research reports

Highlights

• Real GDP growth in the US was an annualized 4.2% y/y (3rd estimate) in 2Q18, unchanged from the 2nd estimate. In September 2018, unemployment rate declined by 0.2ppts to 3.7%.
• Based on rapid estimates, in August 2018, economic growth slowed in all regional economies and came in at 2.1% y/y in Kazakhstan, 2.0% y/y in Georgia, 1.1% y/y in Russia, and 0.6% y/y in Armenia. In 8M18, real GDP growth was 3.7% y/y in Belarus and 0.7% y/y in Azerbaijan.
• In September 2018, annual inflation in the US was 2.3%, down from 2.7% in previous month. Based on the Eurostat flash estimate, annual inflation in EU19 was 2.1% in September 2018, up from 2.0% in August 2018.
• In September 2018, annual inflation was below the target level in Georgia (2.7%), Russia (3.4%), Armenia (3.5%) and Belarus (5.6%); inflation was within the target range in Kazakhstan (6.1%), and above the target in Ukraine (8.9%) and Turkey (24.5%).
• Monetary policy rate was increased to 9.25% (from 9.0%) in Kazakhstan as of October 17, 2018. The policy rate has remained unchanged in other countries.

Please see the full report for detailed coverage of the fixed income markets of Georgia, Armenia, Azerbaijan, Belarus, Kazakhstan, and Ukraine.

GR released poor FY17 audited results. On the back of the continued decline in freight traffic volumes, the top line decreased 6.8% y/y to US$ 173.2mn, from an already low base. On the positive note, logistic service and freight car rental revenue, together accounting for 20.8% of total, were up 32.4% y/y to US$ 29.4mn and 13.5% y/y to US$ 6.7mn, respectively. Following the addition of four new passenger trains, passenger traffic revenue boosted, up 19.7% y/y to US$ 9.1mn. Ambiguity on Tbilisi Bypass Project translated into a US$ 152.2 impairment loss in 2017. As a result, FY17 net income was negative at US$ 141.2mn. Significant drop in EBITDA caused the net debt-to-EBITDA ratio to reach 4.9x, exceeding the Eurobond covenant of 3.5x. The outlook for GR’s performance slightly improved in 2018, with 1H18 revenues increasing 3.9% y/y to US$ 80.4mn.

FY17 revenue was down 6.8% y/y to US$ 173.2mn, from the low base of US$ 185.9mn in 2016. Decrease in freight transportation revenue, down 15.3% y/y, was the main reason behind the decline. Freight handling and other revenue categories declined 10.6% y/y to US$ 20.0mn and 21.3% y/y to US$ 3.3mn, respectively. On the positive note, logistic service and freight car rental revenue, which account for 20.8% of total, were up 32.4% y/y to US$ 29.4mn and 13.5% y/y to US$ 6.7mn, respectively. Passenger traffic category increased for the second consecutive year with FY17 revenue up 19.7% y/y to US$ 9.1mn. In 1H18, the downward trend reversed with revenues increasing 3.9% y/y to US$ 80.4mn helped by the increased freight car rental and logistic service revenue categories.

Operating expenses (excluding impairment loss on PPE), which are mostly GEL-denominated, declined 3.7% y/y to US$ 148.0mn in 2017. The decrease is mostly attributed to GEL’s 6.0% depreciation against US$ in 2017 vs 2016 (in GEL terms operating expenses increased 2.1% y/y). Reduction of the revenue, coupled with reduction in other income from continuing operations were the main reasons behind the 12.3% y/y decrease in adjusted EBITDA to US$ 72.3mn in 2017.

US$ 152.5mn impairment loss was recognized on Tbilisi Bypass Project reflecting ambiguity on the project. Considering the significant uncertainties related to the future of the project and the associated potential economic benefits, the carrying value of the project (GEL 397.3mn) was written down to its recoverable amount (GEL 14.7mn). This resulted in GEL 382.6mn or US$ 152.5mn impairment loss recognition, hitting the bottom line, which came in at US$ -141.2mn.

Main Line Modernization Project is the only ongoing capital project by Georgian Railway. A US$ 95.0mn is expected to be spent over 2018-21, while the project finalization is anticipated for end-2019. The company plans to finance the capital expenditures with its internal sources.

FY17 net debt-to-EBITDA ratio came in at 4.9x, exceeding the Eurobond covenant of 3.5x. According to the terms and conditions of the 2012 Eurobond prospectus, GR and any of its subsidiaries are not allowed to incur, directly or indirectly, any financial indebtedness if net debt-to-EBITDA ratio exceeds 3.5x. We expect the ratio to remain above the Eurobond covenant in the medium term which will limit GR’s borrowing capacity under Eurobond covenants.

Electricity consumption growth rate was revised upwards by 3ppts for 2018. On August 27, 2018 Ministry of Economy and Sustainable Development updated the forecast of electricity (capacity) balance for 2018. Based on this document, forecast for electricity consumption in 2018 was revised upwards to 13.0TWh, which is 9.9% y/y increase and the highest growth of electricity consumption since 2010. This growth in demand expected to be satisfied by increased thermal generation and imports. Notably, imports are planned at last year’s record high level. The new balance also incorporates the changes into legislation made in May 2018 regarding the eligibility criteria for direct consumers and traditionally includes actual figures for 7M18.

