Dec 25, Colombo: Fitch Ratings has revised the Outlook on Ceylon Electricity Board's (CEB) National Long-Term Rating to Negative from Stable and has affirmed the rating at 'AA+(lka)'.
The Outlook revision follows the Outlook revision on Sri Lanka's 'B' Long-Term Foreign-Currency Issuer Default Rating (IDR) to Negative from Stable.
The rating on CEB, which is fully state owned, is equalized with that of the Sri Lankan sovereign to reflect strong linkages, in line with Fitch's Parent and Subsidiary Rating Linkage criteria. The equalization takes into consideration CEB's strategic importance to Sri Lanka in ensuring power security and supply of affordable electricity to the public.
KEY RATING DRIVERS
Strong Linkages with State: Fitch assesses linkages between CEB and the state to be strong, reflecting explicit guarantees and financial support through equity infusions and debt funding. The government also implicitly guarantees CEB's project loans, which account for around 80% of its outstanding debt. These loans are extended by bilateral and multilateral agencies and routed through the government for power infrastructure development. CEB's strategic importance to the state stems from its position as the country's sole grid operator and distributor and the generator of 80% of Sri Lanka's electricity.
Fitch believes the Sri Lankan government uses CEB as a vehicle to provide an essential public service. CEB provides electricity at subsidised tariffs without adequate and timely financial compensation from the government. We do not expect CEB's linkages with its parent to weaken in the medium term, as the provision of electricity at subsidised rates can be carried out only by a state entity such as CEB, because private companies would not be willing to bear losses.
Weak Standalone Credit Profile: Fitch assesses CEB's Standalone Credit Profile to be much weaker than its support-driven rating and believes providing a notch-specific standalone credit view of CEB is difficult due to poor margin visibility and the need for continued state support to sustain operations. CEB continues to make operating losses because tariffs are lower than its average generation, distribution and transmission costs - which compel the company to borrow to sustain its day-to-day operation. The balance sheet is further weakened by large investment in new generation capacity and network upgrades, which are funded primarily through borrowings.
Weak Financial Profile: We expect CEB's operating EBITDAR to remain weak in the medium term, especially in the absence of tariff increases and rising generation costs. Similarly, we expect free cash flow (FCF) to remain negative over the medium-term due to the company's aggressive expansion plans, which will increase debt and further weaken its balance sheet. CEB's operating EBITDAR was LKR17 billion in 2018, but FCF was negative LKR66 billion due to high interest costs, working capital outflows and capex.
Unfavourable Tariff Structure: We do not expect the government to adopt a tariff structure for electricity that reflects the cost of production and distribution ahead of elections in 2020. CEB's average tariff, which has not been revised since 2013, is around 10%-15% below the average cost of supplying electricity. The government has introduced cost-reflective pricing formulas for other essential goods, such as fuel and liquefied petroleum gas, but there is no indication that this will be adopted for electricity. By law, the government has to bear the costs of any subsidies provided by CEB to its customers. However, CEB has not been fully compensated for subsidy-related losses in the past.
Significant Investment in Generation: The regulator expects electricity demand to increase by about 6% a year in the next five years, which will require significant capacity expansion if the industry is to make up for the existing supply shortage. Hydro power, which accounts for around 41% of domestic power generation, has been volatile due to unfavourable weather patterns. This pushed CEB to look for alternative supplies, such as natural gas and renewable energy sources. CEB, which is tasked with improving the country's power infrastructure, will bear bulk of these investments, which management estimates at around USD1.7 billion over 2019-2022.
Full report by Fitch Ratings