Moody's assigns B3 rating to FEGC; outlook stable
October 8, 2010 Moody's Investors Service
Moscow, October 07, 2010 -- Moody's Investors Service has today assigned a
B3 corporate family rating (CFR) and a B3 probability of default rating
(PDR) to JSC Far Eastern Generating Company ("FEGC"), the major power generator in Russia's Far East. The rating outlook is stable. At the same time, Moody's Interfax Rating Agency, which is majority-owned by Moody's, has assigned a Baa3.ru national scale credit rating (NSR) to FEGC.
According to Moody's and Moody's Interfax, the B3 global scale rating reflects Moody's expectations with regard to FEGC's global default and loss, while the Baa3.ru NSR reflects the standing of the company's credit quality relative to its domestic peers.
The B3/Baa3.ru ratings assigned to FEGC reflect the company's weak liquidity and evolving financial profile, which are only partially counterbalanced by its fundamentally sustainable business profile as the fully regulated major power generator in Russia's Far East and monopoly heat supplier in key five local markets of the region. The rating of the company incorporates a one-notch uplift for potential support from its beneficiary majority owner, the Russian government, with such support expected to be channelled through the government-controlled RAO Energy System of East holding company.
FEGC is part of RAO Energy System of East Group. The group essentially represents Russia's Far East electric utility sector, which, contrary to other Russian regions, remains fully regulated. Moody's assesses the business profile of FEGC as fundamentally sustainable but associated with a higher risk compared with the profiles of regulated electric utility peers (which commonly have some higher degree of integration) operating in developed markets. Similar to other rated Russian companies, the immature domestic business environment also contributes to the business risk assessment of FEGC.
Moody's assessment of FEGC's business risk profile positively reflects:
(i) the company's strong position as the major power generator in Russia's Far Eastern market and its monopoly business as the heat generator and supplier in the region; (ii) the sustainable power and heat demand in Russia's Far East and revenue growth opportunities, additionally supported by the federal government's special programme as well as projects aimed at the economic and social development of the region as part of Russia's steps to strengthen its geo-politic position and economic co-operation with countries from the Asia-Pacific region;
(iii) the regulated nature of the company's business, which should provide some predictability of revenues, and increased recognition by the government of FEGC's development needs, reflected in a more friendly tariff regulation and adjusted investment burden in 2009; (iv) some level of potential support, which is likely to be available for FEGC from the federal government in case of financial distress, given the government-adopted regulated model for the Far Eastern electric utility sector and the government being the major beneficiary shareholder of the sector, including FEGC, through RAO Energy System of East holding company.
FEGC's credit quality is mainly constrained by: (i) the company's very weak liquidity position, driven by its predominantly short-term debt maturity profile, pressured covenants and lack of committed credit facilities; (ii) exposure to the evolving regulatory environment for the domestic electric utility sector in Russia's Far East, with no track record of consistent and timely cost recovery for FEGC's business; (iii) FEGC's evolving financial profile, which has been volatile. Although it materially improved in 2009, it remains pressured by FEGC's significant investment needs and the politically biased tariff regulation; (iv) the complex state ownership and control of the domestic Far Eastern electric utility sector through the state-controlled RAO Energy System of East holding company and uncertainty about its future development, which may challenge FEGC's timely access to the federal government's support; and
(v) FEGC's limited track record of operations in the current sector configuration and continuous corporate changes at the company, including the recently changed management team.
FEGC's ratings also incorporate the high geographical concentration of its assets and customer base, its fuel mix concentration on coal and exposure to foreign currency risk. The company's sizable gas purchase contract is denominated in US dollars, while its revenue is generated in roubles. Moody's considers that these additional business risks are only partially absorbed under the current regulations.
FEGC's B3/Baa3.ru ratings are thus largely driven by its uncovered liquidity position and the risk of further volatility of its financial profile in the context of the evolving regulation and the company's large investment needs.
