Published on 10 Dec 2020.
RAM Ratings has assigned respective long- and short-term corporate credit ratings of AAA and P1 to Korea Electric Power Corporation (KEPCO or the Group); the long-term rating has a stable outlook. The ratings reflect KEPCO’s strategic position as South Korea’s national electricity company, track record of technical excellence and very strong relationship with the Government of Korea (GoK). The rating incorporates multiple notches of uplift above KEPCO’s stand-alone credit profile, reflecting our view of very high likelihood of extraordinary support from the GoK, in times of financial stress.
KEPCO is a monopoly in the transmission and distribution of electricity in Korea. Through its full ownership of six power-generating subsidiaries, the Group also controls some 73% of South Korea’s power supply. KEPCO also boasts superior technical and operational track records, which are at par with those of other developed countries, as most of its power plants operate at high capacity factors and efficiency levels. The Group’s transmission and distribution losses and System Average Interruption Duration Index stood at an impressive 3.54% and 8.61 minutes, respectively, in 2019.
Pursuant to the KEPCO Act, the GoK owns 51% of the Group. Given the critical policy role that KEPCO plays in the electricity market and its very strong relationship with the GoK, the latter is expected to readily extend its support if needed. Based on RAM’s rating methodology on government-linked entities, we expect a very high likelihood of extraordinary government support for the Group in the event of financial distress.
The ratings are, however, moderated by KEPCO’s inability to dictate tariffs, which are ultimately decided on by the GoK. While South Korea’s tariff-setting mechanism is designed to permit compensation of fair costs and fair returns, they have not been effective in fully compensating for increased costs. The timing of tariff adjustments is also highly unpredictable. KEPCO’s last major tariff adjustment was in 2016, despite bouts of higher fuel costs or other generation expenses in 2018 and 2019. As a result, the Group incurred pre-tax losses in FY Dec 2018 and FY Dec 2019, and its margin on operating profit before depreciation, interest and tax (OPBDIT) weakened to around 16%-17%, compared to historical averages of 30%. The latter is broadly in line with its peers.
The current low prices of fossil fuels should provide some respite to KEPCO. Its bottom line turned around slightly in 1H FY Dec 2020, despite a 1.4% ebb in power sales amid COVID-19-related lockdowns and a subdued economy. The Group submitted a proposal for a new sustainable tariff system to the GoK earlier this year, although approval and timing of implementation remain uncertain at this juncture. Looking ahead, without any upward revisions to tariffs to compensate for cost increases arising from initiatives to reduce environmental footprint, we believe profitability will be limited in the long-term.
KEPCO’s borrowings have been trending upwards since fiscal 2016, and are envisaged to remain so given its hefty capital expenditure and modest operating cashflow. Its gearing ratio stood at 1.10 times as at end-1H FY Dec 2020, and is anticipated to hover around 2.0 times over the next few years without any tariff increase. The Group’s funds from operations debt coverage ratio is envisaged to remain at the current level of 0.20 times in the near-term. However, it may decline if the commissioning of its four new nuclear power plants – cheapest “fuel” sources – in 2023 is unable to offset rising generating costs.
Given KEPCO’s inherently capital-intensive operations, further debt-funded investments without the corresponding incremental earnings could weaken the Group’s financial metrics. Despite the high debt load, some 99% of its debts entail fixed interest rates while all foreign-currency borrowings (18% of its overall debts) are fully hedged. KEPCO’s well-spread-out debt-maturity profile, easy access to funding and robust financial flexibility alleviate any liquidity concerns.
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Ratings on Korea Electric Power Corporation