Credit Opinion: Eskom Holdings SOC Limited

Transcription

1 ESKOM HOLDINGS SOC Ltd 11 September 2014 MEDIA STATEMENT SUJECT: MOODY S INVESTOR SERVICES CREDIT OPINION UPDATE ESKOM HOLDINGS SOC LIMITED NOTED MOODY S SERVICES CREDIT OPINION UPDATE. KINDLY REFER TO THE CREDIT OPINION ELOW Credit Opinion: Eskom Holdings SOC Limited Global Credit Research - 05 Sep 2014 Johannesburg, South Africa Ratings Category Outlook Senior Unsecured Moody's Rating Negative aa3 Contacts Analyst Paul Marty/London 54 Niel isset/london Monica Merli/London Phone Key Indicators Eskom Holdings SOC Limited[1] CFO pre-wc + Interest/ Interest 3/31/ x 3/31/ x 3/31/ x 3/31/ x 3/31/ x CFO pre-wc / Debt 3.6% 6.5% 13.6% 13.1% 13.4% CFO pre-wc - Dividends / Debt 3.2% 5.7% 12.7% 12.4% 11.1% Debt / Capitalization 70.2% 66.5% 61.8% 63.4% 61.9% [1] All ratios are calculated using Moody's Standard Adjustments. Source: Moody's Financial Metrics Note: For definitions of Moody's most common ratio terms please see the accompanying User's Guide. Opinion Rating Drivers - Expectation of high government support reflects Eskom's critical importance to South Africa's economy

2 - Large capex programme needed to expand the country's electricity infrastructure - Challenging regulatory environment against a backdrop of rising energy costs - Weak financial profile Corporate Profile Eskom Holdings SOC Limited ("Eskom", aa3 / negative) is the dominant, vertically-integrated utility in South Africa, generating 95% of the country's electricity and supplying directly 55% of all end users (the remaining 45% are sold to redistributors, including municipalities). The company has an installed generating capacity of 42 GW, of which approximately 85% is coal-fired, with the rest being a mix of hydro, nuclear and gas. In 2013/14, electricity sales totalled approximately 218 TWh. Eskom also owns and operates approximately 359,000 km of power transmission and distribution lines. Eskom is fully-owned by the government of South Africa (aa1 / negative) through the department of Public Enterprises. Eskom is regulated under licences granted by the National Energy Regulator of South Africa (NERSA) under the Electricity Regulation Act of SUMMARY RATING RATIONALE Eskom's aa3 rating reflects (1) an expectation of high probability of government support for Eskom, reflecting the company's critical role as supplier of substantially all electricity used within South Africa; (2) a challenging regulatory framework relative to operating costs in the context of a very stretched electricity system until new generation comes on stream; (3) the risks associated with the execution of a large capital investment programme, which has been subject to some delays and cost overruns; and (4) Eskom's weak financial profile. Given the full ownership by the South African government, Eskom's rating is based on Moody's rating methodology for government-related issuers (GRIs), and combines (1) the company's stand-alone credit quality or aseline Credit Assessment (CA) of b1, reflecting very weak credit metrics, and (2) an uplift for the potential support the government of South Africa is likely to provide to Eskom in a distress situation - as evidenced by the direct financial assistance provided in the past, such as the guarantee framework agreement of R350 billion ($35 billion) and a R60 billion ($6 billion) subordinated loan. Note that Eskom's aa3 senior unsecured debt ratings relate to bonds and a note programme that are not supported by the government guarantee. DETAILED RATING CONSIDERATIONS EXPECTATION OF HIGH GOVERNMENT SUPPORT REFLECTS ESKOM'S CRITICAL IMPORTANCE TO SOUTH AFRICA'S ECOMOMY Given a stand-alone credit quality commensurate with a speculative-grade profile, Eskom's investment-grade rating relies upon the support that we expect would be provided by the government of South Africa in a distress scenario. The assumption of high support under Moody's rating methodology for GRIs reflects Eskom's strategic and critical importance to the government's social and economic policy: in addition to providing basic electricity connections to households and townships that remain unserved despite the democratic transition in 1994, Eskom is executing a large-scale investment programme required to expand South Africa's infrastructure in order to remove growth bottlenecks. The success of these two complementary strategies is crucial for the country's overall growth and future development - and, arguably, even for its political stability. Our expectation of high support is evidenced by significant, tangible support via (1) the government's R350 billion Guarantee Framework Agreement (GFA) and (2) the subordinated loan amounting to R60 billion. The GFA allows Eskom to request government guarantees on loans up to an aggregate of R350 billion (up from the previous R176 billion limit). Of the guaranteed amount as of 30 June 2014, R126 billion is currently drawn under existing facilities. Eskom's domestic multi-term note programme, totalling R100 billion, is covered by this guarantee plus other loans as determined by the company and the government. The GFA makes provision for payment of unguaranteed debt to be met from cash flow before it would be applied to the guaranteed debt thereby indirectly improving the status of the unguaranteed debt. Should the guarantee be called by the beneficiary, the obligation would be converted into a subordinated loan from the government to the company under similar terms and conditions as those for the R60 billion subordinated loan. However, this does not legally protect creditors against insolvency. The government has also demonstrated its support for Eskom through the implementation of a R60 billion subordinated loan which has been already received in full. Key features of this loan are loan interest coupons and financial covenants that permit Eskom to permanently waive interest payments to the government when such payments would impair the company's financial profile. This provides Eskom with some financial flexibility and

