Samruk-Energy is a vertically integrated, state-owned holding of power companies. SE mines coal, generates, transmits, distributes and sells electric and thermal energy. As a coal miner, SE competes domestically and internationally; in generation, it has a strong market position; in transmission and distribution it is a recognized and regulated monopoly.
Generation contributes the most to the bottom line, but that is about to change after the tariff agreement with the largest power station expires in 2016. The grid businesses have lower margins, but are better credit, benefitting from government support, cost-plus regulation that ensures the stability of incomes, and the free monitoring performed by the antimonopoly regulator.
In terms of credit risk, SE’s leverage may appear too high for a BBB. And the dire need for capex after decades of underinvestment makes deleveraging unlikely. But the main risks, in our opinion, are associated not so much with the debt per se, as with how the regulatory framework handles it (adequately enough) and with the government’s plans to restructure the holding.
According to the plans, SE must sell its stakes in the less important power stations and the grid businesses. This would leave SE with a hydro, two large coal-fired stations, experimental wind and solar projects and more than two thirds of the current debt. But even that should not weaken the credit profile of the streamlined company: the proceeds should offset the debt, the government support will remain strong, and the government seems to understand the importance of not weakening the investment story ahead of SE’s flotation (scheduled for 2015-16 under the People’s IPO program).
Top generator. SE was established in 2007 in order to consolidate the state energy sector’s assets. In terms of capacity, SE is the country’s largest electricity generating company with a total installed capacity of 9.66GW as of June 2014 or 47% of the country’s total. It currently has stakes in Kazakhstan’s three largest power plants of a national importance. More than half of the generating capacity is represented by coal-fired plants, while hydropower plants and gas-fired plants account for 26% and 20%, respectively. Another coal-fired plant with a planned capacity of 1.32GW is under construction and slated for commercial operations by 2018.
Regulated stability. SE saw strong earnings growth (+20% CAGR in 2009-2013) as the group benefitted from sizeable annual tariff hikes, rebounding generation volumes and asset transfers. The company operates as a natural monopoly in the heat energy generation, regional transmission and distribution sectors. Thus tariffs are set individually for each subsidiary and based on the ‘cost plus’ principle on the annual basis. Tariffs for generating companies have already been set for the 2009-2015 period, but are uncertain after 2015. Electricity and heat generation represented 62% of assets and generated 73% of EBITDA in 2013, while the distribution division - 20% and 25%, respectively.
Debt is mostly concentrated at the parent level. More than 60% of total debt (T110bn) is concentrated at the parent level, while all of the cash flows comes from subsidiaries and its joint ventures, which creates a structural imbalance. The parent debt figure includes the Eurobond issue (T79.5bn) and a loan from the shareholder (T28.4bn).
Privatization risks. Samruk-Kazyna plans to sell a 5-15% stake in SE as a part of the People’s IPO program in 2015. The decision to maintain the majority stake in SE is credit supportive, in our view. We expect SE to remain a highly strategic asset that would benefit from the state support; as such, demand for SE bonds should continue to benefit from the parent support.
The government also required SE to sell its three generating assets, all distribution and sales divisions in 2014-2015, which we see as credit negative, because they represented about T34.3bn or 53% of group’s 2013 EBITDA and T17bn or only 10% of debt as of end of 2013. However, it will be almost fully compensated by a consolidation of EGRES-1, with high profitability (2013 EBITDA of T49bn) and relatively low debt (T10.5bn).
Highly leveraged profile amid elevated capex requirements. SE ‘s investments have recently been higher than earnings, turning free cash flows negative and lifting leverage, although the spending has been partially funded by Samruk-Kazyna. SE is set to continue investing heavily in the modernization and expansion programs, creating the risk of the leverage increasing further, even if the spending is funded by a combination of cash flows, borrowing and government support. SE had a negative exposure to the tenge devaluation in February 2014 due to the mismatch between tenge-denominated revenue streams and mostly USD-denominated debt (63% of total debt).
Strong government financial support. The government has historically provided strong financial support to SE in the form of capital injections, cheap loans and guarantees on bank loans. We view the probability of receiving support from the government as high, given its strategic importance to the country’s economy.
Negative outlook on ratings. Fitch placed SE’s BBB rating on Rating Watch Negative. The outlook on SE’s BB+ rating from S&P is also negative. Fitch stated that a fully debt-funded acquisition of EGRES-1 would signal a reduced willingness of the state to provide financial support. S&P warned that potentially higher than expected investment levels could result in weaker-than-expected credit metrics over the rating horizon. SE’s potential rating downside with S&P and Fitch, apparently, have already been priced in with SE’17 (BBB-) and Intergas’17 (BB+) trading at similar levels.
Recommendation. SE’17 is trading at z+212, much tighter (44bp) than Kazakhstan Engineering’16 (BBB-/Ba2/NR) and almost at the same level as Intergas’17 (BBB-/NR/BB+). SE has relatively weak standalone credit ratings (Fitch and S&P standalone at B and B+), than those of Intergas (Moody’s baseline rating of Ba2, S&P standalone of BB), but at the same level as KE (Moody’s BCA of B2, Fitch standalone of B). Given the strategic importance, potential growth of the electric power generation capacity, strong domestic positioning on the one hand, and elevated capex needs and deterioration in leverage metrics on the other hand, we have a neutral view on bonds SE’17. Taking into account equivalent ratings and difference in maturities of Eurobonds of KE and SE, we estimate that KE’16 should trade at 30bp tighter than SE’16.
SE’s tenge bonds are extremely illiquid: there have been no transactions after the initial placement of T2bn bonds in June 2013 at 7.0%. We recommend to Hold SE’s Eurobonds due to a limited potential of yield tightening and Hold tenge bonds due to its low liquidity.
 This is calculated as 100% of installed capacity of projects in which SE has a 50% or higher equity interest.