Fitch affirms Dubai Electricity and Water Authority at 'AA-'; Outlook Stable

A planned Sukuk issue by DEWA Funding Limited is rated expected 'AA-' (AA minus). The final rating for the Sukuk issue is contingent upon receipt of final documentation conforming materially to information already received (preliminary prospectus dated 20 May 2008).

DEWA is the exclusive vertically integrated electricity and potable water utility in the Emirate of Dubai and is fully state-owned. Its creditworthiness is closely aligned with that of the State, with the government's involvement in DEWA manifesting itself in numerous ways, including appointment of board members and the setting of electricity and water tariffs. DEWA also closely coordinates its strategic plan, annual budget and funding plans with the government. In addition, DEWA sources its gas, which is the primary fuel needed to fire its generation plants, from the Dubai Supply Authority DUSUP.

The ratings are also supported by its monopolistic position in a market with substantial growth expectations, consistently improving efficiency levels, and a modern asset base. However, on a stand-alone basis, DEWA's creditworthiness would warrant a Long-term IDR substantially below 'AA-' (AA minus). This is partly because of the negative impact of large investment requirements on its financial profile, which, until 2006, was characterised by a net cash position. Year-end 2007 gross debt totalled Dhs9.7bn, of which some AED6bn was short-term.

Meanwhile DEWA has improved its debt maturity profile. Fitch will monitor further funding efforts as well as DEWA's liquidity position, which was weak at year-end (mainly in the form of an undrawn overdraft facility), but has since improved.

While DEWA reported a net loss of Dhs750m in 2007, results in 2008 and beyond will benefit from the recently revamped regulatory frameworks for electricity and water tariffs. From March 2008, applicable customer tariffs for non-UAE nationals vary in function of volumes consumed, resulting in higher average tariffs. This is a step forward from the earlier system of flat tariffs that remained unchanged since 1998 despite substantial cost inflation.

Also, enhanced availability of natural gas, aided by a recently signed agreement with Dolphin Energy Limited, should prevent it from having to revert to expensive diesel oil as a secondary fuel to fire its plants. Its ability to secure long-term gas supply at attractive prices will nevertheless remain a key area of analytical focus for Fitch, especially against a background of an increasingly tight demand and supply balance in the region.

The planned Sukuk will be issued by DEWA Funding Limited, which is incorporated in accordance with the laws of the Cayman Islands. The issue will be comprised of certificates representing an undivided beneficial ownership interest in trust assets. Principal cash flows will include the payment by the issuer to DEWA as the seller of a package of assets of the issuance amount.

On each periodic distribution date, DEWA will pay to the issuer an amount reflecting the rental due in respect of the lease assets. Each payment is intended to be sufficient to fund the corresponding distribution amount payable by the issuer under the certificates.

Sukuk investors should be aware that DEWA has by now issued $2bn under a $4bn securitisation programme ($1bn in August 2007 and $1bn in May 2008). Pursuant to the securitisation, it has undertaken to assign some utility receivables, which are not available for the purpose of servicing the Sukuk debt, nor are a portion of receivables that currently relate to sales to the government and that will be settled in the form of credit notes.

Fitch notes that additional drawings under the securitisation programme may lead to an assignment of further receivables, which could possibly result in a downgrade of the Sukuk rating to reflect subordination risk. However, this risk is partly offset by the expected growth in cash flows on the back of increased volumes and approved tariff increases, and the government's commitment to reduce the percentage of non-cash settled payments. For the Sukuk rating to remain the same as DEWA's Long-term IDR, Fitch would require projected interest coverage based on cash flows available to holders of Sukuk debt to remain comfortably above one time.