KTO’s stand-alone credit quality is supported by long-term ship-or-pay contracts with oil producers, the company’s favourable debt structure and maturity profile, limited competition from alternative oil export pipelines, and good prospects for oil production and export in Kazakhstan. KTO benefits from low transportation costs and a strong market position in Kazakhstan because of its vast pipeline system. KTO distributes more than 57% of Kazakhstan’s total oil exports.

The rating is constrained by significant dependence on Russian pipeline operator OAO AK Transneft (BBB/Stable/—), construction risk related to pipeline capacity expansion projects, an opaque tariff regime and irregular tariff revisions, and operational risk due to aging assets.

S&P base-case operating scenario

S&P’s base-case scenario envisages no tariff increases and no significant fluctuations in the volumes of oil transported by KTO in 2012-2013. Accordingly they expect the company’s revenues to remain at 2011 levels in those years.

S&P think KTO’s profitability could come under pressure as a result of rising operating expenses, which would likely lead to some decrease in margins. Their expectation is that the company will report an EBITDA margin of about 42% in 2012 (compared with 46% in 2011) which they nevertheless find adequate in an industry context.

S&P base-case cash flow and capital-structure scenario

S&P’s base-case scenario incorporates expectations that KTO will maintain healthy cash flow generation in 2012 and 2013 with funds from operations to debt of about 50% (54% in 2011). They also expect the company to generate positive free operating cash flows despite significant planned capital spending to expand the company’s Kenkiyak-Kumkol pipeline to accommodate volumes of up to 20 million metric tons a year.

KTO had minimal balance sheet debt of Kazakhstani tenge (KZT) 303 million ($2 million), on Dec. 31, 2011). S&P do not incorporate any new large-scale investment projects into their base case, and assume that the company will manage to fund its capital spending needs over the next 12 months with internal sources without external borrowing at the company level. Nevertheless, S&P project KTO’s adjusted debt to EBITDA at 1.5´-2.0´ over the medium term, as they consolidate the company’s 50% share of debt in the Kazakhstan-China Pipeline (KCP), a 50-50 joint venture with China National Petroleum Corp. (AA-/Stable/—; Greater China national scale rating cnAAA).

Liquidity

S&P assess KTO’s liquidity as adequate in accordance with their methodology; the company has a sources-to-uses ratio of about 1.2´. However, they note that the company’s cash reserves are concentrated in several domestic banks with lower credit quality than that of KTO itself.

As of Jan. 1, 2012, the company’s main sources of liquidity included:

• Cash and call deposits of KZT22 billion (about $150 million); and
• Cash flow from operations, which we estimate at about KZT50 billion a year.

Key potential uses of liquidity within the 12 months as of Sept. 30, 2011, included:

• Capital spending of KZT40 billion;
• Debt repayment of KZT0.3 billion; and
• Dividend payments of about KZT20 billion.

KTO is subject to certain financial covenants in respect of debt at joint ventures, under which the company has significant headroom, in our view.

Outlook

The stable outlook on KTO reflects the outlook on the parent, KMG. As long as KTO remains a core entity of the KMG group, S&P anticipate that the rating on the company will move in line with the rating on the parent. Accordingly, they would have to revise the parent’s stand-alone credit quality to at least bb- to consider an upgrade.

The stable outlook incorporates their expectations that KTO will continue to benefit from ongoing and potential extraordinary support from KMG and that the benefits of long-term contracts with oil producers and stable regulated cash flows from oil transportation will mitigate heavy capital spending and operational risk.

We could lower the rating if KTO were to undertake new investment projects requiring significant external borrowing, resulting in credit measures that are not consistent with the current rating level, or if we were to see substantial unfavourable changes in new contracts with customers. Indications of weaker support or negative interference from the parent or the state could also put pressure on the rating.

Related criteria and research

• Rating Government-Related Entities: Methodology and Assumptions, Dec. 9, 2010
• Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
• 2008 Corporate Criteria: Ratios and Adjustments, April 15, 2008
• 2008 Corporate Criteria: Analytical Methodology, April 15, 2008