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Media Notice
ESKOM HOLDINGS SOC Ltd
11 September 2014
MEDIA STATEMENT
SUBJECT: MOODY’S INVESTOR SERVICES CREDIT OPINION UPDATE
ESKOM HOLDINGS SOC LIMITED NOTED MOODY’S SERVICES CREDIT OPINION UPDATE. KINDLY REFER TO THE CREDIT OPINION
BELOW.
Credit Opinion: Eskom Holdings SOC Limited
Global Credit Research- 05 Sep 2014
Johannesburg, South Africa
Ratings
Category Moody's Rating
Outlook Negative
Senior Unsecured Baa3
Contacts
Analyst Phone
Paul Marty/London 44.20.7772.54
54 Niel Bisset/London
Monica Merli/London
Key Indicators
Eskom Holdings SOC Limited[1]
3/31/2014 3/31/2013 3/31/2012 3/31/2011 3/31/2010
CFO pre-WC + Interest/ Interest 1.6x 2.0x 3.0x 3.3x 4.1x
CFO pre-WC / Debt 3.6% 6.5% 13.6% 13.1% 13.4%
CFO pre-WC - Dividends / Debt 3.2% 5.7% 12.7% 12.4% 11.1%
Debt / Capitalization 70.2% 66.5% 61.8% 63.4% 61.9%
[1] All ratios are calculated using Moody's Standard Adjustments. Source: Moody's Financial Metrics
Note: For definitions of Moody's most common ratio terms please see the accompanying User's Guide.
Opinion Rating Drivers
- Expectation of high government support reflects Eskom's critical importance to South Africa's economy
- Large capex programme needed to expand the country's electricity infrastructure
- Challenging regulatory environment against a backdrop of rising energy costs
- Weak financial profile
Corporate Profile
Eskom Holdings SOC Limited ("Eskom", Baa3 / negative) is the dominant, vertically-integrated utility in South
Africa, generating 95% of the country's electricity and supplying directly 55% of all end users (the remaining 45%
are sold to redistributors, including municipalities). The company has an installed generating capacity of 42 GW, of
which approximately 85% is coal-fired, with the rest being a mix of hydro, nuclear and gas. In 2013/14, electricity
sales totalled approximately 218 TWh. Eskom also owns and operates approximately 359,000 km of power
transmission and distribution lines.
Eskom is fully-owned by the government of South Africa (Baa1 / negative) through the department of Public
Enterprises. Eskom is regulated under licences granted by the National Energy Regulator of South Africa
(NERSA) under the Electricity Regulation Act of 2006.
SUMMARY RATING RATIONALE
Eskom's Baa3 rating reflects (1) an expectation of high probability of government support for Eskom, reflecting the
company's critical role as supplier of substantially all electricity used within South Africa; (2) a challenging
regulatory framework relative to operating costs in the context of a very stretched electricity system until new
generation comes on stream; (3) the risks associated with the execution of a large capital investment programme,
which has been subject to some delays and cost overruns; and (4) Eskom's weak financial profile.
Given the full ownership by the South African government, Eskom's rating is based on Moody's rating
methodology for government-related issuers (GRIs), and combines (1) the company's stand-alone credit quality or
Baseline Credit Assessment (BCA) of b1, reflecting very weak credit metrics, and (2) an uplift for the potential
support the government of South Africa is likely to provide to Eskom in a distress situation - as evidenced by the
direct financial assistance provided in the past, such as the guarantee framework agreement of R350 billion ($35
billion) and a R60 billion ($6 billion) subordinated loan.
Note that Eskom's Baa3 senior unsecured debt ratings relate to bonds and a note programme that are not
supported by the government guarantee.
DETAILED RATING CONSIDERATIONS
EXPECTATION OF HIGH GOVERNMENT SUPPORT REFLECTS ESKOM'S CRITICAL IMPORTANCE TO
SOUTH AFRICA'S ECOMOMY
Given a stand-alone credit quality commensurate with a speculative-grade profile, Eskom's investment-grade
rating relies upon the support that we expect would be provided by the government of South Africa in a distress
scenario. The assumption of high support under Moody's rating methodology for GRIs reflects Eskom's strategic
and critical importance to the government's social and economic policy: in addition to providing basic electricity
connections to households and townships that remain unserved despite the democratic transition in 1994, Eskom
is executing a large-scale investment programme required to expand South Africa's infrastructure in order to
remove growth bottlenecks. The success of these two complementary strategies is crucial for the country's
overall growth and future development - and, arguably, even for its political stability.
Our expectation of high support is evidenced by significant, tangible support via (1) the government's R350 billion
Guarantee Framework Agreement (GFA) and (2) the subordinated loan amounting to R60 billion.
