South African Power Utility ESKOM Holdings SOC Downgraded To 'BB+' Following Management Suspensions; Outlook Negative

Publication date: 19-Mar-2015 11:31:03 EDT

- The recent announcement of ESKOM Holdings SOC Ltd.'s board regarding the suspension of the company's CEO and three senior executives has led us to have less confidence in the company's corporate governance arrangements as well as in its stand-alone credit profile (SACP).

- We continue to assume there is an extremely high likelihood that ESKOM would receive extraordinary state support if needed, which currently leads us to add six notches of uplift to our assessment of the company's SACP.

- Consequently, we are lowering our long-term ratings on ESKOM to 'BB+' from 'BBB-' and national scale ratings to 'zaA/zaA-2' from 'zaAA-/zaA-1'.

- The negative outlook reflects our opinion that material execution risk remains associated with the government's support plan, and that ESKOM's operating performance has not yet stabilized due to rising costs and the very tight generation capacity margin in South Africa.

DUBAI (Standard & Poor's) March 19, 2015--Standard & Poor's Ratings Services said today that it has lowered its long-term local and foreign currency ratings on South Africa power utility ESKOM Holdings SOC Ltd. to 'BB+' from 'BBB-'. The outlook is negative.

At the same time, we lowered our long- and short-term South Africa national scale ratings to 'zaA/zaA-2' from 'zaAA-/zaA-1'.

The downgrade reflects our reassessment of ESKOM's management and governance to "weak" from "fair." Also, we have revised down our assessment of ESKOM's stand-alone credit profile (SACP) to 'ccc+' from 'b-', leading us to lower the long-term rating to 'BB+' from 'BBB-'.

Our view of ESKOM's "weak" business risk profile factors in our assessment of a "weak" regulatory advantage under the framework supervised by the national energy regulator of South Africa. The business risk profile also reflects our opinion of important execution and operational risks associated with ESKOM's very large capital expenditures program, which has been subject to successive delays at a time when South Africa's reserve margin remains stretched.

Our assessment of ESKOM's "highly leveraged" financial risk profile incorporates our opinion that the company's stand-alone credit metrics will remain weak over the medium term, due to continued delays in implementing tariffs that reflect its real-time costs, investment needs, and the rising debt associated with its large capital expenditures. We apply our standard volatility table to ESKOM, as per our corporate methodology criteria, because we assess its regulatory advantage as "weak."

The negative outlook reflects our opinion that considerable execution risk remains associated with the government's support plan. ESKOM's operating performance has not yet stabilized 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, we think 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, we would need to believe 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 ESKOM board and the South African government.

We could lower the ratings on ESKOM if we were to revise our SACP assessment to 'ccc' or lower, or if we saw a reduced likelihood of extraordinary government support for the company. A deterioration of the SACP could result if we consider 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.

A deterioration in the SACP could occur, for example, if the regulator does not grant additional tariff increases during the current regulatory period (MYPD3), as it did for the fiscal year ending April 2016, that are sufficient to allow Eskom to adequately manage ongoing debt service requirements. A deterioration in the SACP could also occur, due to other elements, such as the announced equity contribution from the government's asset disposal program or conversion of government loans to equity, or if ESKOM's operating performance deteriorated further because of additional cost overruns or a lack of progress in planned efficiencies, without offsetting government support. A weakening of the SACP by one notch would, all else being equal, likely result in a one-notch downgrade of ESKOM to 'BB'.

We could also lower the ratings if we were to revise downward our assessment of the likelihood of extraordinary support from "extremely high." This could occur if ESKOM develops additional funding requirements that are not explicitly covered by government support, or if the announced support program is not implemented on time or in full. All else remaining equal, this could lead us to downgrade ESKOM by three notches, to 'B+'. Finally, we could lower the ratings on ESKOM if we lowered the sovereign rating on South Africa, all else remaining equal. Under our criteria for GREs, a one-notch downgrade of the sovereign would result in a one-notch downgrade of ESKOM.  

We consider an upgrade unlikely in the foreseeable future given the current pressures on the SACP. Under our GRE criteria, an upward revision by one notch in our assessment of ESKOM's SACP would result in an upgrade of ESKOM by one notch, assuming unchanged government support. However, an upgrade could materialize if we believed the likelihood of government support had increased to "almost certain," which would result in us equalizing the ratings on ESKOM with the sovereign rating. That said, we consider this unlikely in light of the government's finite resources and the actions it has taken to support ESKOM to date.

Statement issued by Standard and Poor's, March 19 2015

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