Fitch Affirms Kazakhstan Engineering at 'BBB-'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed JSC National Company Kazakhstan Engineering's (KE) Long-term foreign currency and local currency Issuer Default Ratings (IDRs) at 'BBB-' and 'BBB', respectively, with Stable Outlooks.
Fitch has also affirmed the foreign and local currency senior unsecured ratings at 'BBB-' and 'BBB' respectively and the Short-term foreign currency IDR at 'F3'. A full list of ratings is available at the end of this commentary.
KE's ratings are based on Fitch's Parent Subsidiary Linkage methodology and are notched down two notches from the rating of its ultimate 100% shareholder, the Republic of Kazakhstan (BBB+/A-/Stable). Therefore, any perceived or real weakening of state support - in particular a delay in or smaller expected capital injections from the state - could have a negative effect on the ratings.
KEY RATING DRIVERS
Fitch deems KE's linkage with its parent as moderate to strong due to the state's control, strategic importance of the company to the government's ambition to expand the country's industrial base and diversify the national economy as well as the tangible financial support that has been demonstrated and pledged by the state.
The two-notch differential reflects the lack of debt guarantees provided by the state and the slightly lower priority KE would likely receive compared with key natural resources, utilities or infrastructure companies, whose ratings are notched down once from the sovereign.
Standalone 'B' Category Rating
Fitch believes that on a standalone basis, KE's rating would likely be at the middle to high end of the 'B' category, reflecting its weak business profile, negative free cash flow (FCF), moderately high leverage and adequate liquidity.
Limited Business Profile
KE's business profile is characterised by the company's small size, limited product range, lack of long-term high-tech development achievement and little customer diversification, all of which cap the company's standalone rating in the 'B' category. Nevertheless, we acknowledge the growth that the group is likely to experience in the coming years as the Kazakhstan government makes KE the focal point of the nation's industrialisation and export drive. This, together with the technological know-how KE is acquiring from various joint venture partners, should help visibly improve the business profile over the medium to long term.
Weak Financial Profile
KE's financial profile is weak and indicative of a high 'B'' category manufacturing company. It is characterised by high leverage (7.7x at end-1H15), negative FCF generation, adequate and growing underlying profitability, volatile working-capital flows and heavy investment needs. Given the expansion projected in the short- to medium-term, the capex requirements of the company are unlikely to be met from internally generated cash and may rely on external funding.
For 2015, Fitch expects the funds from operation (FFO) margin to be around low double digits while FFO adjusted gross and net leverage are expected to be around 8x and 2x, respectively. The company's KZT10bn bonds maturing in December 2015 are expected to be repaid with cash reserves, while its USD200m bond which matures in 4Q16 is expected to be partly refinanced.
The company had around KZT35bn of Fitch-adjusted cash at end-1H15, which was more than sufficient to cover the repayment of the KZT10bn bond and short-term lease maturities. Nevertheless, the USD200m bond maturity in December 2016 as well as the group's investment needs leading to neutral to slightly negative FCF in the short- to medium-term, mean that KE will likely need external funding over the coming 12 months. To this end, KE may be reliant on the equity injections pledged by the government, which Fitch assumes will be forthcoming under its rating approach and without which, the company's liquidity position will deteriorate materially.
The Stable Outlook on the Long-term IDR reflects that on the Republic of Kazakhstan.
Fitch's key assumptions within the rating case for KE include:
-Continuation of state support through funding and order placement;
-Slight revenue growth in 2015, followed by double-digit expansion in the subsequent years as the group ramps up production;
-Earnings margins to remain flat;
-Working capital inflows in 2015 as a consequence of advance payments from the local Ministry of Defence; followed by outflows in later years relating to the general growth in business;
-No new debt (debt levels peaked in 2014) with the 2015 bond maturity to be repaid out of cash reserves
Future developments that could lead to positive or negative rating actions include:
- Change to the sovereign's ratings, which could prompt a review of the company's IDRs, National Ratings and Outlook.
-Strengthening of support, such as a provision of written guarantees of KE's debt from the Kazakhstan Ministry of Finance, which would likely lead to closer rating linkage. A weakening of support, such as a reduction in the state's shareholding in KE, waning commitment to and support of the company's projects or a change in the treatment by the state that KE receives relative to other state-owned companies, could lead to a widening of the rating gap between Kazakhstan and KE.
FULL LIST OF RATING ACTIONS
The rating actions are as follows:
Long-term local currency IDR affirmed at 'BBB'; Outlook Stable
Long-term foreign currency IDR affirmed at 'BBB-'; Outlook Stable
Local currency senior unsecured rating affirmed at 'BBB'
Foreign currency senior unsecured rating affirmed at 'BBB-'
Short-term foreign currency IDR affirmed at 'F3'
National Long-term rating affirmed at 'AA+(kaz)'; Outlook Stable
National senior unsecured rating affirmed at 'AA+(kaz)'
National Short-term rating affirmed at 'F1+(kaz)'
For the sovereign ratings of Kazakhstan, Fitch has the following rating sensitivities as of the rating action commentary dated 1 May 2015:
The following risk factors could, individually or collectively, trigger negative rating action:
- Policy mismanagement and/or a prolonged fall in oil prices leading to a decline in sovereign net foreign assets allied to reduced economic and financial stability
- Renewed weakness in the banking sector, which leads to contingent liabilities for the sovereign
- A political risk event
Conversely, the following factors could, individually or collectively, result in positive rating action:
- Moves to strengthen monetary and exchange rate policy
- An effective restructuring of banks' balance sheets
- Steps to reduce the vulnerability of the public finances to future oil price shocks, for example, by reducing the non-oil deficit, currently estimated at more than 9% of GDP
- Substantial improvements in governance and institutional strength