OREANDA-NEWS. Fitch Ratings has affirmed Namibia Power Corporation (Pty) Ltd's (NamPower) Long-Term foreign currency Issuer Default Rating (IDR) at 'BBB-' and Short-Term IDR at 'F3'. Fitch has also affirmed NamPower's National Long-Term rating at 'AA-(zaf)' and its Short-Term rating at 'F1+(zaf)'. The Outlooks on the Long-term ratings are Stable.

The affirmation reflects the alignment of NamPower's ratings with those of the Namibian sovereign (BBB-/Stable). Under Fitch's parent and subsidiary rating linkage methodology, NamPower has strong legal, operational and strategic links with the state of Namibia, including direct government guarantees for part of NamPower's debt. In Fitch's view, the ties between NamPower and its sole shareholder are likely to remain strong in the foreseeable future. NamPower is the monopoly electricity company in Namibia and has a crucial role in executing electrification policies and ensuring sufficient electricity supply.

This includes the Kudu Gas-to-Power Project (KuduPower), for which the Minister of Finance announced the support package in the Medium-term Expenditure Framework for the next three years. The total government support package of NAD4.93bn (USD0.4bn) will be used to support the balance sheets of Nampower and National Petroleum Corporation of Namibia.

KEY RATING DRIVERS
Strong Government Support
Given the track record of tangible state support and the government's involvement in NamPower's investment decisions, Fitch expects this relationship will remain unchanged in the medium term. NamPower has previously benefited from state financial support in the form of a NAD360m (USD30m) energy subsidy in 2008. Fitch expects future energy subsidies to pay for the fuel used in generation before KuduPower comes into operation. The state also guaranteed 19% of NamPower's debt as at financial year end 2014 (FYE14) and we expect the zero dividend policy to be maintained.

Delays in KuduPower
Fitch expects a delay of 12-18 months before the KuduPower station will start generating power. The project has suffered a set-back as Tullow Oil Plc withdrew its participation in the project, which resulted in a delay of the final investment decision to mid-2015.

Electricity Imports to Weight on the Business
With KuduPower currently expected to be commissioned between end-2019 and mid-2020, NamPower will continue to import an increasing amount of electricity to satisfy domestic demand. Fitch expects NamPower's operating margin to decrease due to the relatively expensive imports compared with its own hydro power. Although the tariff regulation allows for cost pass through, electricity imports will likely dilute the profit margin.

Fitch expects near-term material weakening of NamPower's credit ratios due to the margin reduction and increased investments with a recovery expected after the KuduPower commissioning. As a result, we believe NamPower will likely face pressure on some of its loan covenants with Development Financial Institutions (DFIs). However, we expect that the DFIs will likely take a longer-term view and allow medium-term relaxation of covenants.

Security of Supply
At FYE14 NamPower imported 66% of the total energy it supplied. Given the growth of the Namibian economy and step load from the extractive industries, demand will outstrip supply. NamPower is largely dependent on energy imports. However, given the energy and capacity deficiencies in neighbouring countries, the utility cannot continue to rely on imported energy to meet domestic demand.

Peak demand increased to 629 megawatt (MW) at FYE14 (FYE13: 614MW). NamPower's total installed generation capacity is 501 MW, of which Ruacana is 346MW dependent on seasonality and rainfall. In 2015 NamPower faces the termination of longstanding power purchase agreements with Zimbabwe and Mozambique for 240MW. Fitch believes the supply will remain under severe pressure in FY16.

As a result, NamPower will further invest minority equity of up to 30% into a scalable private-public partnership project to provide up to 250MW of gas-fired modular capacity to balance the domestic market demand and strategically support the security of supply. Fitch expects this project to play a critical role in meeting demand before KuduPower starts generating electricity.

Kudu Power Project Funding
NamPower is expected to be the controlling partner for the KuduPower combined cycle gas turbine project, with estimated total costs NAD14.9bn (USD1.2bn), including financing costs and with 75/25 debt to equity ratio. The project is strategic for both the country and NamPower. However, the size is beyond the company's financial capacity. As such, the government will provide a significant contribution, including equity contribution of NAD3.7bn (USD0.3bn), guarantee undertakings, limiting financial and commercial risks for NamPower.

