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Rating Action:

Moody's assigns Ba2 rating to IDGC of Volga; stable outlook

12 Oct 2012

First-time rating

London, 12 October 2012 -- Moody's Investors Service has today assigned a Ba2 corporate family rating (CFR) and probability of default rating (PDR) to JSC IDGC of Volga (IDGC of Volga), a Russian electricity distribution grid business servicing seven regions in the European part of Russia and a core operating company of state-controlled IDGC Holding (Ba1 developing). The outlook on the ratings is stable. This is the first time Moody's has assigned a rating to IDGC of Volga.

RATINGS RATIONALE

IDGC of Volga's Ba2 CFR mainly reflects (1) its higher business risk compared with the generally low risk of regulated grid peers operating in developed markets; (2) its large investment programme designed to renovate a depleted asset base which could create pressures on the company's financial profile and liquidity; (3) a degree of concentration of the company's customer base both geographically and in terms of revenues from large customers. Moody's attributes the company's higher business risk to the evolving regulation of the Russian grid sector and uncertainties surrounding the state strategy for the sector, including privatisation plans. The sector's configuration is changing. The state has placed IDGC Holding, the parent company of IDGC of Volga, under the management of FGC UES (Baa2 stable). A potential merger of IDGC Holding and FGC UES, also controlled by the state is being discussed.

IDGC of Volga rating positively factors in (1) its position as the dominant distribution grid business in its highly populated service area, which consists of seven regions (located in the European part of Russia, to the southeast of the central regions of the country); (2) a degree of state support available for the company through IDGC Holding, which provides a one-notch uplift to IDGC of Volga's standalone credit quality; (3) the linkage between electricity transmission tariffs and IDGC of Volga's investment programme, established following the recent regulatory-asset-base (RAB) tariff revision for all of the company's seven regional branches; (4) headroom under the company's financial profile within the current rating (based on management's H1 2012 accounts, the company's FFO interest coverage for H1 2012 on a last-12-months basis is 11.7x and funds from operations (FFO)/net debt is 77.3%, including Moody's standard adjustments).

The rating also incorporates IDGC of Volga's long-term debt maturity profile, with short-term debt obligations in the middle of 2012 accounting for just 2% of its total debt, and access to state-owned banks, which Moody's expects will mitigate investment-driven pressures on the company's liquidity. At the same time, Moody's positively notes management's commitment to maintaining a conservative financial profile, including maintaining unadjusted debt/EBITDA significantly below 3.0x.

In Moody's view, the evolving regulation and grid sector's configuration remains the key risk for Russian grid businesses, including IDGC of Volga, and a key component in determining their rating, suppressing differences in their credit profiles. Electricity transmission tariffs remain subject to political considerations within the new RAB regulatory model, which was implemented to improve transparency of tariffs and attract investments to the grid sector. In this environment, the visibility of the long-term evolution of grids' financial profiles remains limited, although this is mitigated by a degree of state support available for the sector and its players.

The stable outlook on IDGC of Volga's rating reflects Moody's view that the company has sound plans to develop and adjust its business taking into account tariff evolution, availability of funding and the wider economic environment. The stable outlook is also predicated on Moody's expectation that IDGC of Volga will be able to manage its financial profile in line with the current rating category, with FFO interest coverage and FFO/net debt not weakening below 3.5x and 20%, respectively.

WHAT COULD CHANGE THE RATING UP/DOWN

Moody's does not expect upward pressure on the rating until there is a better visibility with regard to the mid- to long-term evolution of both (1) IDGC of Volga's financial profile in the evolving regulatory environment; and (2) the grid sector's configuration.

Negative pressure on the rating could result from (1) Moody's view that access to supportive measures from the state or its agents was no longer available for IDGC of Volga through IDGC Holding; (2) a negative shift in the developing regulatory regime and deteriorating margins; (3) a failure on the part of IDGC of Volga to adjust its investment plans to tariff decisions and thereby limit the deterioration of its financial profile going forward, with total FFO interest coverage falling below 3.5x and FFO/net debt below 20%. Furthermore, if the company were unable to proactively address its liquidity needs and maintain reasonable headroom under the financial covenants of its bank agreements, negative pressure could be exerted on the ratings.

PRINCIPAL METHODOLOGY

The principal methodology used in this rating was Regulated Electric and Gas Networks published in August 2009. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Headquartered in the city of Saratov, Russia, IDGC of Volga is an interregional electricity distribution grid business, focused on seven regions in the European part of Russia. IDGC of Volga is a regulated natural monopoly, whose electricity transmission revenues accounted for around 98.5% of 2011 total revenues of RUB48.0 billion ($1.6 billion). The largest shareholder of IDGC of Volga is state-controlled IDGC Holding (Ba1 developing), which holds 67.6% of the company's voting shares.

REGULATORY DISCLOSURES

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Ekaterina Botvinova
Vice President - Senior Analyst
Infrastructure Finance
Moody's Investors Service Limited, Russian Branch
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Monica Merli
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Infrastructure Finance
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Moody's assigns Ba2 rating to IDGC of Volga; stable outlook
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