Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has assigned Uzbekistan-based electricity distribution and sales company Regional Electrical Power Networks JSC (REPN) a first-time Long-Term Issuer Default Rating (IDR) of ‘BB-’ with Stable Outlook.

REPN’s rating is equalised with that of its parent Uzbekistan (BB-/Stable) under Fitch’s Government-Related Entities (GRE) Rating Criteria, reflecting strong ties with the state.

The company’s Standalone Credit Profile (SCP) is assessed at ‘b-’, reflecting an opaque regulatory framework for electricity distribution in Uzbekistan, short-term tariffs, weak profitability, high leverage and large foreign-exchange (FX) mismatch between revenue and debt.

Positively, its SCP reflects the company’s dominant position in the domestic electricity distribution market, access to end-user payment collections and Fitch-expected tariff growth above inflation, which should improve the company’s financial profile.

Rating Equalised with Uzbekistan’s: REPN scores 30 support points under Fitch’s GRE Criteria, which together with its ‘b-’ SCP, leads to the rating being equalised with the state’s as per our notching guidelines.

Strong State Linkage: We view the status, ownership and control factor as ‘Strong’ as the state is REPN’s sole shareholder and the company is included in the government’s list of strategically important enterprises. Support track record is ‘Very Strong’ as almost all of the company’s debt is provided by the Ministry of Finance, either directly or by on-lending funds from international development banks, or by Uzbekistan’s Fund for Reconstruction and Development. Other forms of support include equity injections, tax exemptions and minimal dividends to the parent.

Incentive to Support: Fitch views the socio-political impact of a default as ‘Strong’, due to the company’s dominant market share in electricity distribution and supply across the whole country, making it difficult to substitute it in the short-to-medium term. The socio-political impact is compounded by REPN’s large workforce and significant infrastructure renovation programme. The financial implications of a default are ‘Moderate’ because a REPN default should not have a material impact on the availability and cost of funding for the government and other state-owned companies, despite reputational risk for the state.

Price and Volume Risks: REPN is not insulated from price and volume risk and is heavily dependent on regulatory decisions. It purchases electricity from the transmission network and sells it to legal entities and households at regulated tariffs. However, REPN anticipates switching to regulatory asset base (RAB) regulation from 2024, which will result in a more advanced tariff framework than the existing one. This should provide it with more insulation from price and volume risk and improve cash flow predictability.

The government is also considering introducing a social threshold of electricity consumption, above which households will pay a higher tariff. If approved and implemented these measures should improve REPN’s financial profile.

Regulatory Decisions Drive Financials: Almost all of REPN’s revenue and around 90% of costs are regulated, underlining the considerable influence on its financials of the regulator’s decision on tariffs. Regulated costs include that for the purchase of electricity from JSC National Electric Grid of Uzbekistan for further sale to end-customers, and for purchase of electricity lost in the networks. Therefore, regulated cost growth is as important as the tariff increase itself.

‘b-’ SCP: REPN’s business profile is constrained by an opaque regulatory framework, with short-term tariffs that are kept low for social reasons, making REPN’s earnings less predictable than those of other CIS and European networks. Other constraints are operating-environment risk in Uzbekistan, high projected leverage and large FX mismatch between revenue and debt. Positively, REPN has a dominant market position in electricity distribution and supply in Uzbekistan, access to end-user payments collection and Fitch-expected tariff growth above inflation, which should improve the company’s financial profile.

Ambitious Capex Programme: REPN’s business plan incorporates an ambitious investment programme of around USD170 million annually over 2022-2026 for installation of advanced electricity meters and network renovation. It expects to fund investments with above-inflation tariff indexations and international loans channeled through the Ministry of Finance or state-guaranteed loans. We expect REPN to remain negative in free cash flow (FCF) to 2025, as was the case in 2019-2021.

Projected High Leverage: We forecast funds from operations (FFO) gross leverage to be in double digits in 2022 (8.4x at end-2021) before it improves to 5x-6x from 2024. This is based on double-digit tariff growth for legal entities in 2023 and 2024, and around inflation level to 2026. Our projections are highly sensitive to the regulator’s tariff decisions.

High FX Risk: REPN is exposed to foreign-currency fluctuations risk as over 90% of its debt is denominated in US dollars, against all revenue in local currency (Uzbek soum). REPN does not hedge its FX risks even as it plans to continue funding capex from debt raised in foreign currencies from international banks. We forecast Uzbek soum to depreciate around 5% annually, which would have a negative impact on the company’s financial profile.

REPN’s rating is equalised with that of Uzbekistan. The strength of ties with the government under Fitch’s GRE Rating Criteria is comparable to those of JSC Almalyk Mining and Metallurgical Complex (BB-/Stable, SCP: b+) and JSC Uzbek Metallurgical Plant (BB-/Stable; SCP b+) and slightly stronger than for UzbekHydroEnergo JSC (BB-/Stable; SCP b). REPN’s ties with the state are stronger than those of Kazakhstan-based GREs such as Kazakhstan Electricity Grid Operating Company (KEGOC, BBB-/Stable; SCP bb+) and JSC Samruk-Energy (BB/Positive; SCP b+) as those peers require less state support.

On a standalone basis, REPN has a larger asset base and greater geographical and customer diversification than Kazakhstan-based Mangistau Regional Electricity Network Company (B+/Stable), which is balanced by Mangistau’s more established regulatory framework, with a longer record and multi-year tariffs, and a stronger operating environment in Kazakhstan.

REPN has a weaker business profile than Enerjisa Enerji A.S. (AA+(tur)/Stable), a distribution company in Turkiye, and KEGOC, a transmission operator in Kazakhstan, as those peers benefit from stronger regulation and a less depreciated asset base.

Mangistau, Enerjisa and KEGOC all have stronger financial profiles than REPN due to higher profitability, lower leverage, a limited share of FX-denominated debt and more established financial policies.