In Focus: DTEK – Awaiting restructuring proposal
Restructuring comes out of the blue. On 27 Mar 2020, DTEK Energy announced that it will not pay interest on bank debt and its US$1.3bn 10.75% amortising bonds on 31 Mar 2020 and 1 Apr 2020, respectively. The company is working on a standstill agreement and a restructuring proposal. Less than two months ago DTEK reported weak preliminary FY 19 results, but we did not see signs of an imminent restructuring then and, if bonds prices are a measure of market sentiment, neither did the market.
How serious is DTEK Energy’s financial situation? In July 2019, Ukraine made a transition to a new electricity market model with prices established daily based on the balance of supply and demand. Transition to the new pricing model, an abnormally warm winter and the reopening of electricity imports from Russia and Belarus dramatically reduced prices per kWh and DTEK Energy’s profitability in H2 and particularly in Q4 19. According to Market Operator, electricity prices remained weak in Q1 20, which suggests that Q4 19 could be a good proxy for 2020. In this case, DTEK’s EBITDA could fall below US$200mn, causing net leverage to increase to 10x and interest to be barely covered, if at all. According to DTEK’s presentation, the company does not have sizable debt repayments in 2020-22 (US$90mn in total), with most of the US$2bn debt maturing in 2023-24. However, if our rough estimate of 2020 EBITDA is not entirely wrong, DTEK could indeed struggle to pay cUS$190mn interest on debt.
What restructuring may look like? While DTEK is working on the restructuring proposal, we look at the company’s operating cash flows and financial position trying to answer the key question: is it a liquidity problem, a solvency problem, or both? If Q4 19 is a good proxy for FY 20, which seems to be a justified assumption, DTEK’s liquidity must be quite tight. The company’s EBITDA would not be enough to cover interest expense and refinancing even a small amount of debt could be difficult. If this is the case, then DTEK’s debt is too high for the company and a haircut on the principal is necessary. Unless there is a strong case for electricity price recovery in Ukraine or a substantial cost reduction on the company level, we expect DTEK’s restructuring proposal to suggest both a reduction of cash interest and a haircut on principal.
Are DTEKUA bonds rich or cheap at a price of 45? The answer depends on restructuring assumptions. We estimate that a price of 45 reflects a number of restructuring scenarios, which combine a maturity extension to 2025-27, reduction of cash interest to 7-9% and a haircut of 40-50%. With substantially weaker earnings power of the company, the debt service cost has to be reduced in order to generate cash for deleveraging. We estimate that with a 40% haircut, a reduction of cash interest to 7.0-8.5% and maturity extension to 2025-26, DTEKUA could be valued in the range of 45-50 cents on the dollar.
No direct implications for Metinvest and DTEK Renewables. DTEK Energy, DTEK Renewables and Metinvest are controlled by SCM Group, which is ultimately beneficially owned by Rinat Ahmetov. DTEK Energy and DTEK Renewables are sister companies under DTEK B.V. holding company, which is a sister company of Metinvest. This means that from the financial point of view the DTEK Energy restructuring is an isolated case. There are related party transactions between DTEK B.V. companies and Metinvest, but we believe that the majority of financial flows go from Metinvest to DTEK as payments for electricity and gas.
Read the full report here.
Recap of the week’s key credit developments
Zambia (ZAMBIN): Zambia is seeking to restructure its foreign debt, according to Bloomberg reports on Tuesday, after issuing a request for proposal for advisors. It becomes the second country over the last week – that we know of – to seek some kind of debt treatment or relief on its bonded debt, in relation to the impact of Covid-19, following Ecuador’s suspension of some upcoming coupons last week (see here). Details are sparse, however. Zambia’s announcement may not be much of a surprise. Even before Covid-19, the writing has been on the wall for some time. It may be that the economic impact of the coronavirus pandemic has finally pushed Zambia over the edge, given its pre-existing vulnerabilities, and the muddle-through strategy finally reached its limit. Indeed, the final nudge may simply be that the government has virtually run out of reserves – gross international reserves fell to US$1.28bn at end-January, according to central bank data, while the country faces a looming US$750mn bond maturity in 2022. We think any restructuring will have to include bondholders and China, and preferably have IMF involvement, although at this stage it is not clear what Zambia wants; a simple maturity extension or something more severe. See our recent report here.
