Fitch Affirms OGK-2 at 'BB'; Outlook Stable
23 Dec 2016 6:54 AM
Fitch Ratings-Moscow/Warsaw-23 December 2016: Fitch Ratings has affirmed Public Joint-Stock Company The Second Generating Company of Wholesale Power Market's (OGK-2)'s Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BB'. The Outlook is Stable. A full list of rating actions is at the end of this release.
The affirmation reflects Fitch's expectations that OGK-2's credit metrics will improve over 2017-2020, on the back of an increased share of revenue generated under capacity supply agreements (CSAs), moderate capex and in spite of our expectation of higher dividend payments.
The 'BB' rating incorporates a one-notch uplift to the company's 'BB-' standalone rating for parental support from the ultimate majority shareholder, PJSC Gazprom (BBB-/Stable). The delay of commissioning units under the CSAs and the acquisition of OGK-Investproekt resulted in funds from operations (FFO) net adjusted leverage at above 4x at end-2016, which Fitch expects to decline over 2017-2020.
KEY RATING DRIVERS
Stronger Financial Profile
Fitch expects OGK-2's profitability to strengthen in 2016-2017 due to the completion of new units under CSAs with favourable economics. This will boost EBITDA in 2016, which has already grown by 49% yoy in 9M16 and which Fitch expects to grow further in 2017. However, the completion of the acquisition of a 90.5% stake in OGK-Investproekt from Mosenergo (BBB-/Stable) and delays in commissioning of certain power units resulted in OGK-2's FFO net adjusted leverage remaining high at above 4x at end-2016.
We anticipate OGK-2's leverage will improve to slightly above 3x on average over 2017-2020, as newly commissioned units become operational for the full-year from 2017. This is based on our assumption of moderate capex and higher dividend payments.
Solid EBITDA Portion from CSAs
OGK-2 estimates that the newly commissioned units operating under the CSAs contributed about 26% of its 2015 EBITDA, and expects their share to increase to over 70% in 2016-2020. The favourable economics of projects operating under CSAs along with their long-term nature provides visibility and stability to OGK-2's cash flow.
The consistent application of the CSA regulatory framework for Russian generating companies during the recent economic crisis contributed to an improving record in its implementation. In addition, the auctions for capacity sales on the competitive capacity market set the capacity payments over a four-year period, adding to the predictability of generators' cash flows. However, we continue to view Russian regulatory risk for the power sector as high compared to the regulatory frameworks in western European countries.
Moderate Capex, Higher Dividends Expected
The completion of expansion capex in 2016 should contribute to OGK-2's financial flexibility. We expect the company to turn free cash-flow (FCF) positive in 2017 on the back of capex of RUB6bn on average over 2016-2020 against RUB21bn over 2012-2015, but still above the company's maintenance capex need of an average of RUB3.5bn. We also assumed the dividend payout ratio of 50% of net income under IFRS from 2017 in line with other Russian state-owned companies, which is well above company's expectations of 20%-35% of net income under RAS.
Penalties Covered by Inter RAO
The penalties for the postponement of commissioning of new units under CSAs are to be covered by Inter RAO (BBB-/Stable). The agreement has been approved by the Market Council and by OGK-2's board of directors, while the company expects the agreements to be concluded with Inter RAO at the beginning of 2017. According to this agreement Inter RAO will cover the penalties of RUB4bn. We estimate that if these penalties are not be paid by Inter RAO, they may increase OGK-2's leverage metrics by about 0.2x on average annually over the rating horizon, other things being equal.
In 2015-2016 PJSC Mosenergo, OGK-2's sister company, sold its 90.5% stake in OGK-Investproekt to its JV partner - OGK-2, which owned the remaining 9.5%. The transaction was held in two stages with the sale of a 45.5% stake to OGK-2 for RUB2.8bn in December 2015 and the remaining 45% stake for RUB2.8bn in March 2016. This will result in a total payment to Mosenergo of about RUB6.6bn over 2017-2018 and the repayment of the JV's debt to Mosenergo of more than RUB10bn over 2018-2025.
