S&P Small Print Shows South Africa’s Eskom Still at Risk

Eskom Holdings SOC Ltd., producer of about 95 percent of South Africa’s power, would do well to read Standard & Poor’s small print after avoiding its second cut to junk this month.

S&P said Nov. 11 when it held Eskom at its lowest investment grade that the power supplier needs 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 Nov. 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, chief economist at Cadiz Asset Management, which oversees $3 billion including Eskom bonds, said by phone yesterday. “The pressure remains on and we’ll have to watch over the next couple of years how the funding story unfolds. We’re not taking much comfort from what happened this week.”

South Africa’s 20 billion-rand ($1.8 billion) rescue plan announced last month for the utility, which has been plagued by electricity blackouts and delayed openings of two new plants, is enough to preserve the BBB- rating, S&P said this week. The company kept a negative outlook on Eskom’s debt, signaling a 30 percent chance of downgrade within two years, as the power producer struggles to close a 225 billion-rand revenue shortfall in the five years through March 2018.

Yield Increase

Yields on the utility’s dollar bonds due January 2021 have risen 11 basis points to 5.38 percent this month. Emerging-market utilities’ dollar debt rose one basis point to 4.70 percent in the period, JPMorgan Chase & Co. indexes show.

A cut to junk, or non-investment grade, would raise borrowing costs for Eskom as some investors are only allowed to buy investment-grade bonds as stipulated by their funds’ mandate.

S&P’s removal of Eskom from CreditWatch is “acknowledgment of the quality of the steps being taken to resolve the shortfall which includes the government support package,” the utility said in an e-mailed response to questions. “Eskom is very aware that there is always risk in execution in the best-made plans, hence is making every effort to ensure that progress is monitored and any ‘drag’ corrected timeously.”

Base Case

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 ended March 2018 year even as it struggles with its revenue shortfall, the ratings company said. That ratio has 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 by phone yesterday.

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 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 50 billion rand, Davidson said. While the National Energy Regulator of South Africa 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.

“Our base case is challenging, but it’s what the company firmly states and believes it can achieve and is what the government is affirming is its base case as well,” Davidson said.

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