Lebanon (LEBAN): On Friday, the Ministry of Finance held an investor presentation, as the country seeks a sovereign debt restructuring. To summarise, there was nothing on restructuring terms, as should have been expected (clearly, it is too soon for that, despite some reports to the contrary). However, it did set out the perimeter of the debt, and confirmed that local debt will be included as well as the eurobonds, and the government’s restructuring principles (debt sustainability, refinancing capacity, external financial balance and providing a reasonable buffer to protect against exogenous shocks). The presentation set out some interesting facts, including that public debt was 178% of GDP last year and that the real GDP could contract by 12% this year after a 6.9% contraction last year. We think it looks set to be a lengthy process, as we have noted before. As a first step, the deadline for bondholder identification is 17 April. See our recent report here.
Georgia (GEORG): On Monday the IMF released a statement about the coronavirus impact on the Georgia. The Fund noted that the outbreak had worsened the economic outlook, and that authorities were putting measures in place to cushion the human and economic shock. Additionally, the Fund is working with the authorities to provide support under Georgia’s EFF programme, including through additional financing, which should also facilitate future donor support, help with coronavirus containment and support for the Georgian people and economy. Georgia’s small existing EFF (US$285mn, only 100% of quota), approved in April 2017, was extended by one year in December 2019 to April 2021.
Honduras (HONDUR): In a statement on Tuesday, the IMF announced the government will access a US$143mn disbursement already available under its existing SBA/SCF programme. Honduras is expected to face challenges related to the coronavirus outbreak, initially through the impact of a lock down, and further by the impact of reduced external demand, lower remittance inflows, tighter external financial conditions and the contraction in tourism. The disbursement comes as authorities need resources for healthcare and social spending. The US$312mn programme was approved in July 2019 and, hitherto, had remained undrawn.
Senegal (SENEGL): The IMF released a statement on Wednesday that IMF Staff had completed discussions with Senegal for a US$221mn disbursement under its Rapid Credit Facility and Rapid Financing Instrument (RCF/RFI), set up to support countries facing the impact of the coronavirus pandemic. Two-thirds of the fund would come under the RFI and one third under the RCF. The disbursement will support authorities in meeting urgent budgetary and balance of payments needs, coming from the coronavirus’ impact on global economic conditions, which have reduced tourism earnings and remittance inflows. The press release notes that the pandemic has weakened Senegal’s economic outlook, and that authorities have taken strong measures to mitigate the coronavirus impact. Board consideration is expected by mid-April. Recall that the IMF approved a new Policy Coordination Instrument (PCI) for Senegal in January 2020, but the PCI has no money attached.
South Africa (SOAF): On Friday, Moody’s downgraded its long term foreign currency rating for South Africa to Ba1 from Baa3, which strips the country of its final investment grade rating. S&P and Fitch assign the sovereign BB and BB+ ratings respectively, and all three major agencies now have a negative outlook on their ratings. Moody’s cited ‘deteriorating fiscal strength and structurally very weak growth, which Moody’s does not expect current policy settings to address effectively’. The negative outlook reflects the risk that economic growth will prove even weaker and the debt burden will rise even faster than expected.
Suriname (SURINM): S&P downgraded its long term foreign currency rating on Suriname to CCC+ from B and changed its outlook to negative. Moody’s and Fitch have B2 and CCC ratings, respectively. S&P’s move was due to economic and tax shocks. The agency has concerns over future funding, especially as the US$550mn bond comes due in 2026. Additionally, the negative outlook reflects a possible future downgrade if there are no improvements in economic conditions, tax results or financing availability in the next 12 months. Upcoming elections create political uncertainty and limit the policy response to the economic, fiscal and financing challenges.
