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Fitch Affirms Kazakhstan Utility Systems at 'B+'; Outlook Stable

Fitch Ratings - London - 26 Oct 2022: Fitch Ratings has affirmed Kazakhstan-based utility Limited Liability Partnership Kazakhstan Utility Systems' (KUS) Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B+'. The Outlook is Stable. A full list of rating actions is provided below. The affirmation and Stable Outlook reflect Fitch's expectations that funds from operations (FFO) interest cover will remain within Fitch's rating sensitivities in 2022-2025, reflecting the unfavourable interest rate environment, despite low leverage for the rating. The affirmation also considers material FX risk and limited liquidity position. The rating continues to be constrained by weak corporate governance and evolving regulatory framework.

Low Leverage: Fitch projects FFO leverage to average 2.2x in 2022-2025, which is low for the rating. We also expect healthy FFO, averaging KZT36.6 billion over the same period. We continue to treat financial interest-free aid received from affiliated companies (about KZT6 billion) as debt. We now exclude YDD Corporation's debt of KZT24.1 billion from KUS's off-balance-sheet debt for the forecast period, following the release of its asset pledge against YDD's debt in 2022.

Low leverage is mitigated by our expectations that the FFO interest cover will deteriorate towards the negative sensitivity of 3.5x by 2025, reflecting the higher interest-rate environment.

Material FX Risk: KUS is exposed to significant FX risk as revenue is generated in Kazakhstani tenge (KZT), while a large share of its debt is in Russian roubles (78% of total debt at end-June 2022). The tenge depreciation against the rouble (48% in 1H22) inflated KUS's rouble-denominated debt by around KZT31 billion in 1H22. Substituting FX debt with local-currency debt will improve the company's financial flexibility, but may worsen coverage metrics, due to higher interest rates.

Long-Term Generation Tariffs: Electricity generation tariffs are approved until end-2025, which adds visibility to the company's cash flows. From July 2022, electricity generation tariffs have been further revised upwards for KUS's generation companies, Karaganda Energotsentr (12%) and Ust-Kamenogorskaya TPP (11%). Fitch expects tariffs to grow at below inflation thereafter on the back of rising fuel costs.

Long-Term Distribution Tariffs: Electricity distribution tariffs for Mangistau Regional Electricity Network Company (MRENC; B+/Stable) and Karaganda Zharyk (KZh) are approved until 2025. MRENC's distribution tariffs were revised upwards by about 7% for legal entities in 2022, following a 25% increase in 2021. Legal entities account for about 90% of total distributed electricity volumes. For the remaining customers, including households and utilities companies, tariff increases were approved at 2%-5% annually over 2022-2025.

Vertical Integration; Small Scale: KUS's business profile benefits from vertical integration and its strong position in electricity generation, distribution and supply in the highly populated central Kazakhstan (Karaganda region), the south and eastern regions, and from a near-monopoly position in electricity transmission and distribution in the region of Mangistau, one of Kazakhstan's strategic oil- and gas-producing regions, which in total account for 35% of the country's population.

The business profile is constrained by KUS's small scale of operations relative to Kazakh peers such as JSC Samruk-Energy (BB/Positive) and Kazakhstan Electricity Grid Operating Company (KEGOC; BBB-/Stable).

Weak Corporate Governance: Fitch continues to view KUS's corporate governance as weak, reflecting a non-transparent ownership structure, and sizeable related-party and third-party transactions with limited disclosure and uncertain economic benefit to KUS. As a result, KUS has an ESG Relevance Score of '4' for Governance Structure and '4' for Group Structure.

KUS's closest peers are Kazakhstan-based utility holding JSC Samruk-Energy and transmission operator KEGOC. These peers have larger operations and wider geographical presences within Kazakhstan. KUS has a weaker corporate governance that Samruk-Energy and KEGOC due to credit-negative related-party transactions. KUS's financial profile is similar to that of Samruk-Energy, but weaker than that of KEGOC.
KUS is rated on a standalone basis. Samruk-Energy is rated three notches below the sovereign under our Government-Related Entities (GRE) Criteria. KEGOC is rated one notch below the sovereign under the GRE Criteria.

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

  • Average GDP growth of 3.6% and CPI of 8.6% annually in 2022-2025
  • Electricity generation and distribution volumes to grow at low single-digit percentages in 2022-2025; flat heat generation volumes over the same period
  • Electricity generation tariffs to increase below inflation rates in 2023-2025; capacity tariffs to increase to KZT885k/MW in 2023 from KZT590k/MW
  • Electricity distribution tariff growth below inflation rates, as approved by the regulator until 2025
  • Cost inflation slightly below expected CPI
  • Capex averaging KZT32 billion per year over 2022-2025, in line with KUS's management guidance
  • Dividend payments of around KZT1 billion per year from 2023
  • No repayment of loans by third parties is assumed over 2022-2025
  • Cost of new debt at 15%

Factors that could, individually or collectively, lead to positive rating action/upgrade:

  • Increased transparency of the ownership structure and generally stronger corporate governance, with significantly reduced related-party transactions
  • Improved credit metrics, with FFO gross leverage persistently below 3x and FFO interest coverage above 4.5x
  • Long-term predictability of the regulatory framework, with less political interference and a stronger operating environment
  • Improved overall liquidity position with better spread of debt maturities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

  • Deterioration of corporate governance (e.g. a significant increase in loans and guarantees to companies outside the company) leading to weaker-than-expected financial performance or aggressive M&A, resulting in FFO gross leverage persistently higher than 4x and FFO interest coverage below 3.5x
  • Worsening overall liquidity position

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Weak Liquidity: At end-June 2022 KUS had about KZT5.9 billion of cash and cash equivalents and available uncommitted credit lines of around KZT5 billions with an availability period over one year. This, combined with expected positive FCF of around KZT6.8 billion over the next 12 months, is insufficient to fully cover scheduled short-term debt maturities of around KZT22.6 billion.
Debt mostly comprised secured loans from local banks, which are raised at both holdco and opco level and bonds at MRENC level. The largest creditors are Sberbank (KZT98.4 billion) and EBRD (KZT13.3 billion). Around 78% of debt is in Russian roubles, with the remainder raised in tenge and US dollars.

KUS is an integrated utility, with operations in electricity generation, distribution, and supply, across four regions in Kazakhstan, which in total account for 35% of the country's population.

YDD Corporation loan included in off-balance-sheet debt at end-2021 as KUS's assets were pledged against this loan.
Interest-free short-term loan from related parties for working-capital needs reclassified to debt from other accounts payable.
Cash with restricted use reclassified to restricted cash from other current assets.

Sources of Information
The principal sources of information used in the analysis are described in the Applicable Criteria.
The principal sources of information used in the analysis are described in the Applicable Criteria.

Limited Liability Partnership Kazakhstan Utility Systems has an ESG Relevance Score of '4' for Governance Structure and '4' for Group Structure due to non-transparent ownership structure and sizeable related party and third-party transactions. These factors have a negative impact on the credit profile and are relevant to the rating, in conjunction with other rating factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

For full details, see the official website of Fitch Ratings: https://www.fitchratings.com/research/corporate-finance/fitch-affirms-kazakhstan-utility-systems-at-b-outlook-stable-26-10-2022

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