The GFA allows Eskom to request government guarantees on loans up to an aggregate of R350 billion (up from
the previous R176 billion limit). Of the guaranteed amount as of 30 June 2014, R126 billion is currently drawn
under existing facilities. Eskom's domestic multi-term note programme, totalling R100 billion, is covered by this
guarantee plus other loans as determined by the company and the government. The GFA makes provision for
payment of unguaranteed debt to be met from cash flow before it would be applied to the guaranteed debt thereby
indirectly improving the status of the unguaranteed debt. Should the guarantee be called by the beneficiary, the
obligation would be converted into a subordinated loan from the government to the company under similar terms
and conditions as those for the R60 billion subordinated loan. However, this does not legally protect creditors
against insolvency.
The government has also demonstrated its support for Eskom through the implementation of a R60 billion
subordinated loan which has been already received in full. Key features of this loan are loan interest coupons and
financial covenants that permit Eskom to permanently waive interest payments to the government when such
payments would impair the company's financial profile. This provides Eskom with some financial flexibility and
reinforces our view that the government is supportive of the company. Although Eskom has the right to repay this
loan before term, we expect it to be a long-term feature of Eskom's capital structure.
LARGE CAPEX PROGRAMME NEEDED TO UPGRADE THE COUNTRY'S ELECTRICITY
INFRASTRUCTURE
Eskom is engaged in a significant investment programme to expand and upgrade South Africa's electricity
infrastructure to meet the country's changing power needs following a period of underinvestment in the past
decade. Eskom is thus currently carrying out a capacity expansion programme which should contribute some
additional 11 GW by 31 March 2019 from the current position. The company's programme includes the coal-fired
power plants Medupi and Kusile (approximately 4.8 GW each) and pumped storage plant Ingula (1.3 GW). The
execution of this capital programme has been hampered by delays and cost overruns. The completion of the first
unit of Medupi was targeted for end of 2013 but this has been delayed until second half of 2014. The completion of
the entire power station is targeted for 2017. Kusile's first unit is targeted for the second half of 2015 and
completion in 2019, whilst Ingula's completion is targeted for 2015. The aggregate construction cost of these three
plants is currently estimated at approximately R250 billion, of which 65% has already been completed.
In additionto Eskom's capacity expansion programme, the Department of Energy's Integrated Resource Plan
(IRP) updated in November 2013, and which sets out a long-term energy plan for the period 2010-2030, provides
for total installed generation capacity of 81 GW by 2030. This was scaled down by around 8 GW from the previous
2010 plan, reflecting lower electricity intensity of the economy. The plan envisages the development of renewable
energy - up to 17.4 GW - as well as a nuclear fleet plant strategy of 6.7 GW by 2030, although no such capacity is
required before 2025, leaving the door open to alternative options. The decommissioning of Eskom's older coal-
fired power stations is expected to start in 2020, although the plan acknowledges the potential for life extension. By
2030, coal-based power generation is expected to still account for close to 50% of South Africa's installed
capacity.
CHALLENGING REGULATORY ENVIRONMENT AGAINST A BACKDROP OF RISING ENERGY COSTS
South Africa's energy tariffs have historically been amongst the lowest in the world. Against a background of low
investments during the 1990s and - until around 2007 - tariff increases often below inflation, it has been a
significant challenge for the regulator to increase tariffs without harming users unduly. The regulator and Eskom's
principal stakeholders have accepted that prices have to rise in real terms in order to finance the company's
increasing investment needs, and this has been the case since 2008. However, fully cost-reflective tariffs have
yet to be implemented.
Section 15 of the Electricity Regulation Act 2006 states that regulation must allow an efficient licensee to recover
the full cost of its licensed activities, including a reasonable margin or return. Further, NERSA's electricity pricing
policy of November 2008 addresses a number of pricing and tariff issues in principle, such as recognising the
importance of allowing an electricity business to recover its prudent costs of operation and an appropriate return,
to ensure that it is able to fund its operations and make provision for capital expansion. With regard to the
appropriate rate of return, it provides that the assets be valued in an appropriate manner and at a level that covers
the full cost of production, including a reasonable risk-adjusted margin or a return on appropriate asset values.
The first multi-year price determination ran for the period 1 April 2006 to 31 March 2009, followed by the second
multi-year price determination(MYPD2) untilMarch 2013. In its final determination for MYPD2, NERSA approved
tariff increases of around 25% per annum. In March 2012, NERSA reduced price increases for the last year of the
MYPD2 down to 16% from the originally approved 25.9%, based on such application by Eskom. At the time of the
announcement, the Department of Energy indicated that the regulatory period should be five, instead of three
years, to compensate for the downward tariff adjustment.
In February 2013, NERSA approved an 8% annual tariff increase for the period from 1 April 2013 to 31 March 2018
(MYPD3), significantly lower than the 16% requested by Eskom. This will translate into revenues of around R863
billion ($90 billion) over the period, which compares with the R1.087 trillion ($110 billion) applied for by Eskom.
Eskom is unlikely to make up this shortfall solely through efficiencies, and has thus engaged with its shareholder
to discuss its investment and financing options. This adverse regulatory settlement is even more acute in a
context of rising primary energy costs as coal mining and associated costs have been driven upwards by factors
such as depleting reserves, deteriorating coal quality and longer transportation distances. This has been further
exacerbated by a lack of generation capacity and other inefficiencies.
