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ESKOM HOLDINGS SOC LIMITED - STANDARD & POORS RATINGS AFFIRMATION

Release Date: 02/02/2015 15:00
Code(s): EL15 EL31 ES15 EL36 ES33 ES42 EL037 EL28 EL30 EL29 ES18 ES23 ES26     PDF:  
Wrap Text
STANDARD & POORS  RATINGS AFFIRMATION

ESKOM HOLDINGS SOC LIMITED
Market Notice


2 February 2015

SUBJECT: STANDARD & POORS RATINGS AFFIRMATION
(ESKOM HOLDINGS SOC LIMITED )

====================================================
South African Power Utility ESKOM 'BBB-' Ratings Affirmed Despite Strained Liquidity;
Outlook Still Negative

Research update by S&P
Overview
We consider that ESKOM's liquidity headroom has deteriorated due to
project delays and higher costs, so we've reassessed the company's
liquidity to less than adequate from adequate.
Our current view of ESKOM's liquidity does not affect our 'b-' assessment
of the company's stand-alone credit profile (SACP).
We continue to assume there is an extremely high likelihood that ESKOM
would receive extraordinary state support if needed, which currently
leads us to add six notches of uplift to the SACP.
 We are affirming our 'BBB-' long-term corporate credit ratings, and our
'zaAA-/zaA-1' national scale ratings on ESKOM.
The negative outlook reflects our opinion that there is important
execution risk associated with the government's support plan, and that
ESKOM's operating performance has not yet stabilized due to rising costs
and the very tight capacity margin in South Africa.

Rating Action
On Jan. 29, 2015, Standard & Poor's Ratings Services affirmed its 'BBB-'
long-term corporate credit ratings, and its 'zaAA-' long-term and 'zaA-1'
short-term South Africa national scale ratings on power utility ESKOM Holdings
SOC Ltd. The outlook is negative.

