Fitch Ratings has affirmed Azerbaijan-based utilities company JSC Azerenerji's Long-term Issuer Default Rating (IDR) at 'BB+' and Short-term IDR at 'B'. The Outlook is Negative.
The affirmation of Azerenerji's ratings reflect continued strong links with the Republic of Azerbaijan (BB+/Negative), reflecting the company's strong legal, strategic and operational ties with the state. At end-2015, about 91% of the company's outstanding debt excluding accrued interest was guaranteed by the state and another 8.5% was provided by the Ministry of Finance. The Negative Outlook mirrors that of the sovereign.
KEY RATING DRIVERS
State Guarantees Drives Alignment
Azerenerji's ratings continue to be aligned with those of its sole shareholder, the Republic of Azerbaijan, reflecting the strong legal, operational and strategic ties between the company and the state. The rating alignment reflects state guarantees for the majority of Azerenerji's outstanding debt at end-2015, the company's strategic importance to the Azerbaijani economy and strong operational links, including tariff and capex approval by the government, as well as a track record of direct tangible state support. Given Azerenerji's unsustainable standalone profile, we expect it to receive state guarantees for any new, currently unplanned, debt. State guarantees for Azerenerji's debt are included in the government's debt and the government has sufficient resource to meet its obligations to Azerenerji and its creditors.
Explicit State Support
Fitch assumes that the share of state-guaranteed debt will remain fairly stable over 2016-2018 and we do not expect any significant changes to the legal links with the state in the foreseeable future, as there are no plans at present to privatise Azerenerji. The state has also continued to provide equity injections, totalling around AZN970m over 2009-2015, to partially fund its investment programme (around 47% of total capex over this period). We expect that investment projects will continue to be funded from the state budget or will be postponed.
Additionally, following the decree signed at end-2015, the state will provide equity injections of USD172m and EUR204m to Azerenerji to assist the company in repaying its foreign currency loans over 2016-2025. The state will also assist Azerenerji's main customer, state-owned Azerisiq JSC, to pay overdue trade payables to Azerenerji so that the latter may reduce overdue trade payables to State Oil Company of the Azerbaijan Republic (SOCAR, BB+/Negative), another state-owned entity. The government also agreed to provide a AZN360m low interest, long-term loan to Azerenerji so that it can pay its tax due.
Devaluation-Driven Debt Increase
Azerenerji remains exposed to foreign currency fluctuations, as over 70% of its total debt at end-2015 was denominated in foreign currencies, mainly in euros, US dollars and Japanese yen, in contrast to almost all local currency denominated revenue. At end-2015, Azerenerji's debt increased to AZN2.4bn from AZN1.5bn, mainly on the back of local currency weakening. Following the manat devaluation in 2015, the state approved the provision of an equity injection to Azerenerji to partially cover its scheduled foreign debt repayments, as the majority of debt is guaranteed by the state.
Unsustainable Standalone Profile
Azerenerji's standalone profile has weakened, due to its worsening financial performance and weak liquidity. Deteriorating financial performance was mainly driven by the manat devaluation, which resulted in a debt increase, and by the continued imbalanced tariff-setting mechanism, where substantial gas tariff increases have not been matched by an electricity tariff change; the latter continued to pressure on the EBITDA margin. From December 2013, gas prices were increase by 48%, with 0% increase of electricity tariffs. At end-Nov16 gas prices were increased further by 50% and electricity prices were increased by about 5% in July 2016 and additionally by 33% at end-Nov16. Azerenerji expects electricity and gas tariffs to remain flat in the near term. In 2015, FFO has also been affected by the high tax payment of AZN151m (versus AZN2m over 2012-2014, on average), which was partially funded by a AZN360m low interest loan received from the state. We do not expect the worsening standalone profile to affect the ratings unless the company faces an unremedied liquidity squeeze.
Azerenerji is subject to certain financial and non-financial covenants that are tested on an annual basis. Loans of AZN360m, for which waivers were not received at the date of the 2015 IFRS FS, were reclassified into short-term debt. According to the company, Azerenerji has managed to obtain waivers for all of the covenant breaches. All of the covenanted debt is guaranteed by the state. Fitch expects that the forecast weak financials will lead to a continued breach of covenants. We anticipate the company to eventually obtain waivers for covenants breaches, as it has in the past.
Azerenerji is the dominant player in the domestic energy market, holding a near-monopoly position in generation and transmission in the Republic of Azerbaijan. Unlike its CIS-rated peers, almost all of its debt is guaranteed or provided by the state, which drives rating alignment with the sovereign.
Fitch's key assumptions within our rating case for the issuer include:
- Electricity volumes growth in line with Fitch's GDP forecasts of -2.3% to 1.8% over 2016-2019
- Actual electricity and gas tariff growth in 2016 and flat going forward
- Inflation-driven cost increase, which Fitch expects at about 3%-11.5% over 2016-2019
- No dividend payments
- Capex of about AZN320m on average over 2016-2019, largely funded though new equity
- Refinancing and debt repayment supported by the government
- USD/AZN exchange rate of 1.55-1.7 over 2016-2018
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
- A positive sovereign rating action, provided that the links between Azerenerji and the state remain strong
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
- A sovereign downgrade
- Evidence of weakening state support, for example, in an unremedied liquidity squeeze
RATING SENSITIVITIES FOR THE SOVEREIGN (from Rating Action Commentary dated 26 August 2016)
The following factors, individually or collectively, could trigger a downgrade:
- A failure to adjust expenditure or revenue to the lower oil price environment, resulting in an erosion of the external asset position
- A further sustained and prolonged fall in hydrocarbon prices
- Policy initiatives or responses that further undermine macroeconomic stability.
As the Outlook is Negative, Fitch does not anticipate developments with a high likelihood of triggering an upgrade. However, the following factors, individually or collectively, could lead to a revision of the Outlook to Stable:
- An improvement in the budgetary position, beyond the measures currently envisaged, sufficient to increase the longer-term sustainability of Azerbaijan's sovereign balance sheet strengths
- A sustained rise in hydrocarbon prices that restores fiscal and external buffers
- Improvements in governance and the business environment, and progress towards diversifying the economy away from hydrocarbons
Liquidity Contingent on State Support
Fitch views Azerenerji's liquidity as weak and conditional on continued tangible support from the government. At end-1H16, cash of about AZN11m was insufficient to cover short-term debt of around AZN432m. Liquidity risk is somewhat mitigated by the state guarantees on the company's outstanding debt. The state will provide equity injections of USD172m and EUR204m to Azerenerji over 2016-2025 to assist the company in repaying its foreign currency loans.
We expect Azerenerji's ambitious investment programme, which will result in negative free cash flow, to be largely funded by new equity. This should partially free up operating cash flow for the repayment of existing debt maturities. Nevertheless, continued debt service is dependent on ongoing state support.
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