Fitch Ratings has upgraded Ceylon Electricity Board's (CEB) National Long-Term Rating and the rating on CEB's senior unsecure debentures to 'BB+(lka)', from 'B(lka)'. The Outlook is stable.
The upgrade follows the 28 September 2023 upgrade of the Sri Lankan sovereign's Long- Term Local-Currency Issuer Default Rating (IDR) to 'CCC-', from 'Restricted Default (RD)'. CEB's ratings are equalised with that of its parent, the Sri Lankan sovereign, based on our assessment of a 'Very Strong' likelihood of state support under our Government-
Related Entities (GRE) Rating Criteria.
CEB is Sri Lanka's monopoly electricity transmitter and distributor and accounts for around 75% of the country's power generation.
KEY RATING DRIVERS
'Very Strong' State Linkages and Support Record: We believe CEB's 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 its investment strategy. Government support to CEB includes two-step loans, which account for around 20% of
CEB's outstanding debt, debt to equity conversions and taking over certain liabilities. We expect the support to continue, despite the state's weak financials, as CEB fulfils an essential service on behalf of the state.
'Very Strong' Support Incentive: We see the socio-political implications of a CEB default as 'Very Strong'. A default would disrupt services, because CEB accounts for most of Sri Lanka's power-generation capacity. It would also make it difficult for CEB to source imported feedstock for power generation, such as heavy oil and coal. CEB's independent power producer (IPP) agreements, which account for around 20% of the power generated, would also be affected, with no clear alternatives. Most of the IPPs use
imported oil in their operations.
We also believe a default would have a 'Very Strong' financial effect on the state, as CEB's project loans also comprise state obligations. These loans are extended by bilateral and multilateral agencies and are routed through the government for the development of the country's power infrastructure. A default of CEB's outstanding debentures would also limit the ability of other state entities to tap capital markets for funding.
Cost Reflective Tariff Mechanism: In 2022, the government implemented a formula-based tariff mechanism, to be revised bi-annually, to ensure CEB can cover its operating costs and interest obligations. Prior to this, CEB supplied electricity significantly below cost, resulting in large accumulated losses and an unsustainable capital structure. We will monitor the consistent application of the cost-reflective mechanism, which should allow
CEB to breakeven at the cash flow from operations level and improve its Standalone Credit Profile (SCP).
Indeterminate SCP: We do not believe that ascertaining an SCP for CEB is possible in the near-term, as the company's ability to operate depends on continued state support and it cannot be meaningfully delinked from the state. CEB had LKR288 billion of debt as at end-June 2023, after the government took over almost LKR200 billion of projects loans in.
We expect CEB to generate negative free cash flow in the medium term, despite the cost-reflective tariff mechanism, and to depend on the state for expansion and refinancing. We may provide a standalone credit view should CEB maintain a sustained record of profitable operations that reduce reliance on the state.
Weak Operating Performance: We do not believe cash flow from operations will be sufficient to cover CEB's interest obligations in 2023, despite a 150% tariff increase. This is due to the reduced contribution from low-cost hydro power generation during the year, which compelled CEB to purchase emergency power at higher costs to meet the shortfall.
At the same time, energy demand has risen with the gradual recovery of economic activity. CEB has requested an off-cycle tariff hike to cover its increased costs, but it is yet to be approved.
Large Trade Creditors: As of end-August 2023, CEB owed LKR212 billion (June 2023: LKR208 billion) to state-owned Ceylon Petroleum Corporation (CPC), IPPs and non- conventional renewable energy (NCRE) generators. The government plans to take over 70% of the dues to CPC and the IPPs by end-2023 to ease the burden on CEB. Dues to NCREs stand at 10-11 months at present, and CEB plans to settle them gradually with operating cash flow. CEB's payables may rise in the short-term if the proposed off-cycle
tariff hike is not approved.
Planned Restructuring to Boost Efficiency: The government plans to unbundle CEB's generation, transmission and distribution assets across 14 companies established under the Companies Act, as part of Sri Lanka's energy sector reforms. The bill proposing the restructuring will be presented to parliament in October 2023 approval. We expect the
unbundling to provide CEB with autonomy and flexibility, while improving its efficiency and competitiveness. However, it is too early to ascertain how the restructuring will affect CEB's credit profile, as the plan's details are still vague.