Moody's Investors Service (Moody's) has on Wednesday upgraded the ratings of Saudi Electricity Company (SEC) to A1 from A2 on account of increased government support. The upgrade to A1 reflects Moody's revised assumption of government support to "Very High" from "High" under the methodology for Government-Related Issuers (GRI). This assumption leads to the alignment of SEC's issuer rating with Saudi Arabia's sovereign rating. The action is underpinned by a proposed new regulatory framework set to be implemented on Jan. 1, 2021. The new framework will offer a more transparent and predictable compensation mechanism for SEC than is currently the case. In addition, the refinancing of unpaid payables and soft loans in a SR167.9 billion ($44.8 billion) shareholder instrument (SHI) represents further evidence of government support. The latter leads to a cleaner capital structure given the perpetual nature of the SHI and its subordination to senior debtholders. SEC's Baseline Credit Assessment (BCA) is unchanged at baa1 because it was already positioned to reflect ongoing support from the government in the form of soft loans and the provision of feedstock as well as tariff subsidies for the local population. While remaining subsidized, the new regulatory framework will reduce the need for on-going financial support from the government to SEC. The new regulatory framework will lead to more stable and predictable cash flows for most of the company's operations. The framework will allow SEC to recover its operational costs and earn a fair rate of return of 6.0% on its investments under a regulated asset base model with control periods of three years. However, Moody's recognizes the need for an operating track record under the new regulatory framework, especially when it comes to the timeliness of payments. Moody's has determined that the SHI should be considered as a debt instrument. Under this approach, the debt-to-capitalization ratio is estimated at around 78% for 2021. However, the BCA recognizes some of the equity-like characteristics of the SHI including the perpetual maturity and the subordination to any existing and future senior debt. Excluding the SHI from the calculation of Moody's-adjusted debt, the debt-to-capitalization ratio will be materially lower at around 36% in 2021. Moody's notes that the SHI pays cash coupons, which can be postponed at the option of the company under certain circumstances. Moody's also notes that the SHI is a bilateral agreement between SEC and the Ministry of Finance, which may be amended if agreed by the parties. Moody's considers SEC's liquidity profile as adequate and anticipates an acceleration in the company's capital expenditures under the new regulatory framework which will require external funding. As of Sept. 30, 2020, primary sources of liquidity include planned operating cash flows of around SR25.1 billion ($6.7 billion) for the next 12 months (after a SR3.8 billion semi-annual profit payment on the SHI), SR8.1 billion ($2.2 billion) available under committed credit facilities and a cash balance of SR5.8 billion ($1.5 billion) which are insufficient to cover SR10.4 billion ($2.8 billion) of short-term debt as of Sept. 30, 2020, expected dividends of around SR2.9 billion ($0.8 billion) and expected capital expenditures of around SR35.7 billion ($9.5 billion) for the next 12 months. The company is set to generate significant operating cash flows under the new regulatory framework, and will benefit from financial flexibility around the payment of periodic distributions under the SHI and capital spending. However, the company will rely on substantial debt issuances under normal circumstances to finance the vast capital spending program required to meet the growing demand for electricity in Saudi Arabia. Such sustained negative free cash flow could negatively affect the company's financial profile over time. — SG
