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GCR affirms Buffalo City Metropolitan Municipality’s National Scale Issuer Ratings of A(ZA)/A1(ZA), Outlook Stable

Rating Action

Johannesburg, 31 March 2021 – GCR Ratings (“GCR”) has affirmed the national scale long and short term issuer ratings assigned to Buffalo City Metropolitan Municipality at A(ZA) and A1(ZA) respectively, with a Stable Outlook.

Rated Entity Rating class Rating scale Rating Outlook / Watch
Buffalo City Metropolitan Municipality Long Term Issuer National A(ZA) Stable Outlook
Short Term Issuer National A1(ZA)

Rating Rationale

The ratings on Buffalo City Metropolitan Municipality’s (“BCMM’, “the City” or “the Metro”) balance its conservative financial profile, against operating performance and debtors collection pressures exacerbated by the coronavirus pandemic.

Cognisance is taken of BCMM’s status as a metropolitan municipality, although its economic base is small and less diverse than some of the larger metros. In terms of national GDP, BCMM contributes around 1.6%, with the Metro’s longer term average growth rate converging with weak national metrics given the challenging economic environment. Whilst government related services remain the leading economic driver of the Metro, the industrial sector is also an important contributor (particularly the motor industry), as the City is well positioned in East London in terms of its logistics potential, although progress on catalytic projects has been relatively slow. BCMM is located in one of the poorest provinces in South Africa, with the Metro characterised by a high unemployment rate of 31.7% (national rate: c.32.5%), giving rise to rife poverty and inequality levels. However, access to electricity, sanitation and literacy levels in the Metro are much better than the province (and in some cases in line with the national average), mainly a factor of its position as an economic hub.

BCMM reported its first small operating deficit over the review period in FY20, negatively impacted by consumer and business strain from the onset the COVID-19 pandemic. The difficult economic environment is expected to continue to pressurise the Metro’s own-source revenue capacity (contributing around 60% of total income) in terms of low growth prospects for service charges and ensuing debtor collection challenges. This could further prolong capex implementation efforts.

BCMM’s credit risk profile has also been negatively impacted by its weak historic audit outcomes with findings (notably substantial irregular expenditure balances), although ongoing steps to improve management and governance are noted.

BCMM’s conservative leverage levels continue to support the ratings, with the Metro remaining in a net ungeared position in FY20. Gross debt totalled R288m in FY20 (FY19: R398m), with the debt-to-income ratio remaining low at 3.8% (FY19: 4.6%). The City’s commitment on accelerating infrastructure investments will require increased debt financing of R675m over the next two years as grant income, the main funding source, and internal reserves diminish somewhat. Nevertheless, even with the current income pressures, gearing metrics are still expected to remain comfortably below 20%, with sound debt protection measures. The strong leverage assessment is somewhat counterbalanced by funding concentration to the Development Bank of South Africa, although the new debt is likely to be raised from private sector funders, which would be a stronger indicator of demonstrated access to capital.

GCR notes a relative weakening in BCMM’s liquidity profile. The City’s historically large cash balances have declined over the years, as a result of cash flow pressures and increased internal financing of its capital programme. As such, days cash on hand eased to 91 days in FY20 from historical levels well above 100 days and is estimated to be further pressured in FY21 to a new low of 50 days. Nevertheless, this still remains adequate for a Metro, whilst GCR’s liquidity coverage of 1.5x over the next 12 months provides further comfort and is largely reflective of the low near-term debt maturities.

Outlook Statement

The Stable Outlook reflects our expectation that the Metro will maintain its conservative debt management and has sufficient liquidity sources to mitigate against the current cash flow pressures. However, GCR expects the Metro’s financial performance to remain strained over the next 12-24 months, as the weak economic environment weighs on tax revenues and cost escalations remain unabated.

Rating Triggers

If the Metro’s operating performance and liquidity deteriorate beyond our current expectations, negative rating action could be taken. Positive rating action is unlikely in the current weak economic environment.

Analytical Contacts

Primary analyst Sheri Morgan Senior Analyst: Corporate Ratings
Johannesburg, ZA Morgan@GCRratings.com +27 11 784 1771
Committee chair Matthew Pirnie Group Head of Ratings
Johannesburg, ZA MatthewP@GCRratings.com +27 11 784 1771

Related Criteria and Research

Criteria for the GCR Ratings Framework, May 2019
GCR Rating Scales Symbols and Definitions, May 2019
Criteria for Rating Local and Regional Governments, June 2019
GCR’s Country Risk Scores, published February 2021

Ratings History

Buffalo City Metropolitan Municipality

Rating scale Review Rating class Rating Outlook/Watch Date
Long Term Issuer Initial National BBB(ZA) Stable Outlook Aug 2003
Short Term Issuer National A3(ZA)
Long Term Issuer Last National A(ZA) Stable Outlook Aug 2020
Short Term Issuer National A1(ZA)

Risk Score Summary

Rating Components & Factors Risk scores
Operating environment 14.00
Country & sector risk score* 14.00
Business profile (2.50)
LRG Profile (0.50)
Operating performance (1.00)
Management & governance (1.00)
Financial profile 1.50
Leverage and capital structure 2.00
Liquidity (0.50)
Comparative profile 0.00
Government support floor 0.00
Peer analysis 0.00
Total score 13.00

*The country risk score serves as a proxy for sector risk.

Glossary

Debt An obligation to repay a sum of money. More specifically, it is funds passed from a creditor to a debtor in exchange for interest and a commitment to repay the principal in full on a specified date or over a specified period.
Issuer The party indebted or the person making repayments for its borrowings.
Leverage With regard to corporate analysis, leverage (or gearing) refers to the extent to which a company is funded by debt.
Liquidity The speed at which assets can be converted to cash. It can also refer to the ability of a company to service its debt obligations due to the presence of liquid assets such as cash and its equivalents. Market liquidity refers to the ease with which a security can be bought or sold quickly and in large volumes without substantially affecting the market price.
Long Term Rating See GCR Rating Scales, Symbols and Definitions.
Maturity The length of time between the issue of a bond or other security and the date on which it becomes payable in full.
Portfolio A collection of investments held by an individual investor or financial institution. They may include stocks, bonds, futures contracts, options, real estate investments or any item that the holder believes will retain its value.
Rating Outlook See GCR Rating Scales, Symbols and Definitions.
Risk The chance of future uncertainty (i.e. deviation from expected earnings or an expected outcome) that will have an impact on objectives.
Short Term Rating See GCR Rating Scales, Symbols and Definitions.

Salient Points of Accorded Ratings

GCR affirms that a.) no part of the ratings process was influenced by any other business activities of the credit rating agency; b.) the ratings were based solely on the merits of the rated entity, security or financial instrument being rated; and c.) such ratings were an independent evaluation of the risks and merits of the rated entity, security or financial instrument.

The credit ratings have been disclosed to the rated entity. The ratings above were solicited by, or on behalf of, the rated entity, and therefore, GCR has been compensated for the provision of the ratings.

The rated entity participated in the rating process via management meetings, teleconferences and other written correspondence. Furthermore, the quality of information received was considered to be adequate, and has been independently verified where possible. The information received from the rated entity and other reliable third parties to accord the credit ratings included:

  • Unaudited Consolidated Annual Financial Statements June 2020 (Plus four years of comparative audited numbers);
  • Debt facility breakdown at June 2020;
  • The Integrated Development Plan 2020/2021;
  • Schedule A accounts.
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