3 reinforces our view that the government is supportive of the company. Although Eskom has the right to repay this loan before term, we expect it to be a long-term feature of Eskom's capital structure. LARGE CAPEX PROGRAMME NEEDED TO UPGRADE THE COUNTRY'S ELECTRICITY INFRASTRUCTURE Eskom is engaged in a significant investment programme to expand and upgrade South Africa's electricity infrastructure to meet the country's changing power needs following a period of underinvestment in the past decade. Eskom is thus currently carrying out a capacity expansion programme which should contribute some additional 11 GW by 31 March 2019 from the current position. The company's programme includes the coal-fired power plants Medupi and Kusile (approximately 4.8 GW each) and pumped storage plant Ingula (1.3 GW). The execution of this capital programme has been hampered by delays and cost overruns. The completion of the first unit of Medupi was targeted for end of 2013 but this has been delayed until second half of The completion of the entire power station is targeted for Kusile's first unit is targeted for the second half of 2015 and completion in 2019, whilst Ingula's completion is targeted for The aggregate construction cost of these three plants is currently estimated at approximately R250 billion, of which 65% has already been completed. In addition to Eskom's capacity expansion programme, the Department of Energy's Integrated Resource Plan (IRP) updated in November 2013, and which sets out a long-term energy plan for the period , provides for total installed generation capacity of 81 GW by This was scaled down by around 8 GW from the previous 2010 plan, reflecting lower electricity intensity of the economy. The plan envisages the development of renewable energy - up to 17.4 GW - as well as a nuclear fleet plant strategy of 6.7 GW by 2030, although no such capacity is required before 2025, leaving the door open to alternative options. The decommissioning of Eskom's older coalfired power stations is expected to start in 2020, although the plan acknowledges the potential for life extension. y 2030, coal-based power generation is expected to still account for close to 50% of South Africa's installed capacity. CHALLENGING REGULATORY ENVIRONMENT AGAINST A ACKDROP OF RISING ENERGY COSTS South Africa's energy tariffs have historically been amongst the lowest in the world. Against a background of low investments during the 1990s and - until around tariff increases often below inflation, it has been a significant challenge for the regulator to increase tariffs without harming users unduly. The regulator and Eskom's principal stakeholders have accepted that prices have to rise in real terms in order to finance the company's increasing investment needs, and this has been the case since However, fully cost-reflective tariffs have yet to be implemented. Section 15 of the Electricity Regulation Act 2006 states that regulation must allow an efficient licensee to recover the full cost of its licensed activities, including a reasonable margin or return. Further, NERSA's electricity pricing policy of November 2008 addresses a number of pricing and tariff issues in principle, such as recognising the importance of allowing an electricity business to recover its prudent costs of operation and an appropriate return, to ensure that it is able to fund its operations and make provision for capital expansion. With regard to the appropriate rate of return, it provides that the assets be valued in an appropriate manner and at a level that covers the full cost of production, including a reasonable risk-adjusted margin or a return on appropriate asset values. The first multi-year price determination ran for the period 1 April 2006 to 31 March 2009, followed by the second multi-year price determination (MYPD2) until March In its final determination for MYPD2, NERSA approved tariff increases of around 25% per annum. In March 2012, NERSA reduced price increases for the last year of the MYPD2 down to 16% from the originally approved 25.9%, based on such application by Eskom. At the time of the announcement, the Department of Energy indicated that the regulatory period should be five, instead of three years, to compensate for the downward tariff adjustment. In February 2013, NERSA approved an 8% annual tariff increase for the period from 1 April 2013 to 31 March 2018 (MYPD3), significantly lower than the 16% requested by Eskom. This will translate into revenues of around R863 billion ($90 billion) over the period, which compares with the R1.087 trillion ($110 billion) applied for by Eskom. Eskom is unlikely to make up this shortfall solely through efficiencies, and has thus engaged with its shareholder to discuss its investment and financing options. This adverse regulatory settlement is even more acute in a context of rising primary energy costs as coal mining and associated costs have been driven upwards by factors such as depleting reserves, deteriorating coal quality and longer transportation distances. This has been further exacerbated by a lack of generation capacity and other inefficiencies. WEAK FINANCIAL PROFILE The group's financial metrics weakened further in 2013/14 as a result of lower tariff increases than in the previous year, higher operating costs, and the continued roll out of its large capex programme. Revenue for the financial

