Fitch affirms ratings of Kazakhstan Electricity Grid Operating Company "KEGOC"; outlook Stable

/Fitch Ratings, Moscow, November 25, 14, heading by KASE/ – Fitch Ratings has affirmed Kazakhstan Electricity Grid Operating Company's (KEGOC) Long-term Issuer Default Rating (IDR) at 'BBB+'. The Outlook is Stable. A full list of ratings actions is provided at the end of this commentary. The affirmation reflects KEGOC's continued strong links with the Republic of Kazakhstan (BBB+/Stable). KEY RATING DRIVERS Ratings Aligned with Sovereign's KEGOC's ratings are aligned with those of the Republic of Kazakhstan (BBB+/Stable), reflecting its strong legal, strategic and operational ties with the Kazakhstan state. The ties are based on the company's 100% indirect state ownership, direct government guarantees and the strategic importance of the national electricity transmission grid. Kazakhstan's National Welfare Fund Samruk-Kazyna (S-K), the immediate parent company of KEGOC, continues to support KEGOC; it provided the company with KZT2bn over 2011-9M13 to implement the Ossakarovka Transmission Rehabilitation Project. Strong Legal Links Strong legal ties are underpinned primarily by debt guarantees provided by the state, which at end 3Q14 covered 42% of total debt, as well as by favourable regulation policy. S-K is offering a 10% stake in KEGOC to the Kazakh public at end-2014. Fitch expects that following the IPO, S-K will maintain a majority stake in KEGOC and that the government guarantees for part of KEGOC's debt will remain in place. Fitch may review KEGOC's rating alignment with the sovereign rating if the share of government-guaranteed debt decreases below 40% of total debt on a sustained basis and/or if links with the government weaken. Strong Strategic Links The strength of strategic links is underpinned by KEGOC's monopoly position in electricity transmission and technical dispatching and by its role as a dominant market player in power balancing. The company owns and operates about 24,000 km of transmission lines and 74 electric power substations throughout Kazakshtan. Standalone Profile KEGOC's standalone profile is significantly weaker than its government-supported IDR and is commensurate with a weak 'BB' rating. The main constraints on its credit profile are its exposure to foreign exchange and interest rate risks as well as its fairly high leverage. At end-2013, 70% of KEGOC's debt was denominated in US dollars and 30% in euros at variable interest rates. Fitch estimates that the share of guaranteed loans may over the next few years decrease to around 30% of total debt from 42% at end-3Q14, which may result in the rating being notched down from the sovereign. High Tariffs Approved The regulatory bodies of Kazakhstan have approved high tariffs starting from November-2014, as the government wants KEGOC to operate in a "market environment" and eventually to pay dividends to shareholders. The approved tariffs envision a growth rate of 30%-50% relative to the previous years. Capex-Driven Negative FCF Expected Fitch expects KEGOC to report positive cash flow from operations in 2014-2017. However, free cash flow (FCF) is likely to remain negative, mainly driven by substantial capex plans of KZT117bn over 2014-2017 to upgrade the national electricity grid and electric power facilities. For 2014, Fitch estimates KEGOC's cash flow from operations at KZT22bn, before capex (KZT24bn). The agency expects KEGOC to rely on borrowings to finance the cash shortfall. Deleveraging Expected As a result of higher tariffs, Fitch expects the company to reduce its FFO adjusted leverage rapidly to around 3.0x by 2015 from 4.6x in 2013. We expect KEGOC's dividend pay-out ratio to increase to 50% starting from 2015, reflecting the higher dividend demands of partial public ownership. We expect 2014 FFO gross adjusted leverage to remain around 5.0x due to forex losses of KZT18.5bn, following local currency devaluation in early 2014, preventing deleveraging in the short-term. RATING SENSITIVITIES Positive: future developments that may, individually or collectively, lead to a positive rating action include: – A positive change to Kazakhstan's ratings provided the links between KEGOC and the sovereign do not weaken – 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 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, 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 7 November 2014: The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently well-balanced. The main factors that individually or collectively might lead to rating action are as follows: Positive: –Steps to reduce the vulnerability of public finances to oil price shocks, for example by narrowing the non-oil fiscal deficit –Effective restructuring of bank balance sheets –Entrenching low and stable inflation under a more flexible exchange rate regime –Substantial improvements in governance and institutional strength Negative: –Policy management leading to a sustained decline in sovereign assets or reduced economic or financial stability –A sustained commodity price shock –Renewed weakness in the banking sector and crystallisation of contingent liabilities –A political risk event LIQUIDITY AND DEBT STRUCTURE Fitch views KEGOC's liquidity as adequate, based on its balanced debt maturity profile (annual scheduled maturities were around KZT11bn at end-2013), its cash position of KZT7bn as of end-3Q14, along with short-term deposits of KZT20bn and available credit lines of KZT2.8bn. However, the latter are restricted for use in identified capex projects and may not be drawn for general liquidity purposes. Cash balances are mostly held in local currency with local banks, which is a risk. As of end-3Q14 KEGOC continued to be funded by EBRD (54%) and IBRD (46%) with floating interest rates varying from 1% to 4%. The Kazakh tenge has depreciated 17% against the US dollar for the year to November 2014 and by 7% against the euro over the same period. All of KEGOC's debt is denominated in the US dollar or euro, while almost all its revenues are in the local currency. We have incorporated the depreciation into our forecast for 2014, which increases debt substantially. However, KEGOC's FFO adjusted leverage would increase only to 5.0x in 2014 from 4.7x in 2013, due to high tariffs and IPO proceeds. FULL LIST OF KEGOC's RATINGS Long-term foreign currency IDR affirmed at 'BBB+'; Stable Outlook Long-term local currency IDR affirmed at 'A-'; Stable Outlook Short-term foreign currency IDR affirmed at 'F2'. Contact: Principal Analyst Alexey Evstratenkov Analyst +7 495 956 9984 Supervisory Analyst Elina Kulieva Associate Director +7 495 956 9975 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow 115054 Committee Chair Paul Lund Senior Director +44 20 3530 1244 Contacts for media in Moscow: Kseniya Ivanova, tel. + 7 495 956 6810/9901, ksenia.ivanova@fitchratings.com [2014-11-26]