We assess the ties between the company and its ultimate majority shareholder as moderately strong. The strength of the ties is supported by OGK-2's integral role in Gazprom's strategy of vertical integration and the fact that it contributed 16% of Gazprom Energoholding's EBITDA in 2015. Furthermore, 52% of OGK-2's total outstanding debt at end-1H16 was loans from Gazprom.
OGK-2's rating is supported by its strong market position and expected solid financial profile, which is enhanced by a significant share of EBITDA generated under CSAs with favourable economics. This is the key factor mitigating the company's exposure to market risk, and supports the stability of its cash-flow generation. OGK-2 has a weaker financial profile than its closest peers Mosenergo and TGC-1 (BB+/Stable). However, Fitch expects it to improve within the rating horizon. There is no Country Ceiling impact on the rating. OGK-2's IDR incorporates a one-notch uplift to the company's 'BB-' standalone rating for parental support from the ultimate majority shareholder, PJSC Gazprom.
Fitch's key assumptions within our rating case for the issuer include:
- Domestic GDP and inflation increase of 1.3% and 5.8% in 2017 and by 2.0% and 5.5% in 2018, respectively
- Net power output marginal growth at CAGR of below 2% over 2016-2020
- Gas tariffs indexation by around 3% over 2016-2020
- Power price growth slightly below gas price increase over 2016-2020
- Electricity tariffs to increase below inflation
- Dividends at 50% of net income under IFRS starting from 2017, against management expectation of 20-35%
- Capex in line with management expectations for 2016-2018, and at about the 2018 level thereafter
- Average cost of new borrowings of 10.5% in 2016, 9.5% in 2017 and thereafter
- The repayment of RUB6.6bn for the acquisition of a 90% stake in OGK-Investproekt from PJSC Mosenergo within 2017-2018
- Penalties for later commissioning of power units under CSAs to be paid at RUB819m in 2016 and the remaining RUB4bn to be covered by Inter RAO.
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
- Improvement in financial profile due to, among other things, increased predictability of the regulatory and operational framework in Russia, higher-than-expected growth in tariffs and/or volumes supporting FFO net adjusted leverage below 3x and FFO fixed charge coverage above 4x on a sustained basis.
- Stronger parental support.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
- Inability to improve credit metrics so that FFO net adjusted leverage remains above 4x and FFO fixed charge coverage stays below 2.5x on a sustained basis due to, among other factors, lower volumes of electricity and capacity sales, lower tariffs or a margin squeeze caused by the rise of fuel prices not fully compensated by electric prices growth, weak working capital management, M&A transaction resulting in higher debt and/or an intensive capex programme.
- Weakening of parental support, which may result in a removal of the one-notch uplift to OGK-2's standalone rating.
- Deterioration of the regulatory and operational environment in Russia.
LIQUIDITY AND DEBT STRUCTURE
OGK-2's cash and cash equivalents stood at RUB4.9bn at end-9M16 which together with uncommitted unused credit facilities of RUB41bn mainly from major Russian banks were sufficient to cover upcoming short-term debt maturities of RUB37bn. Under all credit facilities OGK-2 does not pay commitment fees, which is a common practice in Russia. We expect funding from state-owned banks to be available to the company. The majority of debt at end-9M16 (about 52%) was capex-related loans from Gazprom. OGK-2's investment programme under CSAs is almost completed, which might result in positive FCF generation starting from 2017.
FULL LIST OF RATING ACTIONS
Long-term foreign currency IDR affirmed at 'BB', Outlook Stable
Long-term local currency IDR affirmed at 'BB', Outlook Stable
Short-term foreign currency IDR affirmed at 'B'
Short-term local currency IDR affirmed at 'B'
National Long-term Rating affirmed at 'AA-(rus)', Outlook Stable
Local currency senior unsecured rating affirmed at 'BB'
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Summary of Financial Statement Adjustments
- Operating leases: We applied a 6x multiple (relevant to Russia) to operating lease expenses to create a debt-like obligation.
- Debt: Reclassification of other long-term liabilities of RUB2.8bn to long-term debt, which relates to the liabilities as a result of OGK-Investproekt acquisition.
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