Rushydro Outlook Revised To Positive On Recapitalization And Improving Performance, #BB/B# Ratings Affirmed

Stocks and Financial Services Press Releases Monday December 19, 2016 17:27
MOSCOW--19 Dec--S&P Global Ratings

MOSCOW (S&P Global Ratings) Dec. 19, 2016--S&P Global Ratings today revised its outlook on Russian state-controlled hydropower company PJSC Rushydro to positive from stable. At the same time, we affirmed our 'BB/B' long- and short-term corporate credit ratings and 'ruAA' Russia national scale rating on the company.

The outlook revision reflects our expectation that recapitalization and improving operating performance could prompt an upgrade, fueled by expected strengthening in Rushydro's financial metrics. We currently assess its stand-alone credit profile (SACP) at 'bb and see upside rating potential if the company's credit measures sustainably strengthen, including funds from operations (FFO) to debt above 30%, and if negative free operating cash flow (FOCF) turns at least neutral following the 2017 peak we expect in capital expenditures (capex).

On Nov. 24, 2016, Rushydro's board approved recapitalization under which state-owned VTB Bank acquires newly issued shares for Russian ruble (RUB) 40 billion and quasi-treasury shares for RUB15 billion. As a result, VTB will hold 13% of Rushydro, with the Russian government's stake dropping to 60.5% from 66.8%.

We expect RusHydro's financial metrics will benefit from ongoing recapitalization and higher EBITDA generation, supported by low costs and higher water levels at hydro power plants (HPPs), capacity market liberalization for HPPs in 2017, and cost cutting and capex optimization efforts, particularly at the company's less-efficient thermal power generation subsidiary RAO Energy System of the East. This is offset by the large capex program set to peak in 2017 and the resulting negative FOCF.

In 2016, Rushydro enjoyed higher water levels, which support higher electricity output and increased EBITDA. In 2017 and beyond, the company should benefit from liberalization of hydropower capacity payments. Commercial capacity auctions have already taken place and should bring incremental stable revenues. As a hydropower-focused group, Rushydro benefits from its position as a low-cost, renewable, and flexible electricity producer with one of the largest power plant fleets in Russia. Although the Russian electricity industry has some overcapacity in our view, and even though electricity prices are inherently volatile, our expectation of positive economic growth in Russia starting in 2017 should help support electricity demand.

Still, we think Rushydro's FOCF will remain heavily negative due to the expected capex peak in 2017. This is the key constraint on our current SACP assessment for Rushydro, but we assume that capex will fall sharply in 2018.

Rushydro has an aging asset portfolio with large investment needs. With over 75% of installed capacity in hydropower, Rushydro is naturally exposed to weather conditions and water levels. In addition, Rushydro's regulated thermal subsidiary RAO ES of the East continues to face risks linked to a relatively high cost base and politicized tariff-setting. Although Rushydro has approved a new cost-cutting program, we see uncertainty around how quickly the company will implement it. Also, we continue to see some risk that the Russian government could manage RusHydro's strategy with broader social or political intentions, rather than based purely on company-focused economic aims.

In the past, this was illustrated by RusHydro's acquisition of a controlling stake in RAO ES of the East, which was the reason why RusHydro needed to make additional sizable investments in the region's electricity infrastructure. In 2016, the Russian government introduced the requirement of a 50% dividend payout for most government-related entities (GREs), including Rushydro, regardless of the company's heavy investment program.

We believe that recapitalization demonstrates ongoing government support and the government's commitment to retain its strategic influence over Rushydro.

The company plays a very important role for balancing the country's energy system, and remains the key supplier of electricity in some regions, notably in the Far East. If Rushydro were to default, this could have reputational consequences for the government and other GREs, in our view. Still, Rushydro competes with other commercial generators and its stake in Russia's overall electricity output is about 15%. We see a strong link between Rushydro and the government, and we expect the government will keep majority control in the company, in line with the Presidential Decree that sets the minimum government stake at 60.5%. Still, we continue to see potential uncertainty related to the government's plan to increase budgetary revenues through privatization and higher dividends, and we note frequent changes in its privatization program.

Therefore, we continue to foresee a moderately high likelihood of extraordinary state support to Rushydro in the event of financial distress.

We understand that under the forward contract between Rushydro and VTB, Rushydro would have to cover the difference if the price of VTB's stake in five years is below its current price under the transaction, adjusted for dividends paid to VTB (if the price of the stake is higher than currently, VTB would have to pay the difference to Rushydro). However, Rushydro would not have to repurchase the whole stake. In our analysis, we treat recapitalization proceeds as equity, and Rushydro's liability under the forward contract as debt. We understand that the deal is likely to close in the first quarter of 2017 and that management plans to use the proceeds to repay RUB55 billion of legacy debt at the level of its weakest thermal generation subsidiary RAO ES of the East.

The positive outlook on Rushydro reflects potential rating upside if the recent recapitalization and improving operating performance sustainably strengthen the company's financial risk profile over the next 12-18 months, including FFO to debt above 30% and negative FOCF turning at least neutral.

We could upgrade Rushydro if we see sustained strengthening in the financial risk profile, leading to a stronger SACP. This could happen, for example, if we expected that FFO to debt would stay sustainably above 30%, and Rushydro's FOCF turned to neutral or positive after the expected 2017 peak in capex.

We would also likely raise our rating on Rushydro if we raised our rating on the sovereign, or if we revised up our assessment of the likelihood of extraordinary government to the company.

We could revise the outlook to stable if the company's high investments offset benefits from the recapitalization and strengthened operating performance, while preventing sustained strengthening in credit measures. This could lead to FFO to debt staying below 30%, and FOCF remaining negative.


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