Fitch Downgrades Saudi Electricity Company to 'A+' on Sovereign Downgrade
OREANDA-NEWS. Fitch Ratings has downgraded Saudi Electricity Company's (SEC) Long-term Issuer Default Rating (IDR) and senior unsecured rating to 'A+' from 'AA-'. The Outlook on the Long-term IDR is Negative.
Fitch has also downgraded SEC's outstanding Sukuk issues, including issues under Saudi Electricity Global Sukuk Company, Saudi Electricity Global Sukuk Company 2, and Saudi Electricity Global Sukuk Company 3, to 'A+' from 'AA-'.
The downgrade of the ratings follows the recent downgrade of the Kingdom of Saudi Arabia (KSA; AA-/Negative; see "Fitch Downgrades Saudi Arabia to AA-; Outlook Remains Negative" dated 12 April 2016 on www.fitchratings.com) and reflects Fitch's top-down rating approach with a one-notch differential between the company and the sovereign ratings to reflect their continued strong links.
KEY RATING DRIVERS
Sovereign Support Critical
Fitch views SEC's operational and strategic links with KSA as strong, while the legal links are moderate in the absence of an explicit sovereign guarantee for the majority of SEC's debt, in accordance with Fitch's Parent and Subsidiary Rating Linkage methodology. We thus notch down SEC's ratings by one level from KSA's ratings. The Negative Outlook mirrors that on KSA's rating.
KSA directly owns 74% of SEC (and indirectly owns another 7% through Saudi Aramco, a state-owned enterprise). Fitch assesses SEC against the broader global electric utility peer group, where it is currently among the highest-rated entities; the residual risks and opportunities inherent in the sector; and the scale of the current investment programme, which will weigh on SEC's balance sheet over the next four years.
Historically, state financial support has been strong, which we assume will continue. At end-2015 SEC had SAR48bn (USD12.8bn) available under the total SAR130bn (USD35bn) of soft loans provided by KSA, which are interest-free. SEC is drawing down the soft loans of SAR51bn (USD14bn) announced in June 2011 and SAR49.4bn (USD13bn) announced in March 2014 by the KSA to partially finance its capital projects.
Since its inception in 1999, SEC has not paid for fuel provided by Saudi Aramco. SEC transferred a total of SAR57bn in 2007, 2011 and 2013 of Saudi Aramco payables to the Ministry of Finance, converting them into long-term government payables. At 31 December 2015 (FYE15) this amounted to SAR100bn (FYE14: SAR92bn). All of the long-term payables are direct to Ministry of Finance, which Fitch excludes from its debt calculations. The KSA has waived all dividend payments from SEC since inception, with the last 10-year waiver running through till 2019. The KSA appoints five of SEC's nine board members, including the Chairman.
The utility regulator, Electricity and Cogeneration Regulatory Authority (ECRA), has licensed SEC to generate, transmit, and distribute electricity in its designated service territory.
SEC is currently undertaking a study as part of the government's initiative to derive greater efficiencies in the electricity sector, which subject to the approval of stakeholders may see SEC's business units being reorganised and its corporate structure evolve. As part of this study, SEC will create four generation companies and offer equity to external partners, while retaining a majority stake in each of the four companies and maintaining control of the board at the generation company (GenCo) level. SEC will also have a centralised treasury (cash and borrowing) at the HoldCo level, thereby limiting the risk of structural subordination. Despite the intended efficiency gains, this may also pose some risks to SEC, in Fitch's view, for example, if we believe that the links with the sovereign will be weaker as a result.
Subsidised Electricity Tariff
Lower oil prices have placed pressure on public finances and accelerated SEC in attaining a commercial cost-reflective tariff. This has led to the government increasing electricity tariffs for the first time since 2010. Fitch has not factored in any additional tariff increases in its rating case post the recent tariff increase.
The Council of Ministers, responsible for setting electricity tariffs, has authorised ECRA to set electricity tariffs for commercial, government, and industrial customers. The tariff charged to residential consumers is solely determined by the Council of Ministers, as it remains heavily subsidised. With the recent tariff increase, 87% of residential customers using below 4,000 Kwh (kilowatt hour) have not been affected.
