Eskom needs power to avoid junk status
ESKOM, the producer of about 95 percent of South Africa’s power, would do well to read Standard & Poor’s (S&P) small print after avoiding its second cut to junk this month.
S&P said last week when it held Eskom at its lowest investment grade that the power supplier needed to cap cost increases at 10 percent a year, complete new power plants on time and win a 40 percent tariff increase from the regulator in the three years to 2018.
Moody’s Investors Service reduced the company to junk on November 7, a day after cutting the sovereign.
“The immediate risk may have been allayed, but certainly they’re not out of the woods,” Adenaan Hardien, the chief economist at Cadiz Asset Management, said last week.
“The pressure remains on and we’ll have to watch over the next couple of years how the funding story unfolds,” Hardien said.
South Africa’s R20 billion rescue plan announced last month for the state-owned power utility plagued by electricity blackouts and delayed openings of two new plants, was enough to preserve the BBB- rating, S&P said.
The company kept a negative outlook on Eskom’s debt, signalling a 30 percent chance of a downgrade within two years, as the power producer struggles to close a R225bn revenue shortfall in the five years through March 2018.
Yields on the utility’s dollar bonds due in January 2021 have risen 10 basis points to 5.37 percent this month.
Emerging market utilities’ dollar debt rose one basis point to 4.70 percent in the period, JPMorgan Chase indexes show.
A cut to junk, or non-investment grade, would raise borrowing costs for Eskom as some investors are only allowed to buy investmentgrade bonds as stipulated by their funds’ mandate.
S&P’s removal of the power utility from CreditWatch was “acknowledgment of the quality of the steps being taken to resolve the shortfall, which includes the government support package”, the utility said.
S&P’s “base-case” scenario, needed to maintain Eskom’s investment-grade status, requires that the company’s ratio of funds from operations to debt be sustained at 5 percent until the year to March 2018. That ratio had fallen to about 3 percent, it said.
“We can definitely say there’s at least a one in three chance that these targets will not be met because they rely on so many positive developments,” Mark Davidson, the London-based credit analyst at S&P responsible for Eskom’s rating, said on Thursday.
To meet those targets, Eskom must raise debt, get its government cash injection in a timely manner, and complete its Medupi power plant, already delayed by two years, without falling further behind schedule, Davidson said.
The power utility would automatically be downgraded if S&P, which will review South Africa’s rating next month, cuts the country’s BBB-- assessment.
Most importantly, Eskom must win 12 percent annual tariff increases each year until 2018, bringing in R50 billion, Davidson said.
While the National Energy Regulator of SA has only agreed to annual increases of 8 percent in the last two years of that period, Eskom can apply for higher raises should its costs be more than expected. – Bloomberg
Eskom retains Standard & Poor’s BBB- rating for the time being, but the pressure of a downgrade to junk status remains as a result of a R225bn revenue shortfall and the two-year delay in bringing the Medupi power plant on stream.