Wrap Text
Fitch downgrades Eskom SOC Ltd to 'BBB', Outlook Stable
ESKOM HOLDINGS SOC LTD
FITCH DOWNGRADES ESKOM SOC TO 'BBB'; OUTLOOK STABLE
Fitch Ratings-London-11 December 2015: Fitch Ratings has downgraded South African utility
Eskom Holdings SOC Ltd's (Eskom) Long-term local currency Issuer Default Rating (IDR)
to 'BBB' from 'BBB+'. The Outlook is Stable. A full list of rating actions is at the end of this
commentary.
The rating action reflects the downgrade of South Africa's Long-term local currency IDR to 'BBB'
from 'BBB+' and Long-term foreign currency IDR to 'BBB-' from 'BBB' (see 'Fitch Downgrades
South Africa to 'BBB-'; Outlook Stable' dated 4 December 2015 on www.fitchratings.com)
Fitch continues to assess the links between Eskom and the government of South Africa (BBB-/
BBB/Stable) as strong, evidenced by the Guarantee Framework Agreement (GFA) and most
recently by the equity conversion of the government's subordinated loan to Eskom. Fitch's
expectation of additional equity contributions in FY16 also supports the alignment of Eskom's IDR
with that of the sovereign.
Fitch views Eskom's standalone creditworthiness as 'B-', reflecting its high leverage, negative
free cash flow and weak liquidity position. While operating profitability has improved (EBITDA
FY15: ZAR27.1bn; FY14: ZAR25.3bn), increased debt has resulted in slight deterioration in both
the leverage and coverage metrics for FY15. Fitch expects Eskom's standalone credit metrics to
worsen for FY16. However, Fitch forecasts the combination of the announced sovereign support
and improved trading expectations (largely driven by tariff increases) to result in relatively stable
leverage for FY16.
KEY RATING DRIVERS
Sovereign Support
In FY15 the government provided tangible evidence of its support for Eskom through the decision
to convert its subordinated shareholder loan (ZAR26.6bn carrying value) to equity, as well as
providing a further undertaking to provide an additional ZAR23bn equity contribution (ZAR10bn
received in July 2015, ZAR10bn expected to be provided in December 2015 and the final
ZAR3bn in March 2016). We continue to view both the new equity, and debt to equity conversion,
as an indication of strong sovereign support for Eskom, despite pressure on the sovereign's
creditworthiness. Along with the GFA, they are the most important elements supporting the
continued rating alignment with the sovereign.
Government Guaranteed Debt
At FYE15 the group had ZAR147bn of government guaranteed debt representing 49% of
outstanding debt for the year. The government guaranteed facilities are set out under the GFA
under which Eskom has available undrawn facilities of ZAR191bn (ZAR50bn is under the specific
domestic multi-term note programme).
Importantly, Eskom's debt issued outside the GFA benefits from a priority of payment clause
where the company would first apply its available resources towards repayment of non-guaranteed
debt given that guaranteed debt is ultimately serviced by the government. We expect Eskom to
continue to issue both guaranteed and unguaranteed debt according to market demand but do not
expect the share of the state-guaranteed debt to reduce significantly below 50% in the short to
medium term.
Management Changes
Fitch views positively the permanent appointment of Brian Molefe as CEO and Anoj Singh as
CFO, delivering clarity to the group's executive management and addressing near-term uncertainty
over governance and strategic direction. A new executive committee was announced on 22 October
2015, which is expected to stabilise and strengthen the utility's leadership.
Weaker Cash Position Impacts Liquidity
While the group has shown some improvement in EBITDA profitability (core EBITDA remains
relatively stable but there are improvements in other revenues and expenses), it still has extensive
capital expenditure and the increase in primary energy costs resulted in a decrease in cash held at
FYE15 (ZAR8.8bn). The additional equity contributions following FY15 are aimed at addressing
short-term liquidity requirements. The group will continue to rely on its ability to raise sufficient
funding to meet capex requirements.
Management has indicated that the ZAR20bn cash liquidity buffer remains a liquidity target.
Sufficient liquidity will be maintained for short-term requirements while capex requirements will
be met through additional long-term debt.
Standalone 'B-' Credit Profile
Eskom's standalone credit profile is commensurate with a 'B-' rating, reflecting the expectation
of significant and increasing leverage required to fund the capacity expansion programme.
