Standard & Poor’s Ratings Services has lowered its foreign currency corporate credit and senior secured debt ratings on the fully vertically integrated, 99.8% government-owned electricity monopoly Israel Electric Corp Ltd. (IEC) to ‘BBB+’ from ‘A-‘. The outlook is negative.
The rating action reflects a combination of factors likely to constrain IEC’s operations and financial strength in the medium term. These include uncertainty about the parameters of the company’s investment programme, which could be affected by uncertain near-term economic prospects or delays to the planned introduction of independent power producers, and its weak financial profile that is not expected to improve in the near future.
The prospect of sustained and substantial financial support from the state appears to have weakened slightly given the company’s recent fiscal deterioration. “Standard & Poor’s continues to believe, however, that the company can continue to rely on government support to service debt on time in the event of a temporary funding shortfall,” says Standard & Poor’s credit analyst Amrit Gescher. “In the absence of this implied government support, IEC’s credit profile would be considerably weaker.”
The rating on IEC remains closely linked to that on the state, given its vital role in safeguarding the security of electricity supply and the wider economy, and almost complete government ownership. The government approves the company’s major decisions and the appointment of IEC’s directors. Furthermore, it has the ultimate say on regulation, both directly and through appointment of the industry regulator, the Public Utilities Authority.
Further important positive rating factors include the company’s favourable long-term debt profile, a tariff increase in mid-2002, and an economic mechanism, although this is partially mitigated by the lack of a clear track record.
The rating is constrained by IEC’s significant investment program to 2006 of about IS22bn (US$5bn). Although earnings should stabilise and increase given the tariff increase, expected pass-through and reduction of foreign exchange losses, and continued underlying demand growth, they are unlikely to have a pronounced impact on the company’s modest interest coverage of about 2x, given its high ongoing interest burden. Flexibility in the investment program appears moderate given a low available reserve margin, the system’s isolation, and the country’s ultimate reliance on IEC to ensure adequate generating capacity.
Concerns about the speed and funding of investments might ultimately accelerate discussions about the structure of the sector and of IEC and the possibility of partial privatisation, although this is not likely in the very near term.
The negative outlook mirrors the outlook on the sovereign. “Although a one-notch sovereign downgrade would not lead to direct and immediate rating pressure, IEC’s performance is closely linked to the general economy and prolonged recession, inflation, or a bad environment for investment could all have a negative impact on the company’s operating environment,” says Gescher.