WEAK FINANCIAL PROFILE
The group's financial metrics weakened further in 2013/14 as a result of lower tariff increases than in the previous
year, higher operating costs, and the continued roll out of its large capex programme. Revenue for the financial
year ended 31 March 2014 was R139.5 billion, up by 8% vs. 2012/13 primarily reflecting the 8% annual tariff
increase granted under MYPD3 and flat volumes sold. This was offset by an 8% increase in operating costs
driven by higher primary energy costs, which were in turn due to the need to operate more expensive OCGT
plants to ensure continuity of supply. After capex in excess of R55 billion, net debt (net of derivatives) rose to
R241 billion at 31 March 2014 from R194 billion at 31 March 2013. As a result, financial metrics weakened to
RCF/debt of 3.2% versus 5.7% in the prior year.
Eskom has been working with the regulator and an inter-departmental task team comprising of the Departments of
Public Enterprises, Energy and National Treasury to come up with a solution to the challenges it faces. We
understand that the task team should present its report to the Cabinet of South Africa in September and we
therefore expect an announcement shortly thereafter. Nonetheless, we believe that it will be a challenge for the
government to approve additional material increases in tariffs given their impact on economic growth and
employment. In the absence of significant tariff hikes and/or equity injection, Eskom's financial profile is likely to
remain stretched for the foreseeable future given its committed investment programme and rising operating costs.
Liquidity
Liquidity is adequate. Based on the 8% annual tariff increase granted by NERSA over MYPD3, we expect Eskom
to generate cash flow from operations of around R15 to 20 billion per annum, which is insufficient to fund annual
capex in excess of R50 billion (there is a moratorium on dividends during the capital expansion phase). Taking into
account annual debt repayments of R15 to 20 billion on average in 2014 and 2015, we thus estimate that Eskom
has financing needs of approximately R50 billion per annum. For the year 2014/15, this is only partly covered by
cash reserves and available-for-sale investments of R30 billion at 31 March 2014. Eskom expects to raise the
remaining funds from various financial institutions with which it has undrawn committed facilities (export credit
agencies, World Bank, African Development Bank, Development Bank of South Africa). In addition, approximately
R180 billion are currently unused under the government's GFA and could be utilized if necessary.
Rating Outlook
The negative outlook reflects the company's weakening standalone credit quality and the risk that the government
and the regulator may not take sufficient tangible measures to improve Eskom's financial profile and ultimately
ensure its sustainability.
What Could Change the Rating - Up
Given the negative outlook, upwards rating pressure is unlikely. However, we could stabilise the outlook on the
rating if (1) the outlook on the government's rating were to stabilise, and (2) a structural solution to Eskom's
stressed financial profile were to be found, most likely in the form of tariff increases and/or permanent government
subsidies.
What Could Changethe Rating- Down
Conversely, downwards rating pressure could develop if (1) Moody's were to further downgrade the government's
rating; (2) the measures expected to be announced in September fail to address Eskom's challenges as
discussed above; or (3) our assessment of high government support for the company were to change.
Other Considerations
Eskom is rated in accordance with the rating methodologies "Regulated Electric and Gas Utilities", published in
December 2013, and "Government-Related Issuers: Methodology Update", published in July 2010.
Rating Factors
Eskom Holdings SOC Limited
600008659
Regulated Electric and Gas Utilities [1] [2]Current As [3]Moody's 12-18 months
at 3/31/2014 forward view As at September
2014
Factor 1: Regulatory Framework (25%) Measure Score Measure Score
a) Legislative and Judicial Underpinnings Ba Ba
of the Regulatory Framework
a) Consistency and Predictability of B B
Regulation
Factor 2: Ability To Recover Costs And Earn
Returns (25%)
a) Timeliness of Recovery of Operating Caa Caa
and Capital Costs
b) Sufficiency of Rates and Returns B B
Factor 3: Diversification (10%)
a) Market Position Ba Ba
b) Generation and Fuel Diversity B B
Factor 4: Financial Strength (40%)
a) CFO pre-WC + Interest/ Interest (3 2.2x Ba 1.0x - 2.0x B
Year Avg)
b) CFO pre-WC / Debt (3 Year Avg) 7.3% Ba 0%-5% B
c) CFO pre-WC - Dividends / Debt (3 6.6% Ba 0%-5% Ba
Year Avg)
d) Debt/Capitalization (3 Year Avg) 66.6% B 70%-75% B
Rating:
a) Indicated Rating from Grid B1 B2
b) Actual BCA Assigned b1 b1
Government-Related Issuer Factor
a) Baseline Credit Assessment b1
b) Government Local Currency Rating Baa1
c) Default Dependence High
d) Support High
[1] All ratios are calculated using Moody's Standard Adjustments. [2] As of 3/31/2014; Source: Moody's Financial
Metrics [3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not
incorporate significant acquisitions and divestitures.
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Further information on the Eskom Holdings SOC Ltd bond issue can be obtained from
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