Eskom’s hopes for low-cost credit dashed by ratings cut

March 20th, 2015, Published in Articles: EE Publishers, Articles: Energize

 

The recent suspension of Eskom’s CE and three other executives has resulted in the power utility’s long-term local and foreign currency ratings being downgraded by Standard & Poor’s Ratings Services to “BB+” from “BBB-“. The ratings agency says that the power utility’s outlook is negative.

The result of this downgrade is that a number of investment houses are now barred from investing in the power utility, which will make it difficult for Eskom to raise funds on the open market. The suspension of these four senior executives, two of which are recent appointments, was done, according Eskom’s chairman, Zola Tsotsi, for the purposes of an independent inquiry into the operations of the utility.

Tsotsi announced this decision at a hastily assembled press briefing on 12 March 2015. He undertook, at that briefing, that the names of those who would undertake the inquiry would be announced within a week. It has since emerged that he will oversee the inquiry, which has caused some commentators to question the independence of the inquiry, and ultimately its value to the utility and to the public at large.

The ratings agency’s downgrade reflects the agency’s reassessment of Eskom’s management and governance to “weak” from “fair”. The agency has also revised its assessment of Eskom’s stand-alone credit profile (SACP) to “ccc+” from “b-“, resulting in the long-term rating being lowered to “BB+” from “BBB-“.

Eskom’s “highly leveraged” financial risk profile, in the agency’s opinion, demonstrates that the company’s stand-alone credit metrics will remain weak over the medium term, due to continued delays in implementing tariffs which reflect its real-time costs, investment needs, and the rising debt associated with its large capital expenditures.

The agency says that the reason for the downgrade is its view of Eskom’s “weak” business risk profile and its assessment of a “weak” regulatory advantage under the framework supervised by the national energy regulator of South Africa (NERSA). The business risk profile is linked to the execution and operational risks associated with Eskom’s very large capital expenditures programme, which has been subject to successive delays at a time when South Africa’s reserve margin remains stretched.

This negative outlook reflects the agency’s belief that considerable execution risk remains associated with the government’s support plan. Eskom’s operating performance has not yet stabilised due to rising costs combined with a doubtful interim tariff regime reprieve, a very tight capacity margin in South Africa, and a less than effective executive management team. Moreover, the agency believes that there is a risk that Eskom’s financing needs may exceed what is currently covered in the government’s additional support package.

To revise the outlook to stable, the agency needs to be convinced that Eskom could sustain adjusted FFO to debt of at least 5% in the medium term, with no additional strain on liquidity. Eskom’s management needs to demonstrate a track record of effective control of major projects and a restored relationship with key stakeholders, such as the utility’s board and the South African government.

Eskom’s ratings could be lowered further, the agency says, if it was to revise its SACP assessment to “ccc” or lower, or if it saw a reduced likelihood of extraordinary government support for the company. A deterioration of the SACP could result if the agency considers that, over the next 12 months, Eskom may be about to experience a near-term liquidity crisis, violation of financial covenants, or is likely to consider a distressed exchange offer or redemption.

The agency considers an upgrade unlikely in the foreseeable future given the current pressures on the SACP. However, an upgrade could materialise if it were to become convinced in the likelihood of government support increasing to “almost certain”, which would result in us equalising the ratings on Eskom with the sovereign rating. That however, is considered unlikely in light of the government’s finite resources and the actions it has taken to support Eskom to date.

Send your comments to: energize@ee.co.za

 

 

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