OREANDA-NEWS. Fitch Ratings has downgraded OJSC Moscow Integrated Power Company's (MIPC) Long-term foreign and local currency Issuer Default Ratings (IDR) to 'BB' from 'BB+' and removed them from Rating Watch Negative. The Outlook is Negative. A full list of ratings actions is at the end of this release.

The rating actions reflect a revision in Fitch's rating approach for MIPC driven by the ownership change following the City of Moscow's (BBB/Negative/F3) sale of its 89.98% stake in MIPC to OOO Gazprom Energoholding, a 100% subsidiary of OAO Gazprom (BBB/Negative). Fitch has revised its rating approach under its Parent and Subsidiary Rating Linkage methodology to bottom-up, which is based on the standalone rating of MIPC of 'BB-'/Negative and a one-notch uplift for the support of its major shareholder, Gazprom Energoholding. In the previous top-down approach, MIPC's ratings were notched down by two levels from those of the City of Moscow, its former majority shareholder.

KEY RATING DRIVERS
Rating Incorporates Implied Support
MIPC's 'BB' rating includes a one-notch uplift for parental support from its majority shareholder Gazprom Energoholding as Fitch considers the strategic and operational ties between MIPC and its parent company as strong, and legal ties as limited. Fitch regards the acquisition of MIPC's stake as strategic for Gazprom Energoholding. It fits in Gazprom's strategy of vertical integration and creation of the full value chain and their operational inter-dependence with regard to gas supplies/purchases. Fitch would expect timely financial support to be available if the need arises. This is based on evidence of support at two other Gazprom Energoholding subsidiaries, OGK-2, which received a capital injection of about RUB23bn through an additional share issue, and OJSC Mosenergo (BB+/Stable) through a payment terms extension for gas purchases from Gazprom during the financial and economic crisis.

Fitch notes that gas, which is used at all MIPC's generation facilities, is purchased from OAO Gazprom Mezhregiongas Moskva, owned by Gazprom, and that Mosenergo, majority-owned by Gazprom Energoholding, is the major supplier of heat energy to MIPC. Mosenergo supplies about 70% of its heat to MIPC's network.

Standalone Rating
MIPC's standalone rating of 'BB-' reflects its stable near-monopoly market position in heat and hot water sales in Moscow and Moscow region, negative free cash flow due to sizeable capex and a large cost base. Our analysis of its standalone financial profile includes subsidies provided by the City of Moscow. The rating also incorporates exposure to the fully regulated heating segment with uneconomic residential tariffs, volume risk inherent in the tariff mechanism, exposure to fuel prices as well as uncertainty of the regulatory framework changes in the medium term. The maximum heat tariff growth for the City of Moscow for 2014 was approved at 1.2%, starting from 1 July.

Negative Outlook
The Negative Outlook reflects our projections that the company's funds from operations (FFO) adjusted net leverage ratio may be above our rating guideline of 3x in 2015-2016 unless MIPC improves its free cash flow generation, for instance through cost optimisation or a reduction of its capex plan. We expect leverage to rise to above 3x in 2014 from about 2x in 2013, partly due to weaker FFO on the back of lower heat volumes driven by an exceptionally warm 1Q14. Failure to improve leverage to below 3x in 2015-2016, for instance if opex or capex optimisations are not implemented, could lead to a downgrade.

Supportive Subsidies Continue
MIPC has continued to receive large subsidies from the City of Moscow to cover the uneconomic residential utility tariff. The subsidies amounted to RUB16.1bn in 2012 and RUB14.9bn in 2013 compared with 2013 preliminary EBITDA of RUB18.1bn. The standalone rating is based on the assumption that the company will continue to receive subsidies for uneconomic tariffs from the City of Moscow at least in the medium term. However, Fitch expects that the subsidies will decrease as Moscow likely switches to a more targeted subsidisation of households by category. We assume that if subsidies decrease in the next few years, tariffs will be increased accordingly so that the company's profitability is not impaired due to changes in subsidies.

Cost-Optimisation Programme
Gazprom Energoholding plans to reduce operating costs of MIPC and realise synergies between MIPC and Mosenergo as some heat production assets of the two companies are located near each other. Fitch notes that there is substantial room for fixed costs optimisation, including workforce reductions, which could improve the company's financial profile.

Significant Capex Programme
Fitch assumes that MIPC total capex will be about RUB22bn annually over 2014-2016, to be spent mainly on the reconstruction and modernisation of the heat supply network and on equipment, rather than on capacity expansion. We expect this capex will result in negative free cash flow.

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating actions include:
- Strengthening ties between MIPC and Gazprom Energoholding and/or Gazprom, possibly manifested by more tangible support received by MIPC in form of equity injections and/or loan guarantees.
- Economic residential heat tariff and profitable operations would be positive for the standalone credit profile. However, Fitch does not expect this to happen in the medium term.
- Stronger financial profile than forecast by Fitch due to, among other things, optimisation of its core heating generation and distribution businesses and reduction of company's historically high fixed costs would be positive for the rating.

Negative: Future developments that could lead to negative rating action include:
- Weakening of the parental support may result in a removal of the one-notch uplift to MIPC's standalone rating.
- Significant deterioration of the credit metrics on a sustained basis (FFO adjusted net leverage above 3x and FFO interest cover below 5x).
- A reduction of subsidies from the City of Moscow, which is not accompanied by higher tariffs.

LIQUIDITY AND DEBT STRUCTURE
Manageable Liquidity
At end-2013 MIPC had RUB17bn of short-term debt compared with RUB2bn of cash in hand and RUB15bn of unused credit facilities. The short-term debt largely comprises loans from state-owned Sberbank, which are likely to be renewed or extended. In July 2013 MIPC redeemed its RUB6bn local bonds. In 2011-2012, MIPC rolled over its short-term bank loans and concluded long-term loan agreements with Sberbank that mature in 2014-2016. Fitch expects MIPC to roll over its short-term bank loans in 2014. We expect MIPC's free cash flow to remain negative in 2014-2016, and as a result it will need to obtain additional funding.

FULL LIST OF RATING ACTIONS
Long-term foreign currency IDR downgraded to 'BB' from 'BB+', removed from RWN, Outlook Negative
Long-term local currency IDR downgraded to 'BB' from 'BB+', removed from RWN, Outlook Negative
Long-term National Rating downgraded to 'AA-(rus)' from 'AA(rus)', removed from RWN, Outlook Negative
Short-term foreign currency IDR affirmed at 'B'
National Short-term Rating affirmed at 'F1+(rus)', removed from RWN.