OREANDA-NEWS. Fitch Ratings has affirmed Kazakhstan-based JSC Samruk-Energy's ratings, including its Long-term Foreign-Currency Issuer Default Rating (IDR) of 'BBB-', and foreign-currency senior unsecured rating of 'BB+'. The Outlooks on the long-term ratings are Stable. The full list of rating actions is provided at the end of this commentary.

The affirmation reflects strong strategic and operational ties with the Kazakh state and our expectation that the government would provide timely support to Samruk- Energy to meet and service its liabilities, if required. We expect the company's standalone credit profile to be under pressure from substantial capex, continued tenge depreciation and potentially adverse tariff developments.

KEY RATING DRIVERS

Top-Down Minus Two Notches

We apply a two-notch differential between the rating of Samruk-Energy and the state (BBB+/Stable). We continue to view the operational and strategic links between Samruk-Energy and ultimately the state as strong, which supports the application of the top-down rating approach. The strength of the ties is underpinned by the company's strategic importance to the Kazakh economy as the company controls about 38% of total installed electricity generation capacity and 36% of total coal output in the country. The strength of ties is also supported by the state's approval of the company's strategy and capex programme, and by tangible financial support in the form of equity injections, asset contributions, subordinated loans and subsidies.

The government demonstrated its support in November 2015. Wholly state-owned sovereign wealth fund Samruk-Kazyna (BBB+/Stable) reduced the interest rate on the KZT100bn loan it provides to Samruk-Energy from 9% to 1%. The loan will also be subordinated to all other unsecured obligations of Samruk-Energy. This measure will help the company meet the 5.0x debt/EBITDA covenant set in the EBRD agreement at the end-2015 test date. We understand that Samruk-Kazyna is also considering the possibility of converting the KZT100bn loan into equity in 2016 as a measure of extraordinary support.

Tenge Depreciation Negative for Credit Metrics

The tenge depreciation by around 85% since August 2015 has had a negative effect on the company's credit metrics, as around 40% of its debt is denominated in US dollars and euros, with almost all revenues generated in local currency. Samruk-Energy does not have any hedging mechanisms other than keeping a portion of its cash in dollars (72% at end-November 2015). The tenge is now floating and the company plans to reduce its exposure to FX risk by issuing tenge-denominated debt.

Tight Leverage Covenant

The company's debt/EBITDA covenant set in the loan agreement with the EBRD is tight due to Samruk-Energy's weak financials. The bank has reset the covenant from 4.5x to 5.0x for 2015, which Samruk-Energy expects to meet at end-2015. We expect covenant pressure to persist in the following years. This will be more reflective of the company's standalone mid 'B' category profile than of an investment-grade rating.

Potential Tariff Freeze

The introduction of the capacity market in Kazakhstan, initially planned for 2016, was postponed until 2019 to ease the pressure on industrial producers. This adds uncertainty to the 2016-2019 tariff regulation as capacity payments were meant to supplement wholesale electricity prices. A freeze of generation tariffs for Kazakhstan's northern zone is being considered by the authorities. This would affect Samruk-Energy's largest operating subsidiary Ekibastuz GRES-1 (BB+/Stable). Fitch expects the final tariff decisions and capex programme to be approved by end-2015 or early 2016.

The impact on Samruk-Energy's financial profile is unclear because the tariff freeze may lead to higher price competitiveness for producers and ultimately be compensated for by higher generation volumes. Fitch assumes 0% generation tariff growth for 2016-2018 and lower capex spending in 2018-2019.

Asset Privatisation

Samruk-Energy is privatising its nine subsidiaries. The company has so far sold its 50% stake in Zhambylskaya GRES for KZT2.4bn. Under the state privatisation programme, in 2016 the company should sell its power distribution assets (MEDNC and VK REK including supply company Shygysenergotrade), and a generation power plant (Aktobe CHP). It also plans to privatise one more distribution company, Alatau Zharyk Company, power supply company AlmatyEnergosbyt, Tegis Munay and the large Almaty generation plant in 2H16- 2017. The company expects to use privatisation proceeds for a Eurobond repayment in December 2017.

The rating impact of asset privatisation would depend on the sale prices achieved. Nine assets earmarked for privatisation contributed around 68% to revenue and 30% to EBITDA in 2014. They had a relatively low debt burden of KZT14bn. Samruk-Energy's profitability should improve after the disposals as it will retain its highly profitable hydro power plants and Ekibastuz GRES-1. The leverage impact will be neutral if the company achieves at least 50% of the expected price.

Ambitious Debt-Funded Capex

Samruk-Energy has a substantial capex programme of KZT266bn for 2015-2018. As a result, we expect its free cash flow to remain significantly negative for 2015-2018. However, if the tariffs for Samruk-Energy's generation subsidiaries are frozen for 2016-2018 the government may revise the company's capex programme downward.