May 03, 2011 |
|Fitch Ratings-London/Moscow-29 April 2011: Fitch Ratings has downgraded OJSC Territorial Generation Company No.2's (TGK-2) Long-term foreign and local currency Issuer Default Ratings (IDR) to 'CCC' from 'B' and National Long-term rating to 'B-(rus)' from 'BBB-(rus)'. Fitch no longer maintains Outlooks for TGK-2 ratings. The agency has simultaneously assigned a foreign and local currency senior unsecured rating of 'CCC', National senior unsecured rating of 'B-(rus)' and a Recovery Rating of 'RR4' to TGK-2's rouble-denominated bonds maturing in 2011 and 2013. |
The downgrades reflect the company's poor cash generation track record in FY08-FY09 and H110, high leverage and resumption of capex growth and Fitch's expectations that TGK-2's financial performance will have deteriorated in FY10 due to low heat tariff increases, poor cash collection, the company's failure to convert its generation facilities in Arkhangelsk to natural gas in 2010 as originally anticipated, as well as breaches of bank loan covenants at 31 Dec. 2010.
TGK-2 reported weak cash flow in 2008-09 and H110, which meant that cash flow from operations (CFO) was insufficient to cover interest payments. This was mostly due to the volatility of fuel oil prices, which were not factored into tariffs, and poor cash collection in a number of regions, including Archangelsk and Yaroslavl. About half of TGK-2's revenues come from heat sales and the company is considered a monopoly in many localities where it operates. Heat remains a regulated business and heat tariffs are approved by regional tariff commissions using a 'cost plus' mechanism that only factors in fuel price fluctuations in future tariffs. Moreover, a considerable part of TGK-2's electricity generation comes from the Arkhangelsk region, which is also a regulated territory because of its 'non-price zone' status. Both these factors continue to expose TGK-2 to price risks, as TGK-2 is unlikely to be able to recover its fuel costs incurred in FY08-09 until FY11-12.
Fitch forecasts that following a successful conversion of power and heat generation to natural gas in the city of Arkhangelsk in Q111 and the company's plans to convert one of two combined heat and power plants (CHPP) in Severodvinsk to gas beginning in Q311, TGK-2 should improve its fuel mix from expensive and volatile fuel oil to natural gas and, hence, increase its operating margins. Historically, about half of TGK-2's fuel costs were for fuel oil. TGK-2 expects that after the planned conversion to natural gas is completed in 2012, the share of fuel oil will decrease to about 3% of total fuel consumption, compared with about 25% presently.
TGK-2's highly leveraged capital structure remains one of Fitch's key concerns. TGK-2 has increased its reliance on state bank financing and domestic capital markets to finance its operations and capital investments.
TGK-2 has plans for an ambitious capex programme in excess of RUB20bn in 2011-14 that includes construction and upgrades of several generating assets with total installed capacity of 1,570 MW, including the Kudepsta thermal power plant (Krasnodar region) for the 2014 Sochi Winter Olympic Games. Fitch estimates that to finance its capex, TGK-2 will need to increase borrowing and will therefore maintain leverage above 7 times (x) in 2011-14.
In July 2010, TGK-2 announced a private share placement of RUB19bn to finance capital investments, little of which has been paid to date. In Fitch's view, if this is successfully completed as scheduled before 29 June 2011, it would lead to a significant reduction in leverage and would be a positive rating factor for TGK-2. Another positive rating factor would be TGK-2's demonstrated ability to improve its operating margins and deleverage to a more appropriate level of funds from operations (FFO) adjusted leverage below 5.0x that would allow FFO interest coverage to increase above 1.5x.
Fitch also notes TGK-2's weak corporate governance, such as the ongoing prolonged litigation between Sintez Group, TGK-2's principal shareholder, and a group of minority shareholders, and the absence of independent directors or directors that represent minority shareholders on the company's board.
TGK-2 is a heat and power generation company that operates in six regions across the north of European Russia. TGK-2 owns 15 CHPPs, 13 boiler houses and 2,000km of heat supply pipes. Its combined installed electric capacity is 2,531 MW and heat capacity is 12,286 GCal per hour. It also leases 56 boiler houses from local authorities.
|Full company name||Territorial generating company #2, PJSC|
|Country of risk||Russia|
|Country of registration||Russia|