Nov 20, 2020 (LBO) – Fitch Ratings has affirmed Sri Lanka-based Ceylon Electricity Board's (CEB) National Long-Term Rating at 'AA+(lka)' with a Negative Outlook.
They have also affirmed the National Rating on CEB's proposed senior unsecured debentures at 'AA+(lka)'.
CEB's ratings are equalised with that of its parent, the Sri Lankan sovereign (B-/Negative), in line with Fitch's Government-Related Entities (GRE) Rating Criteria.
This is based on the assessment of a very strong likelihood of support from the state. CEB is the country's monopoly electricity transmitter and distributor, accounting for around 75% of the power generation.
KEY RATING DRIVERS
Very Strong State Linkages: Fitch believes CEB's status, ownership and control by the Sri Lankan sovereign is 'Very Strong'. The government fully owns CEB, appoints its board and senior management, sets tariffs and decides on its investment strategy. CEB fulfils an essential service for the state by providing electricity at subsidised rates.
We assess the support record as 'Very Strong' as we believe there is a high likelihood of state support for CEB. Government support to CEB has included direct grants, two-step loans from multinational agencies, which account for around 70% of its outstanding debt, equity injections and guarantees on bank loans for some of its investment projects and working-capital requirements. We expect the support to continue as the government would want to ensure uninterrupted power supply in the country.
Very Strong Incentive to Support: Fitch sees the socio-political implications of a default by CEB as 'Very Strong' as it would lead to service disruption since the board accounts for most of the country's power-generation capacity. A default would also make it difficult for CEB to source feedstock used for power generation such as heavy oil and coal, which are imported. CEB's independent power producer agreements, which account for around 25% of the power generation, will also be affected as these are external arrangements with no clear alternatives and most of them use imported oil in their operations.
A default by CEB would have a 'Very Strong' financial effect on the state, as CEB's project loans, which account for around 70% of its outstanding debt, are also the state's obligations. These loans are extended by bilateral and multilateral agencies and routed through the government for development of the country's power infrastructure. Thus, a default on these project loans can be tantamount to a government default, dampening the state and its related entities' ability to raise debt.
Weak Standalone Profile: Fitch assesses CEB's standalone credit profile to be much weaker than its support-driven rating and believes providing a notch-specific standalone credit view of CEB is difficult due to poor margin visibility and the need for continued state support to sustain operations. CEB continues to post operating losses in the absence of a cost-reflective tariff structure or an effective subsidy reimbursement mechanism. CEB's current average tariff, which has not been revised since 2015, is around 20% below the average cost of supplying a unit of electricity.
Weak Financial Profile: We expect CEB to report EBITDA losses in the medium term, especially in the absence of an increase in tariffs and rising generation costs. We expect its low-cost hydropower generation to remain volatile in most years, which would require CEB to rely on high-cost thermal power, driving up costs. We do not expect planned capacity additions from low-cost liquefied natural gas to come online before 2023. CEB had negative free cash flow (FCF) of LKR55 billion in 2019 on an EBITDA loss of LKR29 billion, high interest costs and significant capex.
Impact from Pandemic Manageable: We do not expect the pandemic to have a material impact on CEB's operations as it is considered an essential service. CEB's receivable collection was affected during the lockdown period of April to May, which has normalised since July. However, CEB had to absorb some of the relief measures extended by the government such as payment write-offs. The pandemic also helped CEB to reduce its generation costs amid lower electricity consumption, which was primarily met through low-cost generation sources, and a drop in global prices of coal and heavy oils.
Significant Investments: We expect CEB to invest heavily on new generation capacity and the upgrade of the transmission network to meet the country's electricity demand, which the regulator expects to rise by 6% per year in the medium term. The government is considering increased private-sector participation in developing the power sector, but CEB will continue to play an active role, which would require material capital outlay. Most of these investments will be funded by low-cost project loans, but the additional debt burden would further weaken CEB's balance sheet.
DERIVATION SUMMARY
CEB is a monopoly in electricity transmission and distribution and owns and operates the majority of the country's installed power-generation capacity. It provides electricity at subsidised rates, fulfilling an essential service for the sovereign. CEB's rating is equalised with that of the sovereign in line with our GRE rating criteria, where it is assessed as 'Very Strong' under each sub-factor score.
Sri Lanka Telecom PLC (SLT, AA+(lka)/Negative), another Sri Lankan GRE, has a stronger credit profile than the sovereign and its rating is capped by the state under the GRE criteria. SLT is assessed as 'Strong' for status, ownership and control because the state holds a majority stake in SLT directly and indirectly, and exercises significant influence over its operating and financial profile. We regard the record and expectation for state support for SLT as 'Strong', given its strategic importance in expanding the country's fibre infrastructure. SLT has not required tangible financial support due to its healthy financial profile.
Fitch sees the socio-political implications of a default by SLT as 'Moderate' due to the presence of three other privately owned telcos. However, a default could affect the fixed-line market because SLT acts as a policy company to invest in fibre networks across the island to support the government's vision of fibre-based internet for all households. Fitch also sees the financial implications of a default as 'Strong', as a financial default by SLT may have an impact on the availability and cost of financing options for other GREs.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Sri Lanka's annual electricity demand growth to average 6% in 2021-2023
- No material increase in electricity tariffs in the next 12-18 months
- Generation mix to broadly remain at 32% coal, 30% fuel, 30% hydropower and 8% others.
- Capex of LKR100 billion per annum in 2021-2023 mainly on new generation capacity
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- A revision of our Outlook on Sri Lanka's Long-Term Foreign-Currency Issuer Default Rating (IDR) to Stable from Negative
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- A significant weakening in the likelihood of support from the sovereign
- A downgrade of the Sri Lankan sovereign's Long-Term IDR could result in corresponding action on CEB's National Long-Term Rating.
LIQUIDITY AND DEBT STRUCTURE
Government Supports Liquidity: CEB had LKR3.7 billion in unrestricted cash at end-June 2020 to meet LKR31.0 billion in debt due in the next 12 months. Around LKR12.0 billion of the debt consisted of working-capital lines, which we believe will be rolled over in the normal course of business. The government has already settled some of the contractual maturities of multilateral loans on behalf of CEB and we expect state-owned banks to extend liquidity support, as and when required, amid CEB's negative FCF generation.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS
CEB's ratings are equalised with that of its parent, the Sri Lankan sovereign, in line with Fitch's Government-Related Entities Rating Criteria.