S&P affirms ratings of KazTransGas and Intergas Central Asia; outlook revised from Stable to Negative

/Standard & Poor's, Moscow, February 19, 15, heading by KASE/ – Standard & Poor's Ratings Services said today that it affirmed its 'BB+' long-term corporate credit ratings on Kazakh gas utility company KazTransGas (KTG) and its 100% owned gas pipeline operator Intergas Central Asia JSC (ICA). We revised the outlook on both companies to negative from stable. We also affirmed the 'BB+' rating on the senior unsecured debt and withdrew the recovery rating of '4'. The rating action follows the downgrade of Kazakhstan (see "Kazakhstan Long- Term Ratings Lowered To 'BBB' From 'BBB+' Following Oil Price Decline; Outlook Negative," published on RatingsDirect on Feb. 9, 2015) and KMG ("Kazakhstan-Based Oil Company KazMunayGas Ratings Lowered To 'BB+' After Sovereign Downgrade; Outlook Negative," published on Feb. 16, 2015). We continue to view KTG as having moderately strategic status in the KMG group and enjoying a "moderately high" likelihood of timely and sufficient extraordinary government support from the government of Kazakhstan. We assume, however, that in case of financial stress, any extraordinary support to KTG would likely come directly from the government. Therefore, we base the corporate credit rating on KTG on its stand-alone credit profile (SACP) plus uplift for potential government support, capped at the level of its parent company. The revision of our outlook on KTG mirrors that on KMG and reflects our view that if the ratings on KMG are lowered, that would lead to a similar rating action on KTG. In accordance with our criteria for government-related entities (GREs), our view of a moderately high likelihood of extraordinary government support is based on our assessment of KTG's: - "Important" role for Kazakhstan, given its strategic importance as the monopoly gas supplier in the service area, and ICA's status as the national trunk gas pipeline operator; and - "Strong" link with the government via full ownership of KTG by its parent, 100% state-owned oil and gas champion KMG. We equalize the ratings on ICA with those on KTG, reflecting the overall creditworthiness of the KTG group. The consolidated approach reflects the companies' close integration, KTG's 100% ownership of ICA and other major subsidiaries, financial guarantees on much of the group's debt issued by ICA and KTG, large intragroup cash flows, and an absence of effective subsidiary ring-fencing. The rating action also reflects our assessment of KTG's SACP at 'bb', based on its "fair" business risk profile, "intermediate" financial risk profile, and "negative" financial policy. KTG's "fair" business risk profile is supported by the stable and regulated nature of the gas transportation business and ship-or-pay terms until the end of 2015 in the gas transportation contract with Russian energy major Gazprom. KTG's status as the national gas operator and its solid market position stemming from the favorable location of the group's transit pipelines also bolster the business risk profile. It is constrained by the company's exposure to Kazakhstan country risk, which we assess as "high," and heavy dependence on Gazprom in its gas transportation and sales activities. Furthermore, it has an aged asset base and faces potential competition from alternative gas export pipelines transporting Central Asian gas. Moreover, retail gas tariff regulation in Kazakhstan is not transparent. KTG's financial risk profile is "intermediate," in our view, supported by moderate debt levels and resulting in the ratio of debt to EBITDA not higher than 3x and funds from operations (FFO) to debt of at least 30% in our base-case projections for 2014-2015. It is constrained by continued ambitious planned investments in gas transmission and distribution, leading to negative free operating cash flow generation in 2014-2015 in our base case. Moreover, rising cash flow volatility stemming from the increasing share of unregulated gas sales in the group's revenue composition also pressures the financial risk profile. Furthermore, KTG's exposure to foreign currency risk also constrains the financial risk profile, as more than 95% of the company's debt is denominated in U.S dollars. The foreign currency risk is mitigated to some extent because much of KTG's revenues are U.S. dollar denominated: 57% of its 2013 revenues were U.S. dollar denominated (we expect a similar proportion for 2014). We assign a "negative" financial policy modifier because we think the financial policy framework allows KTG to take a more leveraged position than we currently expect, primarily on the back of higher investment needs. In our base case for KTG, we assume: - Revenue growth of about 15% in 2014 supported by devaluation of the Kazakhstani tenge (KZT) and of about 3% in 2015; - EBITDA margins of 22%-25%; - Capital expenditures of about KZT55 billion-KZT70 billion per year; and - Dividends of about KZT12 billion. Based on these assumptions, we arrive at the following credit measures for the company: - Standard & Poor's-adjusted debt to EBITDA of 2x-3x; and - FFO to debt of 30%-45%. The negative outlook mirrors that on KTG's immediate parent, KMG. In accordance with our group rating methodology, the ratings on KTG are at the moment capped by the rating on KMG, so a negative rating action on the parent would lead to a similar rating action on KTG, all else being equal. Downside scenario We think pressure on KTG's credit profile also could result from a more aggressive financial profile than we currently anticipate. That would include weakened credit ratios (notably debt/EBITDA rising above 3.0x) due to any unexpected financial underperformance, extensive reliance on short-term funding, or KTG's increased capital expenditures requiring significant external borrowing and leading to leverage above our expectations. For instance, if KTG increased capital expenditures because of a greater need to invest in gas distribution assets or start new large investment projects. The ratings could also come under pressure as a result of any indications of negative interference from KMG, including, but not limited to, inducement to pay excessive dividends. If we revised down our assessment of KTG's SACP by one notch, it would lead us to lower the long-term rating to 'BB', provided that the sovereign long-term local currency rating and the likelihood of extraordinary financial government support remained the same. If we saw signs of weakening state support, we might consider revising down the likelihood of extraordinary government support for KTG. Under our criteria for GREs, we would have to revise the likelihood of extraordinary government support down to "moderate" from the current "moderately high" to result in a downgrade of KTG. This might be a result of increased substantial privatization risk, negative interference track record, or reshuffling of government priorities in its support initiatives. Upside scenario Ratings upside is currently limited by the ratings on the parent. The outlook might revert to stable only if we change the outlook on KMG to stable. Ratings upside might result from better cash flow generation and higher earnings derived from profitable gas-trading operations as the volumes of associated gas sales increase. Notably, we would expect to see FFO to debt above 45% and debt to EBITDA below 2x on a constant basis (without any potential stresses to liquidity) to consider a revision of the SACP upwards to 'bb+'. However, under our criteria for GREs, this one-notch upward revision of the SACP will not result in rating changes since they are capped by the rating on KMG. Primary Credit Analyst: Sergei Gorin, Moscow (7) 495-783-4132; sergei.gorin@standardandpoors.com Secondary Contact: Elena Anankina, Moscow (7) 495-783-4130; elena.anankina@standardandpoors.com [2015-02-23]