Electricity consumption growth slowed in August 2018, increasing by just 1.0% y/y after the 11.8% y/y growth during May-July period. The slowdown in growth can be explained by the high base of August 2017 (+14.4%) and favourable weather conditions leading to decreased needs for air-conditioning. Domestic consumption of electricity in 8M18 was up by 7.7% y/y. Eligible consumers’ increased their consumption by 24.4% y/y, explained by addition of new companies to the group of eligible consumers, in line with legal changes effective since May 2018. Consumption by distribution licensees was down by 3.1% y/y in August 2018, caused by above-mentioned reallocation of eligible consumers and favorable weather conditions.

There was no export of electricity in August 2018 because of the deficit in the system. Generally, August is considered as an export month, but high growth in electricity consumption led to significantly low exports of electricity during 2015-2017 (3-year average at 28GWh).

Drop in hydro generation (-12.3% y/y) caused thermal generation (+81.2% y/y) and imports (+36.7%y/y) growth in August 2018. The low volume of hydro Generation is explained by bad hydrological conditions and maintenance works on some regulated HPPs. Notably, generation of new HPPs increased in August, contributing positively to the total supply of electricity. A 9.2% of electricity demand was satisfied by electricity imports from Azerbaijan (65.7% of imports) and Russia (34.3%).

Wholesale market prices in Georgia increased 0.6% y/y to USc 4.7/kWh in August 2018. A 16.4% of total electricity supplied to the grid in August 2018 was traded through the market operator ESCO, with the rest traded through bilateral contracts.

Turkish electricity prices increased by dramatic 70.6% y/y in TRY terms, but in US$ terms y/y growth was mere 4.6%. This was market reaction to TRY’s radical depreciation in August 2018 as energy sector is highly sensitive to FX movements and is anchored to US$, based on analysts’ assessments. In august 2018, average electricity prices in Turkey reached US$ 5.3/kWh

GOGC released 1H18 unaudited results. Revenue was down 18.0% y/y to US$ 136.1mn in 1H18, mostly due to a 15.0% y/y decrease in sale of gas to US$ 89.1mn. Revenue from electricity generation, second largest revenue category, was also down 14.7% y/y to US$ 33.4mn. Rent from gas pipelines almost halved in the reporting period, falling 47.2% y/y to US$ 8.5mn due to the new tariff methodology introduced in Sep-2017. Operating expenses shrank 8.3% y/y to US$ 113.9mn in 1H18. Considerably decreased revenues caused a 39.8% y/y drop in adjusted EBITDA in 1H18 to US$ 30.0mn. The Gardabani II CCPP construction is on track with c.30% of the total project cost already invested as of 1H18.

GOGC reported US$ 136.1mn revenue in 1H18, down 18.0% y/y. Drop in gas sales (-12.9% y/y to 766 mmcm), mostly driven by reduced gas demand for power generation, was the major reason behind the 15.0% y/y decrease of gas sales revenue to US$ 89.1mn. Electricity sales, which made up 24.5% of total revenue in 1H18, shrank 14.7% y/y to US$ 33.4mn due to electricity balance specifics. The pipeline rental revenue sharply declined to US$ 8.8mn (-47.2% y/y). This was caused by replacing the volume-based pricing with a fixed monthly fee of GEL 3.5mn according to the modification of the pipeline rental agreement between GOGC and the state-owned operator of the gas pipeline system (Georgian Gas Transportation Company) in Sep-2017. Revenue from the sale of crude oil dropped 52.3% y/y to US$ 0.9mn in the reporting period. Oil transportation revenue was the only revenue category in the green, up 7.2% to US$ 4.2mn.

1H18 operating expenses were down 8.3% y/y to US$ 113.9mn as cost of gas dropped 12.3% y/y. Due to lower gas consumption, gas volumes purchased by GOGC’s decreased 13.7% y/y in 1H and this combined with a 6.5% y/y increase in average gas purchase price caused cost of gas sold to drop by 10.3% y/y to US$ 83.8mn (87.6% of the total gas costs). The cost of gas used in electricity generation also dropped 24.0% y/y to US$ 11.9mn due to the reduced demand on gas from Gardabani I. Other expenses, accounting for 4.2% of the total, almost doubled reaching US$ 4.8mn, driven by the increased costs for banking, consulting and other professional services.

On the back of the decreased revenue, 1H18 adjusted EBITDA dropped 39.8% y/y to US$ 30.0m. As a result, the adjusted EBITDA margin contracted from 30.1% in 1H17 to 22.1% in 1H18. The FX gain was down 40.0% y/y to US$ 11.2mn as GEL’s appreciation against USD was 5.4% in 1H18 vs. 9.1% in 1H17. A US$ 0.9m income was received from GOGC’s 49.9% shares in Kartli Wind Power Station in 1H18.  All of the above contributed to the 41.1% y/y decrease in net income to US$ 37.8mn.

Operating cash flow was at US$ 27.4mn in 1H18, compared to US$ 37.3mn in 1H17. In 1H18 GOGC’s operating cash flow was reduced by US$ 2.6mn due to interest payment on a US$ 26.0mn 2-year loan facility, borrowed in 2017. Construction of Gardabani II CCPP is on track, with US$ 46.2mn or c.30% of total already invested in 1H18. GOGC plans to invest additional US$ 74.0mn in 2H18, while the remaining portion (US$ 50mn) will be spent in 2019.