Fitch Affirms Industrial Development Corporation of South Africa at 'AA+(zaf)'; Stable Outlook
The rating affirmation reflects Fitch's expectations of unchanged links between IDC and its sole shareholder, the Republic of South Africa (BBB-/BBB/Stable). The latter's extensive control and oversight underpins our assumption that extraordinary support would be forthcoming if needed despite a lack of first-demand guarantee on all IDC's financial liabilities. Fitch views IDC as credit-linked to its sponsor, using a top-down approach under its public-sector entities outside the U. S rating criteria.
KEY RATING DRIVERS
IDC plays a key role in the national development strategy as it promotes industries and industrial undertakings in line with the government's policy objectives to create jobs and reduce income inequality in areas ranging from mining to manufacturing, infrastructure and services.
It provides long-term financing to companies operating in sectors viewed by the state as strategic for the development of the national economy, including mining, metals and chemicals, ultimately underpinning the strong strategic importance IDC has for the government, especially given IDC's counter-cyclical role in the current economic down-cycle. Operations are carried under extensive control from its sponsor ranging from board members appointment to asset allocations.
IDC's operating performance has come under pressure in the last two years since the domestic economy lost momentum, particularly due to challenging conditions of the cyclical and mature commodity and goods-producing segments suffering from weak demand and low prices.
IDC's profitability for the financial year to March 2016 fell sharply to ZAR177m from ZAR1.7bn of the previous year. The result was materially impacted by impairment charges of ZAR3.6bn, due to protracted weakness of equity investments and loans performance representing 17% of its total financing/investment base. Fitch's base case scenario expects that protracted weakness of the commodities-driven economy will further negatively impact returns from investments and the asset quality of the loan portfolio. This will result in growing provisions for impairments in the medium-term, adding pressure to the company's profitability.
Funding requirements from an expanding loan book and declining reserves from the lower market value of assets are set to add pressure to IDC's debt-to-equity ratio, which Fitch sees weakening towards the internal target of 60% over the medium-term from an estimated 50% in FY16 (or 36% at the mini-group level, which excludes ZAR11bn intercompany loans). This would still be below the maximum 100% imposed by the central government. IDC's liquidity profile at FYE16 was strong with ZAR6bn in cash and cash equivalents.
A recent announcement made by one of South Africa fund managers, Futuregrowth Asset Management, stated that it had decided to stop extending credit to some of South Africa's state-owned companies, including IDC. Futuregrowth is the single-largest lender accounting for one third of IDC's total ZAR6bn public bonds, but Fitch believes that IDC's available cash and funding alternatives will be sufficient to cope with Futuregrowth's departure in the medium term. We also assume adequate support from the government via the Economic Development Department will be in place in case of emergency funding, or via guarantees in favour of IDC.
Fitch sees moderate financial integration between IDC and its sponsor, based on (i) the lack of operational or capital subsidies from the central government in view of the traditionally self-supporting financial profile of IDC, (ii) the accounting of IDC's debt as contingent liability of the government, (iii) the regular dividend paid to its shareholder and (iv) the modest size of IDC's financial liabilities in respect to those of the central government
IDC is rated only on the South African national rating scale implying that a change in ratings would stem only from a change in its relative creditworthiness relative to the national government/best risk in South Africa.
A reduction of the South African government's ownership, oversight, and control over IDC or diminished strategic importance of the entity leading to a reduced probability of extraordinary support could prompt a negative rating action. Conversely, more formalised support by the central government through a first-demand guarantee on all IDC's financial liabilities or other formal support mechanisms conducive to stronger legal links with the sponsor could lead to positive rating action.