Fitch publishes Ceylon Electricity Board’s AAA rating with stable outlook

Fitch Ratings Lanka has published Sri Lanka-based Ceylon Electricity Board's (CEB) National Long-Term Rating of 'AAA(lka)' with a Stable Outlook. CEB is fully owned by the Sri Lanka sovereign (B+/Stable). CEB's rating is equalised with that of the sovereign based on the strong linkages with its parent, in line with Fitch's Parent and Subsidiary Rating Linkage criteria. The equalisation takes into consideration CEB's strategic importance to Sri Lanka in ensuring power security and supply of affordable electricity to the public. KEY RATING DRIVERS Strong Linkages with State: Fitch believes the Sri Lankan government uses CEB as a vehicle to provide an essential public service. CEB provides electricity at subsidised tariffs without much financial compensation from the government. Fitch assesses the linkages between CEB and the state to be strong, reflecting high ownership and management control, explicit guarantees and financial support through equity infusions and debt funding. CEB's strategic importance to the state stems from being the country's sole grid operator and distributor and accounting for the majority of generation capacity. We expect the state to provide extraordinary support to CEB over and above most other state entities. We do not expect the government to liberalise the electricity sector or privatise CEB in the medium term, as high generation costs would compel the government to continue providing subsidies, which can be done primarily through a state entity. As such, we do not expect CEB's linkages with the state to weaken. Weak Standalone Profile: CEB's standalone credit profile is weaker than its support-driven rating of 'AAA(lka)' due to exposure to high regulatory risks, a weak operating performance and debt-laden balance sheet. However, Fitch believes providing a notch-specific standalone credit view of CEB is meaningless due to poor margin visibility. This stems from a lack of clarity on a tariff framework and absence of a cost-reflective pricing formula, which could adequately cover its generation costs. State support will be necessary to sustain CEB's operations over the medium term, as Fitch believes electricity will continue to be sold below cost. Monopoly Status in Power Sector: CEB has almost full network connectivity and accounted for more than 75% of the Sri Lanka's generation capacity at end-2016. CEB will be the key driver in achieving the government's target of increasing current installed capacity by 2.5x within 20 years to meet electricity demand, which CEB expects to rise by 5% per annum over the long term. New capacity in mini hydro, thermal and renewable energy will come from private players, but CEB will undertake all large power-generation projects and improvements to the transmission and distribution network, which require significant capital investments. High Regulatory Risks: Fitch estimates the majority of CEB's electricity tariffs to be below generation cost due to regulated pricing, resulting in large losses for the company. However we do not foresee the government implementing a pricing formula in the near-term, given the political and social implications. High Borrowings: CEB's balance sheet is significantly weak for a utility company owing to its inability to recover operating costs. This has compelled CEB to borrow to sustain its day-to-day operations. Furthermore, CEB is tasked with improving the country's power infrastructure, which requires significant capital investment. Fitch does not foresee CEB's debt burden easing in the medium term unless the government converts part of the debt to equity, as has occurred in the past. DERIVATION SUMMARY Fitch has rated CEB at the same level as the sovereign due to the strong linkages with its parent. The rating is not derived from its standalone credit profile and thus is not comparable with industry peers. KEY ASSUMPTIONS - Electricity consumption growth of 5% per annum over 2017-2020 - No electricity tariff increase in the next two years - Cost of generation per unit to increase by around 3.5% per annum on average -Capex of LKR80 billion per annum on average over the next two to three years, spent mainly on generation, transmission and distribution RATING SENSITIVITIES Developments that may, individually or collectively, lead to positive rating action include: - There is no scope for an upgrade, as CEB is at the highest rating on the Sri Lankan national ratings scale. Developments that may, individually or collectively, lead to negative rating action include: - A significant weakening of the strong linkages between the sovereign and CEB. LIQUIDITY Manageable Liquidity Position: CEB had LKR10.2 billion of unrestricted cash as of end-2016 as well as LKR80 billion of unutilised credit facilities under the 2017 borrowing limit set by the Sri Lankan government to meet LKR17 billion of debt falling due in the next 12 months. However, we expect CEB to make operating losses in 2017 and, together with capex of around LKR50 billion (excluding capex funded by specific project loans), its liquidity position might be tight. We expect the government to step in and provide financial support if required, as has been seen in the past. (Media Release)