Fitch Ratings has affirmed Kazakhstan-based Mangistau Regional Electricity Network Company's (MRENC) Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B+'.

The Outlook is Stable. A full list of rating actions is provided below.

The affirmation reflects continued alignment of MRENC's rating with that of Limited Liability Partnership Kazakhstan Utility Systems (KUS, B+/Stable), the majority shareholder, reflecting their strong ties, including KUS's guarantees for around 80% of MRENC's debt at end-2021.

We assess MRENC's Standalone Credit Profile (SCP) at 'b+', reflecting the company's near-monopoly position in electricity transmission and distribution in the Region of Mangistau, one of Kazakhstan's strategic oil-and gas-producing regions. This is balanced by the company's small size, industry and customer concentrations, and an evolving regulatory framework.

Key Rating Drivers

Long-term Distribution Tariffs: Electricity distribution tariff increases are approved until end-2025, at around 2.5% on average for 2022-2025 for legal entities, which account for 90% of electricity distribution volumes (following a 25% increase in 2021). For the remaining customers, including households and utilities companies tariffs increases were approved at 2%-5% on average over the same period. The approval of long-term tariffs provides greater visibility to the company's cash flows and favourable tariff increases support the company's credit metrics.

Ratings Aligned with Parent: KUS owns 50.19% of equity or 52.63% of ordinary shares in MRENC and provided guarantees for around 80% of MRENC's outstanding debt at end-2021. We expect the share of KUS-guaranteed debt to remain material over the rating horizon. This indicates strong legal ties between the companies and supports MRENC's rating alignment with the parent under Fitch's 'Parent and Subsidiary Rating Linkage Criteria'. This implies the same 'B+' rating for MRENC, which also reflects our view of MRENC's standalone profile. We view the strategic and operational incentives to support MRENC by the parent as moderate.

'b+' SCP: MRENC's SCP of 'b+' reflects improved credit metrics and revenue visibility following the approval of five-year tariffs. The rating is also supported by MRENC's near-monopoly position in electricity transmission and distribution in one of Kazakhstan's strategic oil- and gas-producing regions, high customer quality and prepayment terms under which the company operates. The SCP is constrained by the company's high exposure to a single industry, small size and evolving regulation.

Limited FX Exposure: The repayment of the US dollar-linked bond in 2021 improved MRENC's exposure to foreign-exchange (FX) fluctuations. At end-2021 about 10% of its total debt was linked to the Kazakhstani tenge/US dollar exchange rate compared to 30% at end-2020. In contrast, all its revenue is local-currency denominated. Substituting FX debt with local-currency debt will improve the company's financial flexibility, but may worsen coverage metrics, due to higher interest rates.

Derivation Summary

MRENC is a small electricity distribution company in western Kazakhstan. It has a weaker business profile than Kazakhstan Electricity Grid Operating Company (KEGOC, BBB-/Stable), which operates nationwide, and has greater geographic diversification and lower volume risk. MRENC, like other utilities in Kazakhstan, is subject to regulatory uncertainties influenced by macroeconomic shocks and possible political interference.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

GDP growth of 3.2% and CPI of 8.6% on average in 2022-2025

Electricity distribution volumes to grow at low single-digit percentages in 2022-2025

Electricity distribution tariffs for legal entities to increase at a low single-digit percentage in 2022-2025, as approved by the regulator

Cost inflation slightly below expected CPI to reflect the company's cost control efforts

Capex of around KZT4 billion on average annually in 2022-2025

Dividend payments averaging 50% of IFRS net income in 2023-2025

Cost inflation slightly below expected CPI

Cost of new debt at 15%

KEY RECOVERY RATING ASSUMPTIONS

The recovery analysis assumes that MRENC would be a going concern in bankruptcy and that the company would be reorganised rather than liquidated

Fitch assumes a 10% administrative claim.

The going-concern EBITDA estimate of KZT6.3 billion reflects Fitch's view of a sustainable, post-reorganization EBITDA level upon which we base the valuation of the company

Fitch assumes an enterprise value multiple of 4x.

These assumptions result in a recovery rate for the senior unsecured debt at 'RR1'. However, this was capped at 'RR4'/50% due to the application of a country cap for Kazakhstan. This is explained in our 'Country-Specific Treatment of Recovery Ratings Criteria'.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Positive rating action on KUS, assuming the links remain strong

Enhancement of the business profile, such as greater diversification and scale with FFO gross leverage below 3x and FFO interest coverage above 4.5x on a sustained basis, would be positive for the SCP, but not the Issuer Default Rating

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Negative rating action on KUS

A weaker financial profile leading to FFO gross leverage persistently higher than 4x and FFO interest coverage below 3.5x, which would be negative for the SCP, but may not lead to negative rating action on the Issuer Default Rating, if a significant share of debt continues to benefit from KUS's guarantees.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity: At end-June 2022 MRENC's cash and cash equivalents of KZT2.2 billion together with expected positive FCF one year ahead around KZT0.9 billion are sufficient to cover short-term debt of about KZT2.8 billion. MRENC's debt is mostly comprised of loans from the European Bank for Reconstruction and Development of around KZT14.5 billion and tenge bonds of around KZT3.1 billion maturing in 2023-2024. Around 10% of debt is in US dollar, with the remainder raised in tenge.

Issuer Profile

MRENC has a near-monopoly position in electricity transmission and distribution in the Region of Mangistau, one of Kazakhstan's strategic oil-and gas-producing regions.

Summary of Financial Adjustments

Capitalised interest was reclassified from capex to interest expense.

Cash with restricted use was reclassified to restricted cash from other current assets.

Sources of Information

The principal sources of information used in the analysis are described in the Applicable Criteria.

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

MRENC's rating is aligned with that of KUS.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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