Fitch Downgrades DTEK Energy's IDR to 'C'
Fitch Ratings - Moscow - 31 Mar 2020: Fitch Ratings has downgraded Ukraine-based DTEK Energy B.V.’s (DTEK) Long-Term Foreign Currency Issuer Default Rating (IDR) to ’C’ from ’B-’. Fitch has also downgraded DTEK’s US dollar Eurobond’s senior unsecured rating to ’C’ with a Recovery Rating of ’RR5’. A full list of rating actions is detailed below.
The downgrade indicates that default is imminent, following the announcement by DTEK that it will not pay the interest on its bank debt due on 31 March 2020. DTEK will also not pay Eurobond coupon payments due on 1 April 2020 in respect to its 10.75% senior PIK toggle notes maturing in 2024. DTEK is in the process of developing a standstill agreement and debt-restructuring proposal.
DTEK’s liquidity is insufficient to service the company’s obligations and we expect deterioration of operating cash flow in 2020, reflecting an oversupplied electricity market with low power prices.
KEY RATING DRIVERS
Payment Default and Debt Restructuring Expected: The non-payment of bank debt interest due on 31 March 2020 will result in a downgrade to ’RD’ (Restricted Default). DTEK has announced that it will develop a restructuring proposal and propose a standstill agreement.
Weak Liquidity: At end-2019 DTEK’s cash position was UAH0.3 billion with no available unused credit facilities in contrast to short-term debt of UAH2.1 billion. We expect the company to be free cash flow (FCF)-negative in 2020 on the back of weakened performance, which will add to funding requirements.
High FX Risks: DTEK is exposed to FX fluctuations as almost all of its debt at end-1H19 was foreign currency-denominated (mainly US dollars and euros), while less than 10% of revenue was in foreign currencies in 1H19. From 2020 the company expects to discontinue electricity export sales as trading activities will be taken over by DTEK’s sister company within the larger DTEK Group. This will result in a substantial decrease in FX revenue. Additionally, the formulaic electricity price linkage to FX ceased following the introduction of a new market model in July 2019 and DTEK does not use any hedging instruments. These factors will weaken DTEK’s credit metrics in case of hryvna devaluation.
Performance under Pressure: We expect DTEK’s financial performance to deteriorate in 2020 due to lower generated volumes and electricity prices, which were negatively affected by continued cheap imports of electricity from Russia, mild weather conditions, renewed generation at one of the nuclear power plants (NPPs) in Ukraine in 2019, as well as increasing pressure on the domestic economy from the coronavirus pandemic.
Evolving Regulation: A new electricity market model was introduced in July 2019, replacing the single-buyer market model. It is based on electricity sales on a day ahead, intraday, balancing markets and under bilateral contracts. Following the introduction of the new market model, electricity prices decreased around 5% over July-August, and further since November 2019. We expect the average electricity price to decline in 2020 and then to grow at single-digit rates over 2021-2023.
Distribution Assets Spin-Off: In December 2018, DTEK sold its distribution assets to a company controlled by its parent to comply with the EU’s Third Energy Package. The sureties provided by distribution companies for Eurobonds were released. DTEK’s distribution assets operated on a cost-plus basis and were only marginally profitable. The distribution assets had no debt, and their effect on net cash flow was slightly negative. The effect on DTEK’s financial ratios from the spin-off was very limited. However, DTEK’s business profile will lack full integration due to the spin-off of its distribution segment.
ESG Impact: DTEK has an ESG Relevance Score of 5 for management strategy as management’s decision not to pay interest on its Eurobonds due on 1 April 2020 and on its bank loan on 31 March 2020 was a key driver for the downgrade.
DERIVATION SUMMARY
The downgrade reflects expected payment default. DTEK is the largest private power generating company in Ukraine. DTEK’s peers include Russia-based players such as PJSC The Second Generating Company of Wholesale Power Markets (BBB-/Stable) and Enel Russia PJSC (BB+/Stable), which have a significant share of coal in their fuel mix, and Kazakh-based Limited Liability Partnership Kazakhstan Utility Systems (B+/Stable).
DTEK has a more challenging operating environment affecting its business profile compared with peers, including the evolving regulatory framework, policy instability and possible macroeconomic shocks in Ukraine. DTEK also has a weaker financial profile than most of its peers due to higher leverage and higher debt exposure to FX. DTEK’s ratings do not incorporate any parental support from its ultimate majority shareholder System Capital Management.
KEY ASSUMPTIONS
- Electricity generation volumes to decline in 2020 and to grow slightly in 2021-2022
- Electricity prices to decline in 2020 and to increase at single-digit rates in 2021-2022
- Capex averaging UAH4 billion annually over 2020-2022
- Zero dividends
KEY RECOVERY RATING ASSUMPTIONS
- The recovery analysis assumes that DTEK would be a going-concern in bankruptcy and that the company would be reorganised rather than liquidated
- A 10% administrative claim
Going-Concern Approach
- The going-concern EBITDA estimate reflects Fitch’s view of a sustainable, post-reorganisation EBITDA level, upon which we have based the valuation of the company.
- The going-concern EBITDA of UAH6.5 billion reflects the potential price pressure in the recently established new electricity market and the impact of the coronavirus.
- An enterprise value multiple of 3.0x.
- Eurobonds, bank loans and other debt are ranked pari passu.
Our principal waterfall analysis results in a recovery output percentage of 29%, corresponding to a Recovery Rating ’RR5’ for the instrument rating.
RATING SENSITIVITIES
Developments That May, Individually or Collectively, Lead to Negative Rating Action
- Uncured payment default on bonds, loans or other material financial obligations.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
- Attaining a more sustainable liquidity profile.
- Improvement of the macro-economic environment and company’s operational performance.
BEST/WORST CASE RATING SCENARIO
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 https://www.fitchratings.com/site/re/10111579.
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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.
ESG CONSIDERATIONS
DTEK has an ESG Relevance Score of 5 for Management Strategy as the management’s decision not to pay coupon/interest due on its debt.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.
Additional information is available on www.fitchratings.com
APPLICABLE CRITERIA
APPLICABLE MODELS
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
- Corporate Monitoring & Forecasting Model (COMFORT Model), v7.7.0 (1)
ADDITIONAL DISCLOSURES
ENDORSEMENT STATUS
| DTEK Energy B.V. | EU Issued |
| DTEK Finance plc | EU Issued |