The execution risks associated with the capex programme are highlighted by the timing delays
experienced on all of the current major projects (Medupi, Kusile and Ingula).
Negative Cost Control Impacts
Primary energy costs increased by 19% (higher than tariff increases or inflation) for FY15
to ZAR83.4bn (FY14: ZAR69.8bn) with adverse impacts from coal and Independent Power
Producers. We expect primary energy costs to remain significant in FY16 and FY17 before moving
closer to inflation in the medium term.
Due to delays with Medupi, Eskom was forced to pay penalties under its take-or-pay coal
agreement resulting in a negative impact of ZAR6.8bn. Increased payments to IPPs also
significantly increased primary energy costs by ZAR6.2bn. The continuing use of open cycle gas
turbine (OCGT) fuels, although lower than in FY14, was still a significant ZAR9.5bn cost to the
group (the highest primary energy cost after coal).
Tariff Determination
Nersa, South Africa's energy regulator, allowed Eskom to recoup costs of ZAR7.8bn incurred
during its previous price control (1 April 2012 - 31 March 2013), translating into a 12.7% tariff
increase from 1 April 2015. Eskom has also submitted a further application within this regulatory
clearing account to Nersa for compensation for amounts under-recovered from 1 April 2013 to 31
March 2014. If approved, this may improve pricing from 1 April 2016.
We expect tariff increases of around 13% for FY16 and FY17 to allow for some improvement in
Eskom's credit metrics from FY16. Failing that, further equity support from the government may
be needed. Nersa disallowed Eskom's application for an additional increase of 9.5% in FY16 under
its selective reopener to cover costs for OCGT and the Short-term Power Purchase Programme,
which we expect will lead to further leverage requirements for FY16.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Eskom include:
- The debt/equity swap of the ZAR60bn (ZAR26.6bn carrying value) subordinated shareholder
loan reflected in FY16.
- The additional ZAR23bn equity contribution from the shareholder reflected in FY16.
- Growth in volumes sold limited in FY16 due to load shedding and operational limitations
thereafter assumed to follow GDP growth.
- Tariffs charged reflect the 12.7% increase for FY16 with similar expectations for FY17,
thereafter with high single digit increases.
- Primary energy cost expectations are for low double digit increases in FY16 and FY17 followed
by high single digit increases thereafter.
- Employee expenses assumed to grow at CPI in the short term with higher growth in the medium
term as financial position improves.
- Capex intensity remains high in short-term with some moderation in the medium term.
RATING SENSITIVITIES
Negative: Future developments that could lead to a downgrade include:
- A decline in government support or a downgrade of South Africa's sovereign rating.
- Failure to achieve more cost-reflective tariffs, in the absence of increased government support,
resulting in an unsustainable financial profile and a reduction in Eskom's debt service capability.
Positive: Future developments that could lead to the Outlook being revised to Positive include:
- The revision of the Outlook on South Africa's sovereign rating to Positive, providing that the
strength of parent-subsidiary linkage does not weaken.
LIQUIDITY
At end-FY15 the group had cash reserves of ZAR8.8bn and a ZAR500m revolving credit facility
against short-term maturities of ZAR19.9bn. Eskom continues to maintain a further ZAR6.0bn
of short-term investments in securities, which could be accessed at short notice to support its
liquidity position. The additional ZAR10bn equity contribution from the sovereign is expected
to be received in December 2015 and a further ZAR3bn in March 2016 supporting the liquidity
position.
FULL LIST OF RATING ACTIONS
Long-term local currency IDR downgraded to 'BBB' from 'BBB+'; Outlook Stable
Local currency senior unsecured rating downgraded to 'BBB' from 'BBB+'
National Long-term rating affirmed at 'AAA(zaf)'; Outlook Stable
National Short-term rating affirmed at 'F1+(zaf)'
Contact:
Principal Analyst
Paul Lund
Senior Director
+44 20 3530 1244
Supervisory Analyst
Richard Barrow
Director
+44 20 3530 1256
Fitch Rating Limited
30 North Colonnade
London E14 5GN
Committee Chairperson
Josef Pospisil
Senior Director
+44 20 3530 1287
Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email:
peter.fitzpatrick@fitchratings.com.
Additional information is available on www.fitchratings.com. For regulatory purposes in various
jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this
issuer; the principal analyst is deemed to be the secondary.
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
(pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
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