Credit rating agency Fitch Ratings on Jan. 13 announced that it had affirmed NJSC Naftogaz Ukrainy's (Naftogaz) Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'CCC.'
Naftogaz's $1.595 billion government-guaranteed notes are affirmed at 'B' with a Recovery Rating of 'RR4'.
“The IDRs continue to reflect that default is a real possibility due to the continued weakness of Naftogaz's business and particularly its financial profile and its ongoing dependency on the Ukrainian government for timely liquidity support,” reads the statement.
According to Fitch, one of the key concerns for Naftogaz is the disparity between the prices for gas imported from Russia's Gazprom ('BBB'/Positive) and regulated tariffs for heating companies in Ukraine ('B'/Stable). Tariffs for residential customers and heating companies increased by 50% from 1 August 2010, but plans for further increases did not materialize. Additionally, the price for imported gas jumped by almost 60% between Q410 and Q411 which means that the tariff deficit significantly widened.
The Ukrainian government has approached Russia to renegotiate the price formula in the 10-year gas import contract signed in January 2009. Fitch views the outcome of the talks and its timing as highly uncertain. The government's stance contributed to a pause in negotiations with the International Monetary Fund on financial help to Ukraine. This in turns makes future tariff increases more uncertain.
Assuming the current gas price and domestic tariffs, the deficit (negative free cash flow) would increase in 2012 compared to 2011. This means that Naftogaz will need greater subsidies or capital contributions in order to meet its obligations. Naftogaz received over UAH 21 billion in subsidies and capital increases during 2010 and around UAH 12 billion during 2011.
The tariff deficit is further exacerbated by Naftogaz's customers' poor payment record. Net receivables increased to UAH 16.7 billion at YE10 (of which only 23% were not past due) from UAH 9.3 billion at YE09 (66% were not past due). Additionally, impaired receivables increased to UAH 19.9 billion from UAH 18.9 billion.
Fitch notes that the government has taken steps to improve cash collection rates including penalties to household customers and specialized distribution accounts to side-step heating companies with poor payment morale. In May 2011, the government adopted a number of resolutions leading to a write off of around UAH 11.4 billion of Naftogaz's historical trade receivables and tax payable of around UAH 16 billion. From December 2011, Gazprom extended payment terms for Naftogaz by three weeks (and allowed settlement in the Russian ruble). The agency therefore expects an improvement in Naftogaz's working capital position at YE11.
The current uncertainty extends to a lack of transparency and Naftogaz's business restructuring plans being considered by the government. A scenario of closer cooperation with Gazprom on gas transit through Ukraine and lower import prices may be positive for Naftogaz considering Gazprom's decreased reliance on Ukraine for its gas exports to EU and therefore possible decrease of transit though Ukraine. However, the current uncertainty is negative for Naftogaz's IDRs.
Fitch rates Naftogaz's $1.595 billion notes at 'B', in line with the sovereign rating, based on the unconditional and irrevocable guarantee from the government of Ukraine. The agency does not expect Naftogaz's potential business restructuring to have an impact on the guarantee. The guaranteed notes represent around 24% of Naftogaz's debt (the rest is largely secured on inventories (gas) and/or receivables).
Naftogaz's liquidity remains weak, with a $25 million (UAH 200 million) committed undrawn credit facility due in May 2012, negative free cash flow and UAH 10.4 billion of debt due in 2012 (largely in January and October). The company expects to receive sufficient subsidies from the government and new loans to repay upcoming maturities. Naftogaz also remains significantly exposed to foreign currency and interest rate risks.