ACRA assigns BBB(RU) to JSC Teploenergia, outlook Stable

The credit rating assigned to JSC Teploenergia (hereinafter, the Company) is based on the Company’s very strong market position, a result of its monopoly position in a number of districts of the city of Yakutsk, as well as a low business profile assessment, moderate leverage, acceptable level of debt servicing, moderate profitability, and strong liquidity position.

Teploenergia is a regional company that produces and transports thermal energy in the city of Yakutsk (hereinafter, the City). The sole shareholder of the Company is the Department of property and land relations of the district administration of Yakutsk.

Key rating assessment factors

Very strong market position. The company provides heating to consumers in a number of districts of the City, where it holds an 18.4% market share. Another major heating producer in the City is PJSC Yakutskenergo (part of the RusHydro group). ACRA notes that the heating supply zones between these two companies are separated, therefore there is no competition for the consumer. Due to technical limitations, it is almost impossible to change the supplier of heat resources. Due to its geographical features, the City is characterized by extremely low temperatures for most of the calendar year, so providing heating to the population is a priority for local authorities. Therefore, the City regularly provides support to the Company to ensure smooth operations. In 2015-2018, the volume of state support amounted to RUB 0.7 bln in the form of subsidies and additional capitalization (excluding subsidies to level tariffs).

Low business profile assessment. Regulatory risk is assessed as high. Despite applying the basic pricing rule (“costs plus”), cost calculation is subject to annual adjustments depending on external factors. During the long-term regulation period, the tariff is adjusted annually taking into account the deviation of the actual values of its calculation parameters from the planned ones, as well as changes in the planned values for coming periods. Due to severe climate conditions and, as a result, a long heating period, the cost of production and heating supply in the Republic of Sakha (Yakutia), including the City, is higher than in other regions of the Russian Federation. The amount of an economically justifiable tariff exceeds the subsistence minimum in the City and therefore a preferential tariff is set for the population, which is 40-50% less. The difference is reimbursed to the Company in the form of a subsidy from the state budget of the Republic of Sakha (Yakutia). However, there could be a shortfall in the required subsidies for expenses. This is due to the common practice of containing tariff growth, in which the regulator limits part of the costs incurred by the Company that are included into the tariff base or overestimates planned energy consumption.

Sales risk is also assessed as high. Since 2017, the Company’s business has been characterized by adequate payment collection (over 90%). However, there is overdue debt for non-payments from previous years. As such, the Company needed to create reserves for questionable accounts receivable equaling 30.4% of revenue in 2019 (including subsidies).

The Company’s fixed assets are characterized by significant wear and tear (40-60%). The investment program for 2017-2022, which is aimed at improving the state of production assets, is assessed by ACRA as adequate. However, the restriction on tariff growth is a deterrent to making more large-scale capital investments that would update the networks in a shorter time and thus significantly reduce heat loss during transmission as well as accidents in heating networks.

Moderate operational profile. The tariffs set for the Company are among the highest in the City because of the need to compensate for losses in heating networks, as well as the Company’s extensive investment obligations aimed at reducing these losses, among other things.

ACRA assesses the Company’s corporate management as below average. The Company does not have a risk management system and its main issues are submitted to the Board of Directors, which consists of five people (all except the CEO are representatives of the City administration).

The Company’s financial transparency is low. The Company does not have IFRS financial statements. However, GAAP statements are regularly posted on the website.

Free cash flow is expected to remain negative despite an increase in profitability. In 2019, the Company’s free cash flow (FCF) increased compared to the previous year and amounted to RUB 48 mln (in 2018, its value was negative). The growth in FCF in 2019 is due to an increase in subsidies and the restoration of the previous year’s reserve. ACRA expects that FCF will be negative for 2020 (RUB -138.7 mln) due to the financing of the Company’s investment program. According to ACRA, the Company’s FCF should have a positive average annual value of RUB 161.8 mln in 2021-2023.

The Company’s return on FFO before interest and taxes increased to 6% in 2019 (in 2018, it was negative). The increase in profitability is also due to the amount of subsidies the Company received. ACRA expects the Company’s average annual return to be 26% in 2020-2022.

In 2019, the Company’s revenue decreased by 2% compared to the previous year due to warmer weather, as well as some consumers switching to PJSC Yakutskenergo. ACRA estimates that the Company’s revenue will grow by 7.4% y-o-y in 2020 due to the annual growth of the tariff as well as new consumers.

Moderate leverage. As of April 17, 2020, the Company’s debt portfolio was RUB 175.9 mln (2.6x FFO before net interest payments). The Company’s debt portfolio is represented by a single long-term ruble-denominated bank loan with a final maturity in 2025. ACRA estimates that in 2020, the Company’s total debt will increase to an average annual value of RUB 307 mln (1.2x FFO before net interest payments) due to the need to finance the investment program. After 2020, leverage is projected to decrease steadily to RUB 69.8 mln in 2023 (0.2 x FFO before net interest payments).

The debt service ratio (FFO before net interest payments to interest payments) was 3.5x for 2019 compared to a negative value a year earlier. In the future, as debt is repaid, this ratio should increase.

The Company’s strong liquidity position is based on a comfortable debt repayment schedule in 2021-2025. Additional liquidity support is provided by the amount of cash on the Company’s accounts, equaling RUB 4.2 mln as of January 1, 2020, and interest bills worth RUB 100 mln.

Key assumptions

  • Average rate of tariff indexation and average rate of inflation at 4% and 3.5%, respectively, in 2020-2023;
  • Implementing the capital investment program according to the stated terms and volumes (average annual investment amount of RUB 172.8 mln without VAT in 2020-2022);
  • The Company receiving an annual subsidy of at least 38% of the cost under GAAP.

Potential outlook or rating change factors

The Stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18-month horizon.

A positive rating action may be prompted by:

  • Reduced regulatory risks by implementing long-term and transparent principles of tariff regulation;
  • Increased FCF;
  • Growth in business profitability to 15% of FFO before interest and taxes, while reducing leverage to 2x (total debt to FFO before net interest payments).

A negative rating action may be prompted by:

  • Loss of control by the City or the reduction of the Company’s connection with the City;
  • Increase in total debt above 5.0x FFO before net interest payments while debt structure deteriorates or interest payment coverage falls below 2.0x;
  • Decrease in return on FFO before interest and taxes below 2%.

Rating components

SCA: bbb.

Support: none.

Issue ratings

No outstanding issues have been rated.

Regulatory disclosure

The credit rating was assigned under the national scale for the Russian Federation based on the Methodology for Credit Ratings Assignment to Non-Financial Corporations under the National Scale for the Russian Federation, the Methodology for Analyzing Relationships Between Rated Entities and the State, and the Key Concepts Used by the Analytical Credit Rating Agency within the Scope of Its Rating Activities.

A credit rating has been assigned to JSC Teploenergia for the first time. The credit rating and its outlook are expected to be revised within one year following the publication date of this press release.

The credit rating was assigned based on the data provided by JSC Teploenergia, information from publicly available sources, as well as ACRA’s own databases. The credit rating is solicited, and JSC Teploenergia participated in its assignment.

No material discrepancies between the provided data and the data officially disclosed by JSC Teploenergia in its financial statements have been discovered.

ACRA provided no additional services to JSC Teploenergia. No conflicts of interest were discovered in the course of the rating process.

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