Rationale
The affirmation reflects our view that ESKOM's credit metrics will remain
consistent with its current stand-alone credit profile (SACP) despite pressure
on its liquidity position.
Our view of ESKOM's "weak" business risk profile reflects our assessment of a
"weak" regulatory advantage under the framework supervised by the national
energy regulator of South Africa. The business risk profile also reflects
important execution and operational risks associated with the very large
capital expenditures program, which has been subject to successive delays at a
time when South Africa's reserve margin remains stretched.
We note positive steps regarding the implementation of the South African
government's support plan, including a tariff increase to approximately 12.7%
for the 12 months starting April 1, 2015, and the government's plans to
implement an asset sale program. However, noting the recently announced
extensions to the completion of new plants and the reliance on diesel
purchases, we consider that some of this government support may be slow in
boosting ESKOM's deteriorating liquidity profile. We also consider that,
without a more permanent solution for ESKOM's operational and cost challenges,
the company's business risk profile will likely remain "weak" over the medium
term. These weaknesses are only partly offset by ESKOM's still-dominant
position as the quasi-monopoly power utility in South Africa, with a leading
presence in all parts of the electricity value chain.
Our assessment of ESKOM's "highly leveraged" financial risk profile reflects
our opinion that the company's stand-alone credit metrics will remain weak
over the medium term, due to continued delays in implementing tariffs that
reflect its real-time costs, investment needs, and the rising debt associated
with the large capital expenditures program. We apply our standard volatility
table to ESKOM, as per our corporate methodology criteria, because we assess
its regulatory advantage as "weak."
We have changed our view of ESKOM's liquidity position to "less than adequate"
from "adequate" due to the following observations:
Increased use of expensive diesel fuel, due to a combination of
maintenance outages at coal power stations and project delays on new
generation capacity. The absence of an immediate claw-back pricing
mechanism has resulted in a deterioration of working capital;
Delays and cost overruns at the base-load power stations at Medupi and
Kusile, which intensify pressure on operating costs and capital
expenditures. At this stage, we don't expect completion of these plants
until the second half of 2015 at the earliest. However, Eskom's official
timeline is that the first unit at Medupi will be synchronized with the
grid in the first half of 2015, with the other units to follow gradually.
We note that ESKOM has large amounts of potential headroom under a South
African rand (ZAR) 350 billion (approximately US$30 billion) program of
government guaranteed issuances (ZAR153 billion of this program has been
used and ZAR200 billion remain outstanding). However, we do not typically
consider future issuances under this program to be committed funding.
ESKOM faces capital market debt repayments from January 2015 to January
2016 of about ZAR30 billion of maturing commercial paper (CP) and capital
market debt. Of this, about ZAR22 billion of debt repayment will come due
before June 30, 2015.
The South African government has come forward with an additional support
package that we expect will become effective in the second half of 2015.
The package consists of a ZAR23 billion equity injection from an asset
disposal program and a ZAR60 billion subordinated loan from the
government, which is intended to be converted to equity. Moreover, there
exists an allocation of additional debt of ZAR50 billion under the
existing government guarantee framework to the domestic medium term note
(DMTN) program. In our opinion, these measures will make an impact on
ESKOM's financial health and liquidity only in the second half of 2015.
We believe that this support is subject to some execution risk because
the plan requires elements of new capital market issuance that has not
been committed.
Our current view of ESKOM's liquidity does not affect our 'b-' assessment of
the company's SACP.
We consider ESKOM to be a government-related entity (GRE). Under our criteria
for GREs, we believe there is an "extremely high" likelihood that the Republic
of South Africa would provide timely and sufficient extraordinary support to
ESKOM in the event of financial distress. This is based on our view of
ESKOM's:
 "Very important" role for South Africa, since it is the nation's dominant
electricity provider. The government considers ESKOM to be a strategic
asset and, in our view, privatization is unlikely in the medium term.
ESKOM provides an essential commodity to municipalities and large
industrial customers; and
"Integral" link to the South African government, reflecting its full
ownership by the government and the explicit government support.
Furthermore, ESKOM obtained a dividend waiver during the build program.
Furthermore, the South African government has a strong track record of
providing extraordinary support to critical GREs, including ESKOM, which has
received capital injections and large guarantees from the government in the
past.
Our assessment of the likelihood of government support leads us to apply six
notches of uplift to the SACP, resulting in our 'BBB-' long-term rating on
ESKOM.