4 year ended 31 March 2014 was R139.5 billion, up by 8% vs. 2012/13 primarily reflecting the 8% annual tariff increase granted under MYPD3 and flat volumes sold. This was offset by an 8% increase in operating costs driven by higher primary energy costs, which were in turn due to the need to operate more expensive OCGT plants to ensure continuity of supply. After capex in excess of R55 billion, net debt (net of derivatives) rose to R241 billion at 31 March 2014 from R194 billion at 31 March As a result, financial metrics weakened to RCF/debt of 3.2% versus 5.7% in the prior year.

5 Eskom has been working with the regulator and an inter-departmental task team comprising of the Departments of Public Enterprises, Energy and National Treasury to come up with a solution to the challenges it faces. We understand that the task team should present its report to the Cabinet of South Africa in September and we therefore expect an announcement shortly thereafter. Nonetheless, we believe that it will be a challenge for the government to approve additional material increases in tariffs given their impact on economic growth and employment. In the absence of significant tariff hikes and/or equity injection, Eskom's financial profile is likely to remain stretched for the foreseeable future given its committed investment programme and rising operating costs. Liquidity Liquidity is adequate. ased on the 8% annual tariff increase granted by NERSA over MYPD3, we expect Eskom to generate cash flow from operations of around R15 to 20 billion per annum, which is insufficient to fund annual capex in excess of R50 billion (there is a moratorium on dividends during the capital expansion phase). Taking into account annual debt repayments of R15 to 20 billion on average in 2014 and 2015, we thus estimate that Eskom has financing needs of approximately R50 billion per annum. For the year 2014/15, this is only partly covered by cash reserves and available-for-sale investments of R30 billion at 31 March Eskom expects to raise the remaining funds from various financial institutions with which it has undrawn committed facilities (export credit agencies, World ank, African Development ank, Development ank of South Africa). In addition, approximately R180 billion are currently unused under the government's GFA and could be utilized if necessary. Rating Outlook The negative outlook reflects the company's weakening standalone credit quality and the risk that the government and the regulator may not take sufficient tangible measures to improve Eskom's financial profile and ultimately ensure its sustainability. What Could Change the Rating - Up Given the negative outlook, upwards rating pressure is unlikely. However, we could stabilise the outlook on the rating if (1) the outlook on the government's rating were to stabilise, and (2) a structural solution to Eskom's stressed financial profile were to be found, most likely in the form of tariff increases and/or permanent government subsidies. What Could Change the Rating - Down Conversely, downwards rating pressure could develop if (1) Moody's were to further downgrade the government's rating; (2) the measures expected to be announced in September fail to address Eskom's challenges as discussed above; or (3) our assessment of high government support for the company were to change. Other Considerations Eskom is rated in accordance with the rating methodologies "Regulated Electric and Gas Utilities", published in December 2013, and "Government-Related Issuers: Methodology Update", published in July Rating Factors Eskom Holdings SOC Limited Regulated Electric and Gas Utilities [1] Factor 1: Regulatory Framework (25%) a) Legislative and Judicial Underpinnings of the Regulatory Framework a) Consistency and Predictability of Regulation Factor 2: Ability To Recover Costs And Earn Returns (25%) a) Timeliness of Recovery of Operating and Capital Costs [2]Current As at 3/31/2014 Measure Score a Caa [3]Moody's months forward view As at September 2014 Measure Score a Caa

