December 22, 2016 | Cbonds
Fitch Ratings has upgraded Kazakhtelecom JSC's (Kaztel) Long-Term Issuer Default Rating (IDR) to 'BB+' from 'BB'. The Outlook on the IDR is Stable. A full list of rating actions is available at the end of this commentary.
Kaztel is a strong fixed-line incumbent, with dominant market shares in traditional telephony and fixed-line broadband services, operating in a benign regulatory environment. The company created a mobile venture with Tele2 that gained an approximately 25% subscriber market share and is on track to improving its profitability on the back of a larger scale and post-integration synergies.
Kaztel's funds from operations (FFO) adjusted net leverage is low, and unlikely to spike above 2x on the expected acquisition of Tele2's stake in the mobile joint venture in 2019.
KEY RATING DRIVERS
Strong Incumbent Positions
Fitch expects Kaztel to maintain its leading position in the fixed-line segment, helped by benign regulation and a shortage of alternative networks. Kaztel estimated its revenue fixed-line telephony market share at a dominant 82% at end-2015, and at an exceptionally high 72% in the fixed-line broadband segment.
Macroeconomic challenges post sharp tenge devaluation in 2H15 discouraged alternative operators from active investments into new networks. We believe Kaztel's control over the last-mile infrastructure and the lack of line sharing/unbundling regulation will continue to protect the company from excessive competition in the broadband segment.
Broadband Growth Compensates Voice Declines
We expect broadband revenue growth to continue to compensate for pressures in the traditional voice segment. The Kazakh broadband market still holds significant growth potential, with broadband fixed-line penetration estimated by the company at 8.5% of population at end-2015 (we estimate this to correspond to approximately 40% by household).
We project voice revenue pressure to continue to be driven by fixed-line disconnections. However, the pace of decline has moderated, with voice revenue expected to shed approximately 6% yoy in 2016, compared with a 14.5% yoy decline in 2014.
Improving Mobile Performance
Kaztel's mobile joint venture with Tele2 continues to gain market share, and we expect its financial performance to improve as the company starts benefiting from larger scale and integration synergies. The joint venture continues to invest heavily in 4G coverage and capacity, but we expect it to start generating positive free cash flow (FCF) once the active investment phase is over and profitability improves, which is expected from 2018 onwards.
The mobile joint venture increased its subscriber market share to 25% at end-1H16, a significant improvement from 18% at end-2014. We believe this entity will continue gaining market share on the back of its wider combined distribution network, superior 4G network coverage and successful market positioning, with Tele2 and Altel brands catering to price sensitive and premium segments respectively.
Low Leverage, Strong Cash Flow
Kaztel's leverage is low, helped by deconsolidation of the company's mobile operations following the setting up of the joint venture with Tele2 at end-2015. FFO adjusted net leverage was 0.5x at end-2015, a sharp reduction from 1.2x at end-2014. We expect Kaztel to acquire full control of the joint venture in 2019. Leverage is likely to increase by around 1.0x, but we project FFO adjusted net leverage to be no more than 2.0x.
Kaztel is likely to demonstrate strong FCF generation in 2016-2018, accumulating cash for the acquisition of Tele2's stake in the joint venture in 2019. With fixed-line operations more profitable and not requiring significant development capex, FCF margin may approach low double-digit territory over this period.
Cash at 'BB-' and Above Banks
The company increased the amount of cash liquidity its holds with 'BB-' and higher rated banks. However, holdings at low-rated domestic banks remain substantial. We believe access to such cash remains uncertain Consequently, we only treat as cash placed with banks rated 'BB-' and above as available for debt service, with all other cash treated as restricted and excluded from net leverage metric calculations.
Nevertheless the company has been able to utilise some of its significant cash holdings with such low-rated banks. Further progress with accessing this cash would be treated as positive event risk.
Limited FX Exposure
Kaztel has limited FX exposure, which is primarily represented by its only remaining USD-linked debt instrument, while all other debt is in KZT. The company has successfully managed to withstand pressures driven by sharp tenge devaluation in 2015, and we expect management to maintain a prudent approach to FX funding and capex commitments.
FX risks are mitigated by substantial cash and deposits held in foreign currencies. As of end-1H16, the company had KZT27.1bn (USD80m) of FX debt, which was by more than 60% covered by FX cash liquidity held at banks rated 'BB-' and above. The net FX exposure is equal to less than 0.2x of 2015 EBITDA and hence manageable, in our view.
Weak Parent-Subsidiary Linkage
Kaztel's ratings reflect the company's standalone credit profile. Kaztel is of only limited strategic importance for Kazakhstan, while operating and legal ties with its controlling shareholder, the government-controlled Samruk-Kazyna, are weak. Although indirect government control is a positive credit factor, it does not justify a rating uplift, in our view
Kaztel's ratings are driven by the company's strong market positions in key fixed-line segments, robust FCF generation, low leverage and a benign regulatory environment. The company is rated lower than other CIS and EMEA incumbents due to its smaller scale, lack of geographical diversification and a weak domestic financial market resulting in a lack of liquidity diversification.
Fitch's key assumptions within the rating case for Kaztel include the following:
- Flat to slightly positive fixed-line revenues, with broadband growth compensating voice weakness
- EBITDA margin at 38%-39% in 2017-2019, and 33%-34% in 2019-2020 on the consolidation of the less profitable mobile joint venture
- Capex intensity at 18% of revenue in 2017, 17% in 2018 and 16% in 2019-2020
- KZT24bn of guarantees to mobile JV are treated as Kaztel's debt
- Moderate dividend payment at KZT3bn-KZT7bn per year in 2017-2020, in anticipation of the purchase in 2019 of the remaining stake in the mobile joint venture.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
- Successful integration with the mobile segment but his is unlikely before 2019 when Fitch expects Kaztel to take full control of its mobile joint venture with Tele2.
- Maintaining sufficient liquidity that is diversified between external and internal sources;
- Consistently strong FCF generation with pre-dividend FCF margin in the mid-to-high single digit range.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
-A protracted rise in FFO-adjusted net leverage to above 2x
-A material increase in refinancing risk driven by insufficient liquidity
- Operating underperformance and significant market share erosion including in the mobile segment
Kaztel has sufficient cash on hand to service its debt obligations till end-2019. We estimate that cash placed with 'BB-' and above-rated banks as of end-September 2016, more than covers scheduled debt maturities of KZT4bn in 4Q16-2018. We expect positive FCF to further support liquidity.
However, the Kazakh domestic banking system remains weak, implying the scarcity of local funding and few committed credit facilities.
FULL LIST OF RATING ACTIONS
Long-Term Foreign and Local IDRs: upgraded to 'BB+' from 'BB', Outlook Stable
Short-Term Foreign Currency IDR: affirmed at 'B'
National Long-Term Rating: upgraded to 'AA-(kaz) from 'A+(kaz)', Outlook Stable
Senior unsecured debt in foreign and local currency: upgraded to 'BB+' from 'BB'
Senior unsecured debt in local currency: upgraded to 'AA-(kaz)' from 'A+(kaz)'