Today's rating action reflects Moody's view that the Russian government will distance itself from FGC in the course of the restructuring of the Russian grid sector in line with a Decree on OJSC Russian Grids (Russian Grids) of the President of Russia, published on 22 November 2012. Specifically, the one-notch downgrade of FGC's issuer rating reflects Moody's belief that this restructuring will reduce the probability that the government will provide extraordinary support to the company in a distress situation.
FGC is a government-related issuer (GRI) under Moody's rating methodology for GRIs. FGC's investment-grade issuer rating incorporates an uplift to the company's baseline credit assessment (BCA) -- a measure of its standalone credit quality -- of ba. Moody's has adjusted downwards the probability of state support factored into the company's issuer rating to "strong" from "high", which has reduced the uplift to the BCA, albeit it remains unchanged at ba.
In June 2012, the Russian government transferred IDGC Holding (Ba1 developing), the holding company for 11 core regional and interregional distribution grid companies, under management of FGC, the Russian transmission grid business. However, thereafter, the government has been working out a new strategy for the development of the grid sector, including a further alliance of the two entities. In accordance with the mentioned Presidential Decree, the grid sector is now to be consolidated on the basis of IDGC Holding. The government will transform IDGC Holding, which will be renamed Russian Grids, into a management company for distribution grid businesses and FGC's transmission grid business. The management company will direct the development of the domestic grid sector to increase the quality and reliability of services, control costs and interlink investments in transmission and distribution grids. The government will contribute its stake in the FGC to the management company. As a result, the government's direct ownership of FGC will be replaced by an indirect one.
Moody's expects the government's effective ownership and control over FGC through the management company to be materially below the 75% plus one share currently required under Russian law. Moody's understands that the Presidential Decree requires the government's effective control over FGC to be at least 50% plus one share and requests that a shareholder agreement between the government and Russian Grids be developed, which will enable the government to maintain control over FGC's operations. However, the rating agency considers that the planned change to FGC's ownership structure and position in the corporate framework of the state-controlled grid sector will distance the company from the government and complicate their interaction. Moody's would expect this to reduce the probability of extraordinary state support in a distress situation.
FGC's ba BCA remains constrained by the evolving regulatory regime in the Russian grid sector, its changing configuration and the company's significant investment programme, which exerts pressure on its financial profile. However, the sustainability of the company's regulated and strategically important business as the national transmission grid operator continues to underpin the BCA.
The stable outlook considers that the Presidential Decree contains a reasonably detailed plan of the grid sector restructuring. In Moody's view, the plan highlights the Russian government's clear intention to maintain control over FGC, and the rating agency would expect state support for the company to remain strong. Moody's notes that there are execution risks associated with the plan. The agency also notes uncertainties associated with the evolving regulation and the government's developing strategy for the grid sector. However, the outlook reflects Moody's expectation that the steps outlined in the Presidential Decree will be executed in the coming months in a way that does not negatively affect FGC's business and financial risk profile.
WHAT COULD CHANGE THE RATING UP/DOWN
Moody's considers an upgrade of FGC's rating to be unlikely at this stage given the above mentioned execution risks and uncertainties.
Negative pressure on FGC's ratings could result from (1) unexpected changes to the new restructuring plan or its implementation, signalling weakening support from the government; (2) a negative shift in the developing regulatory regime and deteriorating margins; (3) a failure of the company to manage its investment programme in line with the tariff regulation and contain a deterioration of its financial profile, with funds from operations (FFO) interest coverage and FFO/net debt falling materially and persistently below 3.5x and 25%, respectively; (4) pressured liquidity.
The methodologies used in this rating were Regulated Electric and Gas Networks published in August 2009, and Government-Related Issuers: Methodology Update published in July 2010. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.
Headquartered in Moscow, Russia, JSC Federal Grid Company of Unified Energy System is the monopoly electricity transmission system operator in the Russian Federation. The company's revenues, approximately 96.5% of which are transmission revenues fully regulated by the state, amounted to RUB139.6 billion (around $4.7 billion) in 2011 (other operating income of RUB7.8 billion, primarily from non-core activities, is not included). The Russian government currently directly owns 79.55% of the company's ordinary shares.
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