Fitch Ratings has affirmed JSC National Company Kazakhstan Engineering’s (KE) Long-term foreign currency and local currency Issuer Default Ratings (IDRs) at ‘BBB-’ and ‘BBB’, respectively, with Stable Outlooks.
Fitch has also affirmed the foreign and local currency senior unsecured ratings at ‘BBB-’ and ‘BBB’ respectively and the Short-term foreign currency IDR at ‘F3′.
KE’s ratings are based on Fitch’s Parent Subsidiary Linkage methodology and are notched down two notches from the rating of its ultimate 100% shareholder, the Republic of Kazakhstan (foreign currency IDR BBB+/Stable, local currency IDR A-/Stable). Therefore, any indication or change in Fitch’s view that state support will weaken could have a negative effect on the ratings. In particular, any sign that expected capital injections from the state will be delayed or diminished could be negative for the ratings, the statement says.
Fitch deems KE’s linkage with its parent as moderate to strong due to the state control, strategic importance of the company to the government’s ambition to expand the country’s industrial base and diversify the national economy as well as the tangible financial support from the state that has already been exhibited and pledged. The two-notch differential reflects the lack of debt guarantees provided by the state and the slightly lower priority KE would likely receive compared with key natural resources, utilities or infrastructure companies, whose ratings are notched down by one notch from the sovereign, the statement says.
Fitch believes that on a standalone basis, KE’s rating would likely be at the mid to high end of the ‘B’ category, reflecting its weak business profile, negative free cash flow (FCF), moderately high leverage and adequate liquidity.
KE’s business profile is characterised by its small size, limited product range, lack of long-term high-tech development achievement and little customer diversification, all of which cap the company’s standalone rating in the ‘B’ category.
Nevertheless, we acknowledge the growth that the group is likely to experience in the coming years stemming from the Kazakhstan government’s ambitious plans for the entity as the focal point of the nation’s modernisation, industrialisation and export drive. Coupled with the technological know-how the company is acquiring from various joint venture partners, the business profile is likely to visibly improve within the rating horizon, the statement says.
The 2013 financial results were materially worse than expected by Fitch due to delays concerning certain supplies at the company’s defence division. As a result, revenue and earnings were significantly lower than expected, whilst large working capital built up at year-end meant that FCF was almost negative KZT7bn. Gross and net leverage at end-2013 were 16.9x and 5.3x, respectively, much worse than the 3.6x and 0.2x expected by Fitch.
Fitch expects the effects of the 2013 delays will be at least partly reversed in 2014 and the financial results will broadly return to the previously expected levels. The funds from operation (FFO) margin is expected to be at around high single digits whilst gross and net FFO adjusted leverage are expected to be around 5.7x and 1x, respectively, at end-2014. The majority of debt (a USD200m bond) matures in 2016 and is expected to be refinanced. Debt levels are expected to peak in 2014, as future capacity expansion that the group is undertaking is expected to be financed via equity injections as well as the company’s own operating cash. At end-2015, Fitch expects that gross and net leverage will improve to below 3.5x and 1x, respectively.
To date, the company’s margins have been moderate to weak, but Fitch expects them to improve in the near term on the back of greater cost discipline, efficiency improvements and state assistance. The group’s FCF is likely to be negative in the coming two to three years as a result of high capex needs and working capital outflows. The former relates to the capacity expansion the group is undertaking, while the latter is linked to the overall projected growth in the business, the statement says
The company had around KZT31bn of cash at end-2013, which was more than sufficient to cover short-term maturities (primarily consisting of leases). Nevertheless, the group’s large investment needs mean that FCF is likely to be negative in the short to medium term and external funding will be necessary to finance the projected capex. To this end, KE is reliant upon the equity injections which have been pledged by the government, without which the growth plans would need to be materially scaled back.
The Stable Outlook on the Long-Term IDR reflects that on the Long-Term foreign currency IDR of the Republic of Kazakhstan.
A weakening of support, such as a reduction in the state’s shareholding in KE, a waning commitment to and support for the company’s programmes, or a change in the treatment by the state that KE receives relative to other state-owned companies, could lead to a widening of the rating gap between Kazakhstan and KE, the statement says.
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