Copperbelt Energy Corporation (CEC) has signed a joint development agreement and will hold a stake of approximately 30% in the KuduPower special purpose vehicle (SPV). NamPower will on-sell 300MW to CEC denominated in US dollars. Further equity of 19% will be sourced from another strategic investor.

Power Purchase Agreement (PPA)
All the power produced by KuduPower will be sold to NamPower through a long-term PPA. This is expected to create a secure revenue stream sufficient to support all KuduPower's costs including; debt servicing, operational commitments and investor returns. NamPower's 100% obligation under the PPA will be guaranteed by the government. NamPower will sell about half of the power on the domestic market under the existing cost pass through regulation with the remainder exported under long-term power export agreements (PXA) to CEC and potentially Eskom Holding SOC Ltd (local currency Long-term IDR BBB+/Negative).

The majority of commercial risks (price, volume and FX) are thus expected to be pass-through for NamPower. Similarly power delivery obligation under the PXAs will mirror the project's ability to deliver power to the system, with the key risk for NamPower relating to its ability to upgrade its transmission capacity and maintain its availability. Counterparty risk under the PXA should be mitigated by CEC's equity contribution.

Operational Performance
NamPower's performance has exceeded Fitch's expectations, with the higher than expected operating EBITDA of NAD1,308m resulting from lower energy costs. The energy generated by Rucana increased by 17.2% in FYE14, as the Cunene River flows were better regulated from the Grove and Matala dams within Angola. The recent improvement of the runner replacement and turbine refurbishment at Rucana has also improved efficiency.

The local generation capacity reduced the reliance on imported energy which reduced to 66% (FYE13: 69%). The total cost of electricity increased in FYE14 by 30% which reduced EBITDA margin to 26% (FYE13:31%). Revenue increase by 20% (FYE13: 29%) mainly as a result of the tariff increase of 13% on 1 July 2014.

Fitch expects EBITDA margins to continue the declining trend they have been on since 2011. This is because the utility faces the termination of longstanding PPAs for imported electricity at preferential rates.

LIQUIDITY & DEBT STRUCTURE
Adequate Liquidity
NamPower had a NAD1.6bn cash buffer as of FYE14 supported by a liquid investment portfolio of NAD3.1bn (59% money market and 41% fixed deposit) as of FYE14 (FYE13: NAD2.9bn). This can be accessed at short notice to bolster its liquidity position and investment needs. This compares with NAD231m of short-term debt and Fitch's expectation of negative free cash flow of around NAD110m for 2015.

KEY ASSUMPTIONS
NamPower's minimum 51% equity component for KuduPower is estimated at USD153m. Considering the proposed funding structure, including project-level debt with limited recourse to NamPower, Fitch will focus on NamPower's credit metrics on an unconsolidated basis, initially reflecting NamPower's equity contribution to KuduPower. The final investment decision for KuduPower is expected mid-2015.

Fitch expects future energy subsidies of NAD900m to pay for the fuel used in generation before KuduPower comes into operation.

Tariff increases of 16% expected for 1 July 2015, thereafter an average of 13% per annum is expected in the rating case.

We assume NamPower will raise NAD3.5bn under the existing DMTN programme (Limit NAD5bn, Utilisation NAD750m) between 2015 and 2018.

In the rating case we expect the Namibian government to provide an equity contribution of NAD1.9bn (from the NAD3.7bn committed) between 2015 and 2018.

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating actions include:
A positive action on Namibia's sovereign rating would result in positive rating action on NamPower, providing that the strength of the parent-subsidiary linkage does not weaken.

Negative: Future developments that could lead to negative rating actions include:
- A decline in government support or negative rating action on Namibia's sovereign rating would likely result in negative rating action on NamPower.
- Long-term operating cash flow falling below Fitch's expectations or a final investment decision on Kudu project in the absence of additional government support for both the project and NamPower.