement in the standalone profile (such as independently set long term tariffs) would be limited by the sovereign ratings.
Negative: Future developments that could lead to negative rating action include:
- A downgrade of Namibia's sovereign ratings
- A change in tariff approvals not allowing full cost pass-through, weaker cash collection rates or an increased capex funding on the balance sheet leading to weaker credit metrics such as FFO adjusted net leverage above 2.0x on a sustained basis would be negative for the standalone profile of NamWater.
RATING SENSITIVITIES FOR THE NAMIBIAN SOVEREIGN
Future developments that could result in a downgrade include:
- A failure to narrow the fiscal deficit leading to continued rise in the government debt/GDP ratio.
- Failure to narrow the current account deficit or significant drawdown in international reserves.
- Deterioration in economic growth, for example, due to a worsening of the business environment.
Future developments that could result in the Outlook being revised to Stable include:
- A narrowing of the budget deficit consistent with a stabilisation of the government debt/GDP ratio.
-A marked improvement in the current account balance and increase in foreign exchange reserves.
LIST OF RATING ACTIONS;
Long-Term Foreign and Local Currency IDRs affirmed at 'BBB-'; Outlook Negative
Short-Term Foreign and Local Currency IDRs: affirmed at 'F3'
National Long-Term Rating affirmed at 'AA+(zaf)'; Outlook Negative
National Short-Term Rating affirmed at 'F1+(zaf)'
Long-term senior unsecured rating: affirmed at 'BBB-'
National senior unsecured rating affirmed at 'AA+(zaf)'