The company has a short-term debt maturity profile, which is associated with high refinancing risk. As of the beginning of Q2 2010, short-term debt obligations accounted for about 60% of the company's total debt of
RUB24.3 billion. Net of the debt due to its state-related shareholder and the state itself, these short-term obligations were still well above the company's cash reserves of around RUB840 million. The gap is supposed to be covered largely from refinancing bank facilities. However, under the liquidity management policy, which relies on its monopoly and market dominance status, connections with the state and uncommitted bank funding limits, FEGC lacks committed facilities to address its funding needs reasonably in advance. Moody's regards this practice as particularly risky for FEGC, whose financial profile has been volatile and whose access to the state support may not be quick due to the complicated ownership structure in the Far Eastern power sector and the limited cash reserve and funding facilities readily available at the level of RAO Energy System of East holding company. The rating agency understands that the company plans to extend its debt maturity profile but has yet to demonstrate its commitment and ability to do so.
The company's financial profile is still evolving, in Moody's view, though the rating agency positively notes its material improvement in 2009, with EBITA margin reaching 13.0%, debt/EBITDA decreasing to below 4x and FFO interest and debt coverage improving to 1.9x and 12.9%, respectively. However, Moody's is concerned that the improvement may not be sustainable and is the result of a one-time recognition by the regulator of insufficient cost coverage in past years. The regulation is developing, it lacks consistency and may have various adjustments. It also remains subject to political interference and, historically, has contributed to the significant weakening of FEGC's financial profile. In 2008, given that fuel costs were inadequately covered by the regulated tariffs, the company's margins decreased by two times, its debt burden jumped to 11.7x Debt/EBITDA, and debt coverage was down to 3.4% FFO/Debt (all ratios incorporate Moody's standard adjustments). Given the developing regulation and FEGC's large investment needs, Moody's expects the company to be essentially FCF negative and to increase its leverage.
However, if FEGC failed to materially improve its liquidity profile, Moody's would see the company's flexibility to increase leverage under the B3/Baa3.ru CFR as very limited.
Despite the uncovered liquidity and evolving financial profile, Moody's considers that the company's credit quality is commensurate with B3/Baa3.ru ratings due to some level of the government's support incorporated into the rating. In Moody's view, such support could be available for the company through RAO Energy System of East in case of financial distress. The government supports the company in various forms, including subsidies, although they are limited and not necessarily channelled in a timely manner. The government has also taken over investment projects from the company to mitigate the burden on its financial profile and indirectly facilitates the company's access to state-owned banks. However, Moody's notes that the timeliness of the support may be challenged within the sector's complex framework and that the support may be selective and limited in some cases. As a result, the recognition of the support in the rating was limited to one notch.
Assuming currently no major negative developments in Russia's economy in the medium term, although volatilities and/or delays in a sizable sustainable recovery could not be excluded, Moody's expects FEGC to be able to improve its liquidity and avoid significant deterioration of its financial profile in the next 12-18 months. This expectation is reflected in the stable outlook on the company's rating.
If the company's liquidity position materially improved and its revised liquidity management policy became more consistent with a B category, with refinancing issues addressed reasonably in advance, there could be upward pressure on the rating.
Negative pressure on the company's ratings could result from (i) the economic environment in Russia and/or the company's focus region deteriorating; (ii) growing liquidity pressures, with a higher refinancing risk and challenged covenants, (ii) weakening support from the government, (iii) a negative development in the regulatory regime leading to lower margins; (iv) failure to adjust investment plans in line with the market needs and hence to limit a deterioration of the financial profile, with FFO interest coverage falling below 1.5x, FFO/Debt decreasing sustainably below 8%, Debt/Capital exceeding 70%.
This is the first time that Moody's has assigned ratings to FEGC.
The principal methodology used in rating JSC Far Eastern Generating Company ("FEGC")was Regulated Electric and Gas Utilities rating methodology published in August 2009. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found on Moody's website.
FEGC is the largest power and monopoly heat generator servicing the Russian Far East market which remains fully regulated. In 2009, the FEGC's revenue amounted to RUB41.7 billion (USD1.3 billion). FEGC is indirectly controlled by the Russian government represented by Russia's Federal Property Agency. The latter owns a 52.68% stake in RAO Energy System of East Holding, which in its turn has a controlling stake
(51.03%) in Far Eastern Energy Company, the sole shareholder of FEGC.
Company — Far Eastern Generating Company
Full nameFar Eastern Generating Company JSC