Fitch Ratings has assigned Azerbaijan's OJSC Azerenerji (national energy operator) a long-term foreign currency Issuer Default Rating (IDR) of 'BBB-' and Short-term foreign currency IDR of 'F3', Fitch said on Thursday. The Outlook on the Long-term IDR is Positive.
"The ratings and Outlook are aligned with the Republic of Azerbaijan ('BBB-'/Positive/'F3') reflecting strong legal, strategic and operational ties with the government of Azerbaijan," the report said.
Legal ties relate primarily to debt guarantees provided by the government, which covered 87.1% of Azerenerji's total debt (excluding accrued interest) at YE11. Fitch assumes this ratio will remain relatively stable or increase over the next few years in order to support the alignment. Azerenerji is 100% owned by the State Committee on Property Issues, a government agency. Fitch does not expect any significant changes in the legal links in the foreseeable future due to lack of privatisation plans regarding Azerenerji.
Azerenerji's virtual monopoly in Azerbaijan's electricity generation market, considerable position in the distribution segment, and monopoly in the transmission segment demonstrate the company's critical importance to Azerbaijan's economy. Azerenerji's top management is nominated directly by the President of Azerbaijan, which underlines the links with its owner.
Fitch understands that Azerenerji's operations are closely monitored by government agencies, including the review of the company's budget and capex plans.
"Strong links with the government are also evident through the significant direct financial support historically received from the company's owner," the report said.
Government subsidies totalled 0.6 billion manat between 2009 and 2011. Additionally, based on government decrees issued in 2010 and 2011, Azerenerji wrote down 1.8 billion manat of tax and trade payables due to the state treasury and state-controlled SOCAR ('BBB-'/Stable/'F3') and a corresponding amount of historical overdue trade receivables.
Fitch expects Azerenerji's ratings to track any upward or downward movement of the sovereign ratings, assuming unchanged strength of links with the government. The agency does not expect Azerenerji's links with the government to weaken, but such a scenario would lead to a rating downgrade.
Positive characteristics in Azerenerji's standalone profile, which Fitch views as significantly weaker than the government-supported IDRs, are led by the modern, primarily gas fired, generation fleet, improvements in the household receivable collection rates and favourable prospects for energy consumption in Azerbaijan and certain markets in the region (such as Turkey and southern Russia).
Significant capex, mainly debt and government funded, over the past few years resulted in the 6.1GW generation fleet comprising mainly power plants developed or modernised in the late 2000s with over 15 years of average remaining useful life.
"This should provide a good basis for a relatively low maintenance spending and high availability ratios. However, Azerenerji operates a number of small-scale power plants that may be suboptimal from an efficiency point of view," the report said.
Fitch understands this is mostly to support remote residential areas that were not connected to the network or were effectively disconnected as a result of political disputes in the region. Azerbaijan's considerable gas reserves that recently led to increased gas production (and resulted in a reversal of the country's gas balance from net imports to net exports) allowed oil or coal to gas switch, aiding Azerenerji's generation efficiency, and security of supply.
Household receivable collection rates increased to 84 percent in 2011 compared to just 37 percent in 2006 and improved the company's financial position. Fitch anticipates that the planned increase in the number of smart and prepay meters in households should lead to a further increase in the receivable collection rates.
Concerns about the company's standalone credit profile relate to its financial standing and tariff setting process. Gross debt to EBITDA stood at 7.1x in FY11 and Fitch expects leverage to remain high at above 5x over the next two to three years. The slight decrease in leverage is conditional on capex being mainly financed with government subsidies and loans already available at YE11 (no new debt-funded capex is anticipated by the company, except for a 48 million manat loan signed in early 2012). However, the size of the capex plans is significant at 3.1 billion manat, and the agency can not entirely exclude the need for further debt funding in the coming years. Taking into consideration the already high leverage, Fitch would expect Azerenerji to receive guarantees from the government for any new (currently unplanned) debt.
"Overdue taxes and trade payable balances combined with delinquent receivables contributed to a breach of financial covenants with Azerenerji's lending banks, but so far the breaches have been successfully waived," the Agency's experts believe.
Fitch notes that Azerenerji will likely need further tangible government support (tax write-offs and subsidies) to meet its covenants and fund its ambitious capex plans (committed capex was 1.3 billion manat at YE11 of which around AZN1bn is already funded).
Fitch notes that although the 'cost-plus' electricity tariff setting mechanism is generally favourable to energy companies, the application of this model in Azerbaijan is to a large extent limited by social considerations. Changes to electricity tariffs are infrequent. The last tariff increase was made in 2007. This may have a negative impact on Azerenerji's financial results if there was an increase in the cost base dominated by natural gas (supplied by SOCAR) and labour.
The agency notes that the government also regulates domestic natural gas prices and state employees' wage inflation (i.e. the bulk of Azerenerji's cost base) and any significant changes in gas tariffs are likely to be concurrent with electricity tariff changes. Current operating expenditure considerations (as opposed to capex) appear to dominate the electricity tariff determination and recovery of capex via an increase in tariffs is therefore uncertain despite the fact that the tariffs nominally compensate for depreciation (which should reflect the increasing asset base).
Azerenerji's liquidity is weak and conditional on treatment of its overdue payables. Short-term debt amounted to 298.8 million manat at YE11 compared with a cash balance of 54 million manat and credit lines (related to capex) available for drawing of 362.5 million manat (excluding a 47.7 million manat loan from Abu Dhabi Fund signed in late 2011 and utilised in January 2012).
Fitch's forecasts show that cash flow from operations should be broadly sufficient to cover debt service, but only with the assumption that overdue taxes of 0.8 billion manat at YE11 would remain overdue (or be written down).
"The necessity to gradually repay tax balances would either require higher government subsidies or additional debt to be raised, which would be negative for the company's credit profile," the report said.
Free cash flow is expected to remain deeply negative in 2012-2015 due to significant capex plans. However, a large part of capex is viewed as deferrable (around 60 percent) or has funding already arranged (30 percent) with the remaining part expected to have confirmed government funding in place before YE12.