September 5 (SeeNews) - Standard&Poor's said it has revised the outlook on Bulgarian power utility NEK to negative from stable and affirmed the state-owned company's long-term issuer credit rating at 'B+'.
"The outlook revision reflects S&P's view that Bulgarian Energy Holding EAD's (BEH) ability to provide extraordinary and ongoing support to its subsidiary NEK could deteriorate in the coming years," the global rating agency said in a statement last week.
NEK's stand-alone performance remains weak, so it remains highly dependent on ongoing and extraordinary support from BEH, S&P added.
S&P also said in the statement:
"Given high leverage at the NEK level, the BEH group's credit quality and group support remain the key drivers of the rating on NEK.
The affirmation of the 'B+' rating on NEK reflects the balance between still weak--albeit stabilized--performance on the stand-alone level, and our expectation of continuing ongoing and extraordinary support from its parent BEH and, indirectly, from the Bulgarian government.
There is a lack of clarity regarding the actual timing, amount of investments, project structure, and additional government support for BEH and its large new projects. We also understand that exact terms are still under negotiation. However, we think that the projects are in line with the Bulgarian government's energy strategy, which focuses on security of gas supply and diversification of gas flows to Balkan and Eastern European regions.
Since BEH represents a main support for NEK, we take into consideration the consolidated group's key projects when assessing the rating on NEK. These include the construction of the Greece-Bulgaria gas interconnector project (IGB) and the construction of gas transmission infrastructure to connect the markets between Turkey and Serbia.
Bulgartransgaz, BEH's subsidiary, is now looking to find the main contractor for the expansion of the existing Bulgartransgaz gas transportation system between Turkey and Serbia, which will cost about Bulgarian lev (BGN) 2.8 billion, according to management's preliminary estimates. We understand that the engineering, procurement, and construction (EPC) contractor should provide long-term interest-bearing funding to Bulgartransgaz to cover the full project cost. We view such contractor financing as debt-like. We also understand that BEH will consolidate this EPC contractor funding in its financial statement and repay it with transit revenue from the project once it is commissioned. In addition, BEH has a 50% stake in the IGB, but we understand that grants from the European Energy Programme for Recovery and the Operational Programme "Innovation and Competitiveness", along with the €110 million secured by a state-guaranteed loan, will effectively cover the €260 million project cost.
Due to the size of these investments, we think that BEH's credit quality could come under pressure, with FFO to debt declining well below 20% in 2020-2021. BEH's consolidated adjusted debt in 2020 could rise by about 50% compared to Dec. 31, 2018. We also understand that tenders for the construction of new Belene power plant are under way, although the timing and size of this project remain unclear.
That said, we understand that BEH has yet to decide the capex schedule for the Balkan Gas Hub, and the appeal on the EPC contractor process adds uncertainty. We also expect BEH's stand-alone performance to improve, with EBITDA increasing to BGN885 million-BGN895 million in 2019-2020 from BGN479.7 million in 2018. If BEH's performance improves beyond our current expectations, this could further offset the impact on BEH's consolidated financials and improve its ability to support NEK.
We view NEK's stand-alone credit quality as relatively stable, despite much weaker-than-expected results in 2018. We understand that these were harmed by one-off factors, including a significant increase in carbon dioxide allowances and the fully provisioned BGN60 million litigation claim from WorleyParsons Nuclear Services JSC.
We think that NEK's performance will likely recover, with its debt-to-EBITDA ratio decreasing to 20x-25x by end-2021 from 46.7x currently. Given continuing market liberalization in Bulgaria, from July 1, 2019, NEK is obliged to purchase power only from RES and highly efficient combined heat and power producers with installed capacity of 1 megawatt and lower. This should improve NEK's cost structure. In addition, the Security of the Electricity System Fund remains in place and it will cover NEK's current tariff deficit going forward.
That said, the state has not yet fully implemented the energy reforms, and its strategic decision regarding the company's historical tariff deficit (accumulated before 2016) is still pending. The estimated deficit is between BGN1.4 billion (Energy and Water Regulatory Commission's decision in June 2014) and BGN1.9 billion (the World Bank's estimate in 2015). Overall, we do not expect NEK will be able to reduce leverage quickly, given its very large accumulated historical debt (BGN2.5 billion reported at Dec. 31, 2018).
The key positive factor for our stand-alone assessment of NEK is the favorable structure of NEK's debt portfolio. NEK owes most of its debt to its parent, BEH (71.1%) and the government (26.5%), with loans to banks making up less than 2.5% of total debt (amounting to BGN64.2 million as of Dec. 31, 2018). We treat the loans from the government and BEH as debt, rather than equity, because they are not structurally subordinated to other liabilities. However, we still think that NEK has some flexibility regarding repayments to its parent, and that it will be able to make debt payments to banks according to schedule. We therefore assess NEK's stand-alone credit profile (SACP) at 'b-', factoring in ongoing support from the parent.
We continue to regard NEK as a strategically important subsidiary of BEH and consequently add two notches of uplift from NEK's 'b-' SACP. We cap our rating on NEK one notch below the 'bb-' group credit profile (GCP). Although we do not rate BEH, we factor its credit quality into our rating on NEK. We regard BEH as a government-related entity with a moderate likelihood of receiving extraordinary state support. The 'bb-' GCP takes into account our view of potential extraordinary state support.
The negative outlook reflects our view that the parent's ability to support NEK could reduce. This could happen if the abovementioned sizable investment projects lead to meaningful deterioration of BEH's credit quality, and improvements in BEH's performance beyond our current expectations, state support, capex delays, and the project structure are not sufficient to offset this deterioration. The outlook revision also reflects our view that NEK will likely remain highly dependent on parental support.
We would likely lower the rating on NEK if BEH's credit quality deteriorates to 'b+', based on weaker operating performance, higher leverage, weaker liquidity, or a sovereign downgrade. We could also lower the rating if parental support from BEH diminishes meaningfully. Finally, we could downgrade NEK if we saw a significant deterioration in its liquidity and in its ability to generate sufficient cash flow to repay its relatively modest external debt. However, this is not part of our base case.
A revision of the outlook to stable would largely depend on BEH's performance stabilizing at the 'bb-' level. This would mainly depend on:
- The actual terms of coming investment projects--in particular, the timing and volume of investments or potential government support;
- Debt-to-EBITDA dropping below 4.0x and FFO to debt rising above 20% on a sustainable basis; and
- Maintenance of adequate liquidity.
We could also take a positive rating action on NEK if we saw the successful implementation of market liberalization in Bulgaria, strategic decisions by the company to remove its old accumulated tariff deficit or to dispose of its assets in Belene, and the consequent repayment of the loan to the Bulgarian government."
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