Fitch affirms Ceylon Electricity Board at ‘AAA(lka)’; Outlook Stable

Fitch Ratings has affirmed Sri Lanka-based Ceylon Electricity Board’s (CEB) National Long-Term Rating at ‘AAA(lka)’ with a Stable Outlook.  

CEB’s rating is equalised with that of the Sri Lankan sovereign (B+/Stable), reflecting strong linkages with the parent, in line with Fitch’s Parent and Subsidiary Rating Linkage criteria. 

The equalisation takes into consideration CEB’s strategic importance to Sri Lanka in ensuring power security and supply of affordable electricity to the public as the monopoly electricity transmitter and distributor in the country. CEB also accounts for around 70% of the power generation in the country.  

Key rating drivers were as follows:

Strong linkages with State: Fitch assesses the linkages between CEB and the State as strong, reflecting high ownership and management control, explicit guarantees and financial support through equity infusions and debt funding. 

The Government also implicitly guarantees CEB’s project loans (about 80% of outstanding debt), which are extended by bilateral and multilateral agencies and routed through the Government for development of power infrastructure. 

CEB provides electricity at subsidised rates, fulfilling an essential service for the Government. CEB has almost full network connectivity and accounted for more than 70% of Sri Lanka’s generation capacity at end-2017.   

Fitch does do not expect CEB’s linkages with its parent to weaken in the medium term as the Government’s need to provide electricity at subsidised rates can be carried out only by a State entity such as CEB, as private companies would not be willing to incur losses. 

Fitch views CEB’s standalone credit profile as much weaker than its support-driven rating and believes providing a notch-specific standalone credit view of CEB is meaningless due to poor margin visibility and the need for continued state support to sustain operations.   

Tariff increases unlikely: Fitch does not expect the Government to increase electricity tariffs in the foreseeable future to levels that adequately cover CEB’s generation, distribution and transmission costs. The Government sets tariffs based on its socio-economic objectives and has not revised tariffs for almost three years despite rising generation costs. 

CEB’s average cost of supplying a unit of electricity to customers in 2017 was around 20% higher than the average tariff. The Government faces elections in the next 24 months, and amid rising living costs due to higher fuel costs and local-currency depreciation, Fitch does not expect the Government to raise electricity tariffs or implement a cost-reflective pricing formula.   

Rising generation costs: Fitch expects generation costs to remain high in the next couple of years amid rising oil prices and volatile contribution from low-cost hydropower. It expects the share of hydropower in the generation mix to remain below historical levels due to declining load factors and very little new capacity additions. It expects CEB to turn to high-cost oil-based sources to meet the shortfall.   

In addition, CEB and independent power producers have been compelled to purchase fuel at market prices since mid-2018, after the Government introduced a pricing formula, compared with subsidised prices offered previously. Fitch does not expect the LNG projects proposed under CEB’s generation expansion plan for 2018-2037 to contribute significantly to the generation mix in the next two to three years.   

Weak balance sheet: CEB’s balance sheet continues to weaken due to persistent losses and significant investments. It is unable to recover operating costs under the current tariff structure, and has to borrow to sustain its day-to-day operations. 

Further CEB, as the Government’s main investment arm in the power sector, is likely to have large capex to improve country’s power generation and transmission and distribution network. As such Fitch does not expect CEB’s balance sheet to recover in the medium term unless the Government reduces its debt by converting some of it to equity.  

Derivation summary: Fitch has rated CEB at the same level as the sovereign due to the strong linkages with its parent. The rating is not derived from its standalone credit profile and thus is not comparable with industry peers.  

Fitch’s key assumptions within its rating case for the issuer were as follows: Electricity consumption in Sri Lanka to increase by 5% per annum over 2018-2021; no material electricity tariff increases in the next two years; generation mix to broadly remain at 30% coal, 30% fuel, 30% hydropower and 10% other; capex of Rs. 120 billion in 2018 and to moderate to Rs. 60 billion per annum from 2019, mainly for generation, transmission and distribution.

Rating sensitivities: Developments that may, individually or collectively, lead to positive rating action – there is no scope for an upgrade as CEB is at the highest rating on the Sri Lankan national ratings scale. Developments that may, individually or collectively, lead to negative rating action – a significant weakening of the strong linkages between the sovereign and CEB.   

Tight but manageable liquidity position: As at end-2017 CEB had Rs. 54 billion of unrestricted cash and unutilised credit facilities to meet Rs. 20.1 billion of debt falling due in the next 12 months. Fitch does not expect free cash flow to turn positive in 2018 amid continued operating losses and capex of around Rs. 120 billion. However it believes the Government will step in and provide liquidity support if required, as it has in the past.