Liquidity
Our "less than adequate" assessment of ESKOM's liquidity reflects the pressure
ESKOM faces, based on our assumptions of negative working capital, higher
capital expenditures, and the continued challenging operational environment.
In addition, we think that the company has a relatively high dependence on
what we consider to be uncommitted sources of funding to support its debt
maturity profile.
In our calculation of the company's liquidity sources, we include
sovereign-guaranteed domestic bond issuances amounting to about ZAR12
billion-ZAR15 billion from Jan. 21, 2015, to Jan. 21, 2016, along with
committed facilities amounting to ZAR13 billion from development finance
institutions (DFIs) and export credit agencies (ECAs). We note that the
company may choose to draw down close to ZAR41 billion under the ZAR150
billion sovereign-guaranteed DMTN bond program over March 2014-March 2018, of
which currently ZAR51 billion are still available to be issued. But these
amounts could change, depending on discussions with the government regarding
how to utilize the remaining ZAR200 billion in government guarantee issuances.
However, in our view, the company is unlikely to tap more than ZAR12
billion-ZAR15 billion under its domestic bond program in any given year, based
on what may be some constraints on the domestic market's capacity to absorb
such issuances. We note that ESKOM currently continues to tap issuances of
potentially between ZAR1 billion and ZAR2 billion per month under its CP
program, and is currently exploring alternative funding sources by way of
banks and capital markets as well as the announced equity contribution from
the government through the government's asset disposal program. If these
initiatives are executed successfully, they could help boost the company's
liquidity. However, we do not include potential future sources of CP program
issuances as sources under our liquidity criteria, nor do we include potential
future sovereign-guaranteed issuances (beyond our one-year outlook horizon) or
any other potential issuance. This is because we do not assume that companies
are able to borrow in the future unless such lines are committed. Furthermore,
we do not include the government's expected equity contribution from future
asset disposals.
We forecast that ESKOM will have a ratio of liquidity sources to liquidity
uses of less than 1.2x over the 12 months started Jan. 21, 2015.
We calculate that ESKOM has the following liquidity sources for the 12 months
started Jan. 21, 2015:
Cash and marketable securities of about ZAR19.4 billion;
Estimated funds from operations (FFO) of between ZAR18 billion and ZAR22
billion;
Committed lines of ZAR1.4 billion; and
Debt of about ZAR25 billion to be raised from committed or reliable
sources such as DFIs and ECAs, and the domestic bond market.
For the same period, ESKOM had the following uses of funds for the following
12 months:
Capital expenditures of about ZAR60 billion;
Negative working capital of about ZAR5 billion-ZAR15 billion; and
Loans and interest due of about ZAR30 billion.
Outlook
The negative outlook reflects our opinion that there is important execution
risk associated with the government's support plan, and that ESKOM's operating
performance has not yet stabilized due to rising costs and the very tight
capacity margin in South Africa. Moreover, we think that there is a risk that
ESKOM's financing needs may exceed what is currently covered in the
government's additional support package.
To revise the outlook to stable, we would need to believe that ESKOM could
sustain an adjusted FFO-to-debt ratio of at least 5% in the medium term, with
no additional pressure on liquidity.

Downside scenario
We could lower the ratings on ESKOM if we were to revise our SACP assessment
to the 'ccc' category, or if we saw a reduced likelihood of extraordinary
support for the company. A deterioration of the SACP could result from further
erosion of ESKOM's liquidity, or weakening of credit metrics to such an extent
that adjusted FFO to debt fell significantly below 5% over an extended period.
This could occur, for example, if the regulator does not grant additional
tariff increases during the current regulatory period (MYPD3), as it did for
the fiscal year ending April 2016, if other elements, such as the announced
equity contribution from the government's asset disposal program or conversion
of government loans to equity, or if ESKOM's operating performance
deteriorated further because of additional cost overruns or a lack of progress
in planned efficiencies, without offsetting government support. A weakening of
the SACP by one notch would, all else being equal, likely result in a
one-notch downgrade of ESKOM to 'BB+'.
We could also lower the ratings if we were to revise downward our assessment
of the likelihood of extraordinary support from "extremely high." This could
occur if ESKOM develops additional funding requirements that are not
explicitly covered by government support, or if the announced support program
is not implemented on time or in full. All else remaining equal, this could
lead us to downgrade ESKOM by two notches, to 'BB'.
Finally, we could lower the rating on ESKOM if we were to lower the rating on
the sovereign, all else remaining equal. Under our criteria for GREs, a
lowering of the local currency sovereign rating by one notch would result in a
one-notch downgrade of ESKOM.



Upside scenario
We consider an upgrade unlikely in the foreseeable future. Under our GRE
criteria, an upward revision by up to two notches of our assessment of ESKOM's
SACP would not result in an upgrade of ESKOM, assuming unchanged government
support.
However, an upgrade could materialize if we believed the likelihood of
government support had increased to "almost certain," which would result in us
equalizing the rating on ESKOM with that on the sovereign. That said, we
consider this unlikely in light of the government's finite resources and the
actions it has taken to support ESKOM to date.

Ratings List
Ratings Affirmed
ESKOM Holdings SOC Ltd.
Corporate Credit Rating BBB-/Negative/--
South Africa National Scale zaAA-/--/zaA-1
Senior Secured BBBSenior
Unsecured BBBWWW
_________________________________________________________________________________



Further information can be obtained from
Francois Venter        ESKOM               (011 800-4050)

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