Nigeria (NGERIA): S&P also downgraded its long term foreign currency rating on Nigeria to B- from B and changed its outlook to stable from negative on 26 March. Moody’s and Fitch have B2 and B+ ratings respectively, each with a negative outlook. The downgrade comes amid low international oil prices and lower demand for oil due to the coronavirus outbreak. Federal government policy responses are unlikely to be effective enough to reduce the pressures on the country’s external and fiscal positions and foreign reserves.
Angola (ANGOL): The last week has seen two negative ratings action for Angola. On Tuesday, Moody’s placed Angola’s B3 rating on review for downgrade, due to the shock of lower global oil prices and the tightening of global financing conditions. Moody’s already considers public finances and the external position to be weak. Despite some reforms implemented in recent years, the agency also believes that weak governance undermines the government’s capacity to respond to these shocks. The currency also weakened by 11.3% in Q1 20, largely due to the credit shock facing multiple sectors stemming from the coronavirus outbreak. This increases the external debt burden and debt service costs. Moody’s review period will allow the agency to assess the overall policy response to the shock and the capacity of the authorities to manage the stress on public finances, the impact of lower oil export receipts on foreign reserves, and the risks associated with large domestic and external debt service payments. The move comes after S&P downgraded Angola’s rating to CCC+ from B- on 26 March. Fitch rates the sovereign B- with stable outlook.
Global policy response: Central banks around the world have continued to loosen monetary conditions to support their economies amid the coronavirus pandemic. The Reserve Bank of India, which had been cautious in acting until now, cut its repo rate by 75bps to a record-low of 4.4%, the reverse repo rate has been reduced by 90bps to 3.85% and the cash reserve ratio has been lowered by 100bps to 3%. The Indian Finance Ministry also made its first coronavirus policy response last week, with a fiscal stimulus of 0.7% of GDP. Separately, Chile’s central bank cut its monetary policy rate by 50bps to 0.5% on Tuesday, and on Friday, Colombia cut its key rate by 50bps to 3.75%.
Nostrum (NOGLN): We reiterate our sell recommendation on Nostrum Oil & Gas notes due 2022 and 2025, as the company plans to approach bondholders to initiate debt restructuring negotiations and the next coupon payment approaches in Q3 20. The company released an operating update focusing on three key messages: 1) a massive downgrade of reserves, 2) the termination of a formal sales process, and 3) debt restructuring. With oil price below Nostrum’s operating breakeven level (according to our estimates), the absence of third party gas processing contracts and failed efforts to monetise existing assets through the formal sales process, the company has little to offer bondholders. See our recent report here.
Kurdistan: After the OPEC+ agreement fell apart, we made an initial assessment of the implications of the oil price shock for the oil & gas companies operating in the Kurdistan Region of Iraq. We identified the businesses better prepared for a prolonged period of low oil prices and payment delays, and suggested that capex cuts were just around the corner. Today, we see that many of our assumptions have played out: oil export payments are being delayed – Genel, DNO, Gulf Keystone and HKN Energy have not been paid for November-March 2019 oil shipments; cost-cutting is also underway – the companies have announced substantial capex cuts, which most likely will reduce production in 2020 and 2021. The KRG have demonstrated its high commitment to the independent oil companies operating in the region settling its August-October receivables in January and April 2020, but substantially lower oil prices could constrain the region’s ability to meet its financial obligations on time. We expect the companies to increasingly rely on their cash reserves to finance running costs and revise our recommendations based on the financial autonomy (how long the companies can operate without being paid) and profitability at the current level of oil prices. We have upgraded GENLLN 22s to Buy, downgraded HKNENG 24s to Sell, reiterated Hold on GULFKY 23s and DNONO 20s, 23s and 24s and reiterated Sell on SNMCN 23s. See our recent report here.