OREANDA-NEWS. Fitch Ratings has revised Kazakhstan Electricity Grid Operating Company's (KEGOC) Outlook to Negative from Stable while affirming its Long-term Issuer Default Rating (IDR) at 'BBB+'. A full list of rating actions is available below.

The Outlook revision reflects our view of weakening support of KEGOC by its dominant, indirect shareholder - the Republic of Kazakhstan (BBB+/Stable), especially in light of a decline in the share of state-guaranteed debt and higher (100%) dividend payout policy following its partial IPO. Fitch expects KEGOC to rely on new unguaranteed borrowings to finance its ambitious capex programme. We are likely to downgrade KEGOC by one notch as the guaranteed debt falls below 40% of total (42% at end-2014).

KEGOC's rating continues to reflect overall strong links with the government and we expect timely support in case of need, including should financial covenants need to be waived or renegotiated.

KEY RATING DRIVERS

Capex-Driven Negative FCF Expected
KEGOC plans to execute a substantial government-approved capex programme of KZT157bn for 2015-2018. As a result, we expect the company's free cash flow (FCF) to remain significantly negative for 2015-2018 (KZT15bn annually).

KEGOC expects to finance the extensive capex with the issuance of new debt. Capex will be spent primarily on high-voltage lines connecting energy-rich regions with other regions of the country (North-South High Voltage Lines) and on modernisation projects to upgrade the national electricity grid and electric power facilities.

Tenge Devaluation Pressures Credit Metrics
The recent tenge devaluation by around 50% had a negative effect on the credit metrics of the company, as all of the debt is denominated in USD (62% at end-2014) and EUR (38%) with only a marginal part of the revenue denominated in USD (related to transnational electricity flow). KEGOC does not have any hedging mechanisms other than keeping a portion of its cash in USD (74%). Tenge is now floating and the company plans to reduce its vulnerability to FX fluctuations by issuing tenge-denominated debt. We expect the FX exposure to remain significant.

Potential Covenant Breach
As a result of the tenge devaluation in 2015 and high capex plans for 2015-2018, we expect the company to breach its leverage covenant set forth by its lenders, EBRD and IBRD. The covenants are currently set at net debt/EBITDA below 4.0x and EBITDA/interest expense not lower than 3.0x. The covenants were waived and revised following previous tenge devaluations. Failure to obtain a waiver or revise the covenant may lead to a multi-notch downgrade of ratings.

Deteriorating Standalone Profile
We view KEGOC's standalone profile as commensurate with a low 'BB' rating category, significantly below the government-supported IDR. The main constraints on its credit profile are its operating and regulatory environment with exposure to FX and interest rate risks as well as its fairly high leverage.

Taking into account the tenge devaluation, capex plans, 100% dividends and approved tariff increases, we forecast KEGOC's funds from operations (FFO) adjusted gross leverage in 2015 to deteriorate to around 5.7x (3.8x in 2014) and to remain at around 5x over 2016-2018, and its FFO fixed charge cover to deteriorate to below 5x by 2017 (7.8x in 2014).

Weakening Legal Links Expected
Strong legal ties are underpinned primarily by debt guarantees provided by the state, which at end-2014 covered 42% of total debt. At end-2014 10% - 1 share of KEGOC was sold during the People's IPO to the people of Kazakhstan and the National Pension Fund. Proceeds from the IPO in the amount of KZT13bn were used for KEGOC's capex programme.

Fitch expects that S-K will maintain a majority stake in KEGOC and that the current government guarantees for part of KEGOC's debt will remain in place. However, as the guaranteed debt gradually amortises and the company raises new debt without guarantees, we expect that it will fall below 40%. This, together with higher dividends after the IPO, signal weakening links with the government and we expect to notch down KEGOC by one level from the sovereign rating. The continued linkage also reflects ongoing strategic importance of the monopoly transmission network to the country.

Post-IPO Favourable Tariffs
The Committee on Regulation of Natural Monopolies and Protection of Competition of the Ministry of National Economy of the Republic of Kazakhstan has substantially increased tariffs for KEGOC following its 'People's IPO' to improve the company's economic standing. The tariffs for transmission, dispatching and balancing have been increased by an average of 31% from November-2014. The regulator has also approved maximum tariffs until 2020, which envisions an increase of 7%-14% on average for transmission, dispatching and balancing. In our view long-term tariffs provide necessary clarity, but may not lead to improved margins and may need revising following the tenge devaluation.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Tariff growth 2% below the long-term approved tariffs
- Volumes growth below 1% on average over 2015-2018
- KZT157bn total capex in 2015-2018
- 100% dividend pay-out ratio
- Interest rate for the new borrowings at 9%

RATING SENSITIVITIES
Positive: As the Outlook is Negative we currently do not anticipate an upgrade. However, future developments that could nonetheless lead to positive rating actions include:
-A positive change to Kazakhstan's ratings, provided the links between KEGOC and the sovereign do not weaken
-Strengthening of legal ties (e.g. state guarantees for a larger portion of the company's debt and/)
-Enhancement of the business or financial profile, possibly as a result of stronger regulation and higher equity funding, which would be positive for the unguaranteed debt profile of KEGOC and its standalone rating

Negative: future developments that may, individually or collectively, lead to a negative rating action include:
-A negative change to the Kazakhstan's ratings
-Evidence of weakening state support, due to, for example, the proportion of state-guaranteed debt falling below 40% of total debt on a sustained basis

For the sovereign rating of Kazakhstan, KEGOC's ultimate parent, Fitch outlined the following sensitivities in its rating action commentary of 30 October 2015:

The following risk factors individually, or collectively, could trigger negative rating action:
- Policy mismanagement and/or prolonged low oil prices leading to a weakening in the sovereign external balance sheet.
- Renewed weakness in the banking sector, which leads to contingent liabilities for the sovereign.
- A political risk event.
The following factors, individually or collectively, could result in positive rating action:
- Moves to strengthen monetary and exchange rate policy.
- 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.

LIQUIDITY AND DEBT STRUCTURE
Fitch views KEGOC's liquidity as adequate based on the company's balanced debt maturity profile - annual scheduled maturities totalled KZT14bn as of end-2014. The company had cash and cash equivalents of KZT44.4bn at 1H15, which are mainly kept in local banks, which is a risk given the fragile state of the domestic economy. The company does not have an extensive hedging policy, but retains 79% of cash and deposits in foreign currencies (mainly in USD and EUR).

FULL LIST OF RATING ACTIONS
Long-term foreign currency IDR affirmed at 'BBB+'; Outlook revised to Negative from Stable
Long-term local currency IDR affirmed at 'A-'; Outlook revised to Negative from Stable
Short-term foreign currency IDR affirmed at 'F2'