Fitch assigns Saudi Electricity Company Sukuk 'AA-(EXP)' expected rating

The Stable Outlook on the Long-term IDR mirrors that on the Kingdom of Saudi Arabia (KSA; 'AA-'/Stable).

The final rating is contingent upon the receipt of final documentation conforming materially to information already received and details regarding the Sukuk amount.

The transaction involves the transfer by SEC of a portfolio of assets to Saudi Electricity Global SUKUK Company 2 (SEGSC2), a wholly-owned subsidiary of SEC. In its capacity as the lessor, this company will lease the assets to SEC. As the lessee, SEC will pay rental payments in respect of the assets which are intended to be sufficient to fund the periodic distribution amounts due under the certificates. On the scheduled dissolution date, the trustee may exercise its rights under the purchase undertaking and require SEC to purchase all of its rights, title, interests, benefits and other entitlements in and to the assets.

The Sukuk will be issued on an unsecured and unsubordinated basis. Among other aspects, the Sukuk benefits from a negative pledge and a cross default clause. Proceeds of the issuance will be used for general corporate purposes. The certificates are expressed to be governed by English law.

Key Rating Drivers

- Rating Alignment With Saudi Arabia:

SEC's ratings are aligned with the KSA, based on strong legal, operational, and strategic links, in accordance with Fitch's Parent and Subsidiary Rating Linkage methodology. KSA directly owns 74% of SEC (and indirectly owns another 7% through Saudi Aramco, a state-owned enterprise). SEC has been instrumental in executing KSA's policies on electrification. Through its council of ministers, the government is responsible for approving the electricity tariffs that SEC can charge its customers. Currently, the electricity tariffs for residential customers are deeply subsidised.

- Low-risk Business Profile:

SEC's key credit strengths are its monopolistic position in the electricity transmission and distribution sector and a dominant position in the electricity generation segment within KSA. Low generating capacity utilisation (a function of the market dynamics) and limited visibility in the cost structure remain key rating concerns. In addition, lack of clarity about the future settlement of the subsidised fuel costs payable to Saudi Aramco creates uncertainty about long-term cash flow visibility and stability. In the past, the KSA government assumed the payment of fuel costs onto the account of the Ministry of Finance.

- Continued State Financial Support Critical:

Historically, state financial support has been very strong. Currently, SEC is drawing down upon the government approved SAR51bn soft loans to partially finance its capital projects through 2015. SEC will spend approximately SAR150bn through 2015 on various segments of the electricity infrastructure in the KSA. Fitch notes that the massive capital spending programme under the current tariff regime will adversely affect the credit metrics. Future government support through soft loans and assumption of fuel-related costs will be critical for the company's financial position. Hence Fitch assumes that SEC will continue to receive state support since the current electricity tariff structure for residential customers (about 50% of total electricity consumption within the KSA) is deeply discounted.

- Weakening Standalone Credit Metrics:

Fitch calculated leverage, measured by net debt/funds from operations (FFO), is expected to rise above 4x by 2015 from 2.1x at the end of 2012. These ratios take into account the SAR51bn of governmental support for the new capital projects. Fitch assumes that the company will supplement cash from operations with debt to fund its capital programme and that it will continue to defer fuel costs payable to Saudi Aramco. Nonetheless, SEC's standalone credit profile under a cost plus tariff regime is significantly lower than the current state support driven rating level.

- Liquidity:

Liquidity at SEC is adequate. At the end of 2012, it had approximately SR24bn in total liquidity, including SAR3bn in cash, with most of the remainder comprising headroom under existing government and commercial facilities. This compares with around SR1.5bn of maturities due in 2013, and significantly negative free cash flow expectation. In 2012, SEC successfully raised about SAR6.6bn in new Sukuk.

- Rating Sensitivities:

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

- A positive action on KSA's sovereign rating will likely result in a positive rating action on SEC's IDR, providing that the strength of parent subsidiary linkage does not weaken.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- Decline in the government support or a negative rating action on KSA's sovereign rating would likely result in negative rating action for SEC.