Hong Kong, March 18, 2022 -- Moody's Investors Service has upgraded Korea District Heating Corporation's (KDHC) issuer rating to Aa3 from A1.
At the same time, Moody's has revised the outlook on the rating to stable from positive.
Moody's has also affirmed KDHC's baa2 Baseline Credit Assessment (BCA).
"The rating upgrade reflects KDHC's increasing strategic importance as the major state-owned district heating provider under the Government of Korea's push for more efficient and environmentally-friendly sources of energy and distributed power," says Mic Kang, a Moody's Vice President and Senior Credit Officer.
"The affirmation of KDHC's baa2 BCA factors in our expectation that the company's financial metrics will support the BCA on a sustained basis, given the growing customer base in its franchised areas and profit from sales of electricity generated from its combined heat and power facilities," adds Kang.
RATINGS RATIONALE
The Aa3 rating of KDHC reflects (1) its baa2 BCA; and (2) Moody's assessment of a very high likelihood that KDHC will receive extraordinary support from the Government of Korea (Aa2 stable) in times of need, under its Joint Default Analysis (JDA) for government-related issuers (GRI). This assessment is based on the Korean government's very high willingness and strong ability to provide support to KDHC, given the sovereign's ample financial reserves, as reflected in its Aa2 rating. Such an assessment results in a five-notch uplift to KDHC's final rating.
The government's very high likelihood to provide support to KDHC reflects (1) the company's important role in supplying district heating to customers in its franchised areas, most of which are located in Seoul and its surrounds; (2) the government's low tolerance for reputational and contagion risks that could result from a default of the company; and (3) the company's strong ownership relationship with the government, along with the high level of government supervision.
This assumption of support also factors in the government's long track record of adopting measures to prevent GRIs from defaulting, as well as its transparent and predictable policies.
KDHC's policy role and strategic importance will remain very significant, given that the use of district heating can reduce carbon emissions particularly from buildings and combined heat and power generation is suitable for distributed power.
The government aims to reduce carbon emissions from buildings by 33% by 2030 relative to 2018, based on its revised target for carbon emissions announced in October 2021. KDHC's combined heat and power generation facilities are a more efficient and environmentally-friendly source of energy, which will help the government achieve the target.
In June 2021, the government reiterated its plan to promote distributed power that derives energy from combined heat and power facilities with a capacity of less than 500 megawatts (MW) and renewables with a capacity of less than 40 MW.
These initiatives followed the government's announcement of a five-year plan to increase the supply of district heating and distributed power in February 2020 and a "New Deal" aimed at promoting low-carbon and decentralized energy in July 2020.
In addition, the government is committed to holding a controlling stake in KDHC to help the company focus on its policy roles since 2018, through an amendment of the Mass Energy Act that removes the risk of it losing control over KDHC.
That said, the uplift incorporated in KDHC's rating for extraordinary government support is lower than other rated nonfinancial GRIs in Korea, mainly because of the company's smaller scale and market position relative to those GRIs, the absence of special legislation designated only for KDHC, and the presence of a large number of private companies in the district heating industry.
Moody's continues to assess KDHC's dependence on the Korean government as very high, given that its credit quality is correlated with that of the government due to the close operational and financial linkages between the company and the government.
Moody's expects KDHC's funds from operations (FFO)/adjusted debt (excluding connection fees) to decline to 6%-8% in 2022 from around 11%-12% the rating agency estimates in 2021, because of increasing fuel costs amid delayed cost pass-throughs. But Moody's projects the financial metrics to recover to 8%-11% in 2023-24, mainly because of realization of delayed cost pass-throughs, along with a growing customer base and sustained profit from electricity sales.
These metrics are supportive of KDHC's baa2 BCA.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
KDHC's moderate environmental risk is primarily driven by its exposure to physical climate risk, mostly in the form of climate-driven changes in costs and supply of gas, and changes in demand or prices of heating and power.
KDHC's exposure to social risk is neutral-to-low, mainly because heating and electricity are more efficient and environmentally friendly sources of energy, thereby resulting in neutral-to-low exposure to key social factors – including demographics and societal trends.
KDHC's governance risks are neutral-to-low, which is supported by the company's prudent financial strategy, good management credibility and sound compliance under the government's close supervision.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
The stable outlook on KDHC's rating reflects Moody's expectation that KDHC's strategic importance as a key state-owned operator for combined heat and power facilities and the very high likelihood of government support, if and when needed, will remain intact over the next 12-18 months.
KDHC's rating could be upgraded if the government's ability to support the company strengthens, indicated by an upgrade of the sovereign rating.
KDHC's BCA could be upgraded to baa1 if its FFO/adjusted debt (excluding connection fees) exceeds 15% on a sustained basis. However, a moderate BCA upgrade would not result in an upgrade of KDHC's rating, in the absence of material strengthening of the company's policy role and strategic importance.
KDHC's rating could be downgraded if the government's ability to support the company weakens, indicated by a downgrade of the sovereign rating. In addition, any significant deterioration in KDHC's relationship with the government or a change in the company's policy role would exert downward pressure on its ratings.
KDHC's BCA could be downgraded to baa3 if FFO/adjusted debt (excluding connection fees) falls below 8.5% on a sustained basis. However, such a weakening in KDHC's BCA would not have an immediate impact on its rating because of the very high likelihood of extraordinary support from the government, which provides a buffer to the company's rating.
The methodologies used in these ratings were Regulated Electric and Gas Utilities published in June 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1072530, and Government-Related Issuers Methodology published in February 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1186207. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
Korea District Heating Corporation (KDHC) is a key state-owned provider of heating services to the main urban areas in Korea with an approximate 50% market share. As of 30 September 2021, Korea owned a 64.6% direct and indirect stake in KDHC, excluding Seoul Metropolitan government's 10.4%. The rest was held by the public and the company's employees.
REGULATORY DISCLOSURES
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
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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
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