6 b) Sufficiency of Rates and Returns Factor 3: Diversification (10%) a) Market Position a b) Generation and Fuel Diversity Factor 4: Financial Strength (40%) a) CFO pre-wc + Interest/ Interest (3 Year Avg) 2.2x a b) CFO pre-wc / Debt (3 Year Avg) 7.3% a c) CFO pre-wc - Dividends / Debt (3 6.6% a Year Avg) d) Debt/Capitalization (3 Year Avg) 66.6% Rating: a) Indicated Rating from Grid b) Actual CA Assigned 1 b1 a 1.0x - 2.0x 0%-5% 0%-5% a 70%-75% 2 b1 Government-Related Issuer Factor a) aseline Credit Assessment b1 b) Government Local Currency Rating aa1 c) Default Dependence High d) Support High [1] All ratios are calculated using Moody's Standard Adjustments. [2] As of 3/31/2014; Source: Moody's Financial Metrics [3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved. CREDIT RATINGS ISSUED Y MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DET OR DET-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PULICATIONS PULISHED Y MOODY'S ("MOODY'S PULICATION") MAY INCLUDE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DET OR DET-LIKE SECURITIES. MOODY'S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING UT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY'S OPINIONS INCLUDED IN MOODY'S PULICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY'S PULICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-ASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR

7 COMMENTARY PULISHED Y MOODY'S ANALYTICS, INC. CREDIT RATINGS AND MOODY'S PULICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY'S PULICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY'S PULICATIONS COMMENT ON THE SUITAILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY'S ISSUES ITS CREDIT RATINGS AND PULISHES MOODY'S PULICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL, WITH DUE CARE, MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. MOODY'S CREDIT RATINGS AND MOODY'S PULICATIONS ARE NOT INTENDED FOR USE Y RETAIL INVESTORS AND IT WOULD E RECKLESS FOR RETAIL INVESTORS TO CONSIDER MOODY'S CREDIT RATINGS OR MOODY'S PULICATIONS IN MAKING ANY INVESTMENT DECISION. IF IN DOUT YOU SHOULD CONTACT YOUR FINANCIAL OR OTHER PROFESSIONAL ADVISER. ALL INFORMATION CONTAINED HEREIN IS PROTECTED Y LAW, INCLUDING UT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY E COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIUTED OR RESOLD, OR STORED FOR SUSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR Y ANY MEANS WHATSOEVER, Y ANY PERSON WITHOUT MOODY'S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY'S from sources believed by it to be accurate and reliable. ecause of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided "AS IS" without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY'S is not an auditor and cannot in every instance independently verify or validate information received in the rating process or in preparing the Moody s Publications. To the extent permitted by law, MOODY'S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability to any person or entity for any indirect, special, consequential, or incidental losses or damages whatsoever arising from or in connection with the information contained herein or the use of or inability to use any such information, even if MOODY'S or any of its directors, officers, employees, agents, representatives, licensors or suppliers is advised in advance of the possibility of such losses or damages, including but not limited to: (a) any loss of present or prospective profits or (b) any loss or damage arising where the relevant financial instrument is not the subject of a particular credit rating assigned by MOODY S. To the extent permitted by law, MOODY'S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability for any direct or compensatory losses or damages caused to any person or entity, including but not limited to by any negligence (but excluding fraud, willful misconduct or any other type of liability that, for the avoidance of doubt, by law cannot be excluded) on the part of, or any contingency within or beyond the control of, MOODY'S or any of its directors, officers, employees, agents, representatives, licensors or suppliers, arising from or in connection with the information contained herein or the use of or inability to use any such information. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTAILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE Y MOODY'S IN ANY FORM OR MANNER WHATSOEVER. MIS, a wholly-owned credit rating agency subsidiary of Moody s Corporation ("MCO"), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MIS have, prior to assignment of any rating, agreed to pay to MIS for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS's ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at under the heading "Shareholder Relations Corporate Governance Director and Shareholder Affiliation Policy."

8 For Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY'S affiliate, Moody's Investors Service Pty Limited AN AFSL and/or Moody's Analytics Australia Pty Ltd AN AFSL (as applicable). This document is intended to be provided only to "wholesale clients" within the meaning of section 761G of the Corporations Act y continuing to access this document from within Australia, you represent to MOODY'S that you are, or are accessing the document as a representative of, a "wholesale client" and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to "retail clients" within the meaning of section 761G of the Corporations Act MOODY'S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail clients. It would be dangerous for "retail clients" to make any investment decision based on MOODY'S credit rating. If in doubt you should contact your financial or other professional adviser. Further information on the Eskom Holdings SOC Ltd bond issue can be obtained from Francois Venter ESKOM ( )