Commitment to Growth
SEC is instrumental in meeting the country's growing electricity demand and implementing the state policy of providing subsidised electricity within Saudi Arabia, along with developing a robust, reliable, and stable electricity infrastructure. SEC's current capital spending plan of about SAR185bn (USD49bn) over the next four years (2016-2019) includes investment in electricity generation capacity, transmission infrastructure, and distribution assets.
Stable Standalone Credit Metrics
Fitch-calculated leverage, as measured by funds from operations (FFO) adjusted net leverage, is expected to remain at around 3x in 2016 and at end-2017. This leverage level is lower than expected due to higher tariffs (and despite higher nominal fuel cost). The leverage ratio takes into account the soft loans from KSA. Fitch assumes that the company will supplement cash from operations with debt and government soft loans to fund its capital programme and it will continue to defer fuel costs payable to Saudi Aramco. Higher tariffs may reduce the required capacity build-up. Nonetheless, SEC's standalone credit profile is significantly lower than the current state support-driven rating.
Integrated Business Profile
SEC is a monopolistic, vertically integrated utility in KSA. The company remains dominant in KSA's electricity generation sector even with the emergence of independent power producers (IPPs), holding 73% (78.5%: 2014) of KSA's total generation capacity at FYE15. SEC retains between 20% and 50% equity in four IPPs, sources their fuel and purchases all electricity produced.
At end-December 2015, SEC had approximately SAR24bn in total liquidity, including SAR2bn in cash, SAR6.3bn available committed facilities (of which SAR5.3bn were signed in January 2016) and the remainder comprising committed government soft loans disbursements for financial year 2016. This compares with around SAR2.3bn of maturities due in 2016, and our expectations of significantly negative free cash flow (FCF) for 2016.
- Revenue growth of 23% in FY16 and between 4% to 5% pa from 2017 to 2019. This growth is a combination of an average tariff increase of 21% in FY16 and population growth. In FY15 SEC added 521,000 (6.5%) customers to its network.
- Stable EBITDA margins of about 37%.
- Significant negative FCF due to SEC's plans to invest around SAR185bn over 2016-2019 to meet growing electricity demand (average SAR46bn per year).
- Negative FCF to be funded with a combination of debt, committed government soft loans and additional government funding of SAR25bn to be provided in 2016-2019. Further tariff increases could limit additional government funding.
- Approximately SAR10bn of new financing between 2016 and 2019, to be used to settle the 2017 Sukuk maturity.
- Non-payment for the fuel procured from Saudi Aramco for the foreseeable future or until regulatory environment changes to total cost recovery principle.
- Long-term government payables excluded from debt.
- No negative credit implications from the corporate reorganisation given SEC's policy and importance to KSA.
- No change in the implied support and commitment from, and ownership by, KSA.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Explicit guarantees for the majority of debt from KSA in favour of SEC, providing that the remaining elements of the parent-subsidiary linkage do not weaken.
- A positive rating action on KSA.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- A negative rating action of the sovereign.
- Changes to the implied support and commitment from, and ownership by KSA.
- A significant change in SEC's operational structure resulting in SEC's links with the sovereign diminishing would also prompt a review of the ratings.
SOVEREIGN RATING SENSITIVITIES
For the sovereign rating of KSA, Fitch outlined the following sensitivities in its rating action commentary on 12 April 2016:
The main factors that could lead to a downgrade are:
-Continued erosion of fiscal or external buffers.
-A slower-than-expected narrowing in the fiscal deficit, for example as a result of a failure to implement fiscal reforms or due to a renewed fall in oil prices.
-Spill-over from regional conflicts or a domestic political shock that threatens stability or affects key economic activities.
The Outlook is Negative. Consequently, Fitch does not currently anticipate developments with a material likelihood of leading to an upgrade. However, the following factors could lead to the Outlook being revised to Stable:
-Fiscal consolidation sufficient to stem the depletion of fiscal and external buffers and put the budget on a path to a surplus.
-A sustained period of higher oil prices