Hong Kong, June 18, 2020 -- Moody's Investors Service has affirmed SK E&S Co. Ltd.'s
Baa2 issuer rating.
The outlook remains negative.
RATINGS RATIONALE
"The rating affirmation reflects our assessment that the KRW1.8
trillion gross cash proceeds from SK E&S' sale of a 10.25%
stake in China Gas Holdings in April 2020 will keep its financial metrics
within our expectation for its rating, absent excessive dividend
payouts or material investment projects, or both" says Mic
Kang, a Moody's Vice President and Senior Credit Officer.
"That said, the outlook remains negative, reflecting remaining
uncertainty over the implementation of SK E&S' deleveraging
measures -- including the use of its sizeable cash holdings to lower
debt and reduce debt-funded investments -- given its track
record of using large internal cash sources for dividends,"
adds Kang.
SK E&S' issuer rating reflects its business diversification into power
generation and regulated retail gas distribution, the cost advantage
from liquefied natural gas (LNG) sourcing, and the likelihood of
support from its parent, SK Holdings Co., Ltd,
if and when needed. At the same time, the rating takes into
account the exposure of its profit margin to oil price movements and competition
among power generators in Korea, its business concentration in Korea's
utility sector, and the likely increase in debt leverage in case
of excessive dividend payments, or large-scale overseas investments,
or both.
Moody's expects that SK Holdings will maintain a strong willingness to
support SK E&S, in case of need, owing to SK E&S'
growing strategic importance as a core subsidiary in the group's LNG value
chain and the high reputational risk that could arise from financial distress
at the subsidiary. SK Holdings' willingness to support SK E&S
is further evidenced by the former's provision of a performance guarantee
for SK E&S' commitment to use the Freeport liquefaction facility in
the US for 20 years starting in 2020.
Moody's expects SK E&S' funds from operation (FFO)/adjusted
debt to stay at 14%-20% in 2020-22,
if the company uses the majority of the cash proceeds from the sale of
its stake in China Gas Holdings and its cash holdings of around KRW1.4
trillion at the end of March 2020 to repay debt or fund capital spending,
or if it materially cuts or cancels its investments in some projects,
or both. In addition, SK E&S' financial metrics
will benefit from a new LNG-fired power plant with a capacity of
1 gigawatt in Korea (Aa2 stable), which is scheduled to start commercial
operation in July 2022.
However, uncertainties exist over the projected financial metrics,
because the magnitude of SK E&S' dividend payouts and its final
investment decisions will likely remain unclear until at least later this
year, and is reflected in the negative outlook.
SK E&S' financial metrics will be weaker than the projected
levels if it meaningfully increases upstream dividends, or largely
debt-funds project investments as planned, or both.
In this scenario SK E&S' credit quality would come under further
pressure, in particular because it would signal a continuation of
the company's aggressive financial policy.
SK E&S is likely to decide on the amount of dividend payouts on the
cash proceeds from the sale, in consultation with its parent SK
Holdings Co., Ltd., the holding company of SK
Group, depending on the Group's business strategy and SK E&S'
financial targets.
In addition, given the increased volatility in crude oil prices
and financial markets, SK E&S' final decision on its investment
plan for gas assets overseas, which aims to strengthen its LNG value
chain — spanning from the sourcing of LNG to power and heat generation--,
has yet to be made.
The rating also considers the following environmental, social and
governance (ESG) factors.
First, SK E&S operates in the unregulated utilities and power
sector, which faces elevated immediate environmental risk.
However, SK E&S' LNG power plants will remain a power
source in Korea amid the government's aim to move away from nuclear
and coal power gradually.
Second, SK E&S' exposure to social risk — mainly stemming
from health and safety regulations, responsible production requirements,
and demographic and societal trends -- is mitigated by the
measures it has taken to satisfy the government's strengthening safety
requirements and the public's increasing awareness around safe power generating
practices. Moody's expects Korea's power demand to decline by low-
to mid-single-digit percentages in 2020 and remain nearly
flat in 2021, mainly because of the economic contraction arising
from the coronavirus disruption. But SK E&S' cost competitiveness
among LNG-fired power plants will help keep it well positioned
in dispatch order among the LNG-fired power plants and less affected
by declining power demand.
Third, SK E&S' credit quality takes into account corporate
governance considerations with respect to its aggressive financial strategy.
Its parent SK Holdings has a strong influence over the company's
financial policies, as demonstrated by SK E&S' track record
of its cash holdings mainly being used for dividend payouts or,
to a lesser extent, capital spending, rather than deleveraging.
The negative rating outlook reflects Moody's expectation that SK E&S'
credit quality will remain weakly positioned at the Baa2 rating level
over the next 12-18 months, given remaining uncertainty over
its potential use of its huge cash holdings to meaningfully reduce debt
and around whether it will materially cut debt-funded investments.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATING
Moody's could revise the negative rating outlook to stable if SK
E&S' funds from operations (FFO)/adjusted debt stays comfortably
above 14% on a sustained basis, through the implementation
of material deleveraging measures or a significant cut in its capital
spending.
Conversely, Moody's could downgrade SK E&S' rating if
FFO/adjusted debt falls below 14% on a sustained basis, if
it continues its high dividend payments, if it deploys material
expansionary capital spending, or if there is a significant and
structural weakening in industry fundamentals or all.
The principal methodology used in this rating was Unregulated Utilities
and Unregulated Power Companies published in May 2017 and available at
https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1066389.
Alternatively, please see the Rating Methodologies page on www.moodys.com
for a copy of this methodology.
SK E&S Co. Ltd. is a major private independent power
producer operating gas-fired power and co-generation plants
in Gwangyang, Paju, Hanam and Wirye, with a total capacity
of 3.8 gigawatts as of 31 March 2020, or around 2.8%
of Korea's (Aa2 stable) total power generation capacity. It is
also the largest retail gas distribution company in Korea, with
around 22% market share by sales volume in 2019.
At 31 March 2020, SK E&S was 90% owned by SK Holdings
Co., Ltd., with the remaining stake (10%)
owned by financial investors in Korea.
REGULATORY DISCLOSURES
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The first name below is the lead rating analyst for this Credit Rating
and the last name below is the person primarily responsible for approving
this Credit Rating.
Mic Kang
VP - Senior Credit Officer
Project & Infrastructure Finance
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077
Terry Fanous
MD-Public Proj & Infstr Fin
Project & Infrastructure Finance
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077
Yian Ning Loh
Associate Managing Director
Project & Infrastructure Finance
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077
Releasing Office:
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077
