The affirmation reflects the view of S&P that KMG’s credit metrics will likely improve, owing to the potential upstreaming of KMGEP’s cash to KMG after the minority shareholder buyout, higher oil prices, and the expected completion of key capital expenditure (capex) projects. In addition, S&P expects the recent extension to 2020-2022 of KMG’s option to buy back a stake in the Kashagan oil project will provide KMG with additional flexibility. Still, as long as the Kashagan option is outstanding, and refinancing or repayment of debt at KMG’s immediate parent, Samruk-Kazyna, remains unresolved, uncertainty over KMG’s financial policy will continue to constrain their assessment of the company’s stand-alone credit profile (SACP) at b and the overall rating at BB-.

On Jan. 23, 2018, KMGEP announced that it had received valid acceptance of its tender offer to buy out all outstanding global depositary receipts (GDRs) and that its board unanimously approved the offer to repurchase all of KMGEP’s outstanding common shares. The company expects to complete the minority buyout in March 2018 and subsequently apply to delist KMGEP from the London and Kazakhstan stock exchanges. As a result, KMG’s share in KMGEP could increase to up to 100% from the current 63%. Previously, S&P treated KMGEP’s solid cash balances of about $4 bln as not immediately available to service its parent’s debt. Now we estimate that about $2 bln in cash will be used to buy out KMGEP’s minority shareholders, while most of the remaining $2 bln should become available to KMG. S&P would therefore adjust KMG’s reported debt by deducting this additional surplus cash.

S&P expects KMG’s EBITDA will stabilize at about $2.0 bln-$2.2 bln in 2018-2019. In the currently favourable oil price environment, KMG’s mature and relatively high-cost oil production assets are profitable, oil and gas pipeline businesses demonstrate stable performance, and Tengizchevroil LLP (BBB/Stable/—) may pay dividends on KMG’s 20% stake, despite its ongoing capex program. S&P doesn’t factor in any material dividend income from KMG’s 8.4% stake in Kashagan before the debt at Kashagan is repaid. They expect KMG’s free operating cash flow (FOCF) will turn positive in 2018-2019, after its key capex projects related to refining and the Beineu-Bozoy-Shymkent gas pipeline are completed. Nevertheless, following several years of negative FOCF, KMG has accumulated over $13 bln of adjusted debt as of Sept. 30, 2017, and continues to provide loans to its immediate parent, government-controlled national welfare fund Samruk-Kazyna, to address amortization of Kashagan-related debt. Therefore, S&P expects deleveraging will be only gradual, with funds from operations (FFO) to debt at 12%-17% and adjusted debt to EBITDA at 4.5×-5.0× in 2018-2019.

Uncertainty about financial policy remains the key constraint on the rating. In late 2015, KMG sold 50% of Kashagan B.V. (which owns a 16.88% interest in the world-class Kashagan oil project) to Samruk-Kazyna to temporarily reduce KMG’s reported debt. S&P understands that, to fund the $4.7 bln asset price, Samruk-Kazyna raised about $2 bln in debt from banks and bondholders, and the rest via a bond issued to Samruk-Kazyna. KMG holds an option to buy this asset back, and S&P understands the option has been extended to 2020-2022 from 2018-2020, which increases KMG’s flexibility. S&P also understands that Samruk-Kazyna’s stake in Kashagan is currently frozen by a court order as a result of a long-standing dispute between the Kazakh government and external investors. Still, they cannot rule out the possibility that, before Samruk-Kazyna finds any alternative ways of repaying its debt to third parties or refinancing it, it could ask KMG to exercise the option or otherwise provide support to Samruk-Kazyna. If KMG exercises the Kashagan option and finances it with debt, this would materially increase its leverage, squeeze liquidity, and reduce covenant headroom unless offset by state support or other sources (such as converting the government’s loan to Samruk-Kazyna into KMG’s equity). The value of the stake in Kashagan is roughly equivalent to KMG’s EBITDA for two years.

The rating on KMG continues to factor in S&P’s expectation of a high likelihood of extraordinary state support for KMG, resulting in a two-notch uplift above their assessment of the company’s SACP at b, which is the highest for government-related entities (GREs) in Samruk-Kazyna’s portfolio. KMG is the government’s main asset in the strategic hydrocarbon industry, with priority access to new assets and stakes in all significant oil ventures in the country. It is a large exporter, taxpayer, employer, and supplier of fuel to the domestic market at low prices. In S&P’s view, KMG’s default would have significant repercussions for the government’s reputation and that of other GREs. The Kazakh government’s financial capacity to support GREs is underpinned by the BBB- sovereign rating. Still, KMG is only responsible for 28% of the country’s oil production (12% if only majority-owned production is included), with minority stakes in the country’s largest and most profitable internationally led projects. In S&P’s view, support procedures via Samruk-Kazyna could be complex and time consuming. They believe that the government generally tolerates relatively high debt at KMG and other GREs, and has historically provided limited support to the company. Also, they understand that the government is considering privatization of a minority stake in KMG in the coming years, although the timing and use of the proceeds are unclear.

The stable outlook reflects S&P’s expectation of KMG’s EBITDA stabilizing in 2018-2019, with FFO to debt at 12%-17%, FOCF turning positive, and only gradual deleveraging given already high debt. They also expect a continuing high likelihood of government support.

The uncertainty about the Kashagan option still constrains any rating upside. However, S&P could take a positive rating action following an improvement in KMG’s SACP through a material reduction of consolidated adjusted leverage (with FFO to debt consistently above 20%), consistently positive FOCF, sustainable liquidity, and no risk of a debt-financed Kashagan buyback.

Rating upside could also result from a sovereign upgrade. Rating downside could result from a material weakening of liquidity or leverage, for example if KMG has to undertake large debt-financed investments (such as a Kashagan buyout) without sufficient offsetting state support, or if significantly lower oil prices undermine the company’s sustainable EBITDA generation. Downside could also stem from pressure on KMG to repay debt at Samruk-Kazyna, for example via intragroup loans or the Kashagan option. Given S&P’s expectation of a high likelihood of state support, KMG’s SACP would have to deteriorate to ccc+ or lower to trigger a negative rating action. These are not S&P’s base-case scenarios for the rating, however.