Johannesburg, 14 November 2019 – GCR Ratings (“GCR”) has affirmed eThekwini Municipality’s National Scale Issuer ratings of AA+(ZA) and A1+(ZA) in the long term and short term respectively, with a Stable Outlook accorded.
|Rated Entity / Issue||Rating class||Rating scale||Rating||Outlook / Watch|
|eThekwini Municipality||Issuer Long Term||National||AA+(ZA)||Stable Outlook|
|Issuer Short Term||National||A1+(ZA)|
GCR announced that it had released new ratings framework in May 2019. Consequently, the ratings for eThekwini Municipality were placed ‘Under Criteria Observation’. GCR finalised the review for eThekwini Municipality under the Criteria for Local and Regional Governments, released in June 2019. As a result, the eThekwini Municipality ratings have been reviewed in line with the new methodology and subsequently removed from ‘Under Criteria Observation’.
Summary rating rationale
The ratings on eThekwini Municipality (“ETH”, “the City” or “the Metro”) are underpinned by its strong operating profile, its position as one of the country’s major cities, as well as its strategic transport and logistics infrastructure. Unlike most local governments, the City actively uses leverage to achieve strong capital project implementation, but continues to follow relatively conservative financial policies. Counteracting these strengths are observed procurement process shortcomings, which if not properly remedied, could adversely impact the ratings.
ETH is a key hub of economic activity, representing approximately 7% of domestic GDP and just over 60% of the KwaZulu Natal province’s productivity. As home to Africa’s busiest port, it is a strategic gateway to the continent and rest of the world, and has extensive transportation infrastructure, which has been supportive of the establishment/emergence of certain secondary industries and related tertiary services. The City continues to draw inward migration, but is seen as losing skilled labour to larger Metros. Its economic growth has also slowed, converging towards weak national metrics, while the tax base has been relatively unchanged over several years. Although progress on catalytic projects is noted, stronger economic progression is only achievable in the medium term, on the back of national policy certainty, as well as improved business and consumer confidence.
With respect to management and governance, procurement shortcomings that resulted in a marked increase in irregular expenditure are a concern. While GCR notes recent changes that are meant to enhance overall governance, ETH will be expected to demonstrate the rigour of the remedial internal controls adopted by improving adherence to supply chain management requirements going forward.
Well diversified sources of income are a credit positive, with internally generated revenue (“IGR”) accounting for 74% of total income in FY19. The progression in IGR has also closely matched cost inflation in the five years to FY19, despite intermittent, double digit increases in personnel costs arising from National Bargaining Council outcomes. Capex implementation slowed to a new low of 70% in FY19, mostly due to exogenous delays related to certain projects, although it is expected to continue to average over 80% as infrastructure rollout normalises going forward. ETH has also bedded down new systems that previously saw debtors’ collections decline from over 100% towards 90%, with the rate expected to stabilise at high levels on the back of internal efficiencies and system integration.
Counterbalancing these strengths is persistent pressure on trading service margins, as bulk tariffs continue to rise while consumers’ reliance on the national power grid remains restrained, and ETH strives to stabilise water losses. Against this backdrop, and given expectations of even more stringent operational grant disbursements to Metros, operating surpluses could narrow substantially over the rating horizon despite sustained cost rigour.
The City continues to follow a relatively conservative financial policy, with borrowings only expected to rise moderately YoY despite a measured increase in capex planned ranging from R7.7bn-R8bn in FY20 to FY22, from a R7.1bn initial budget for FY19. Net debt to income is projected to remain at the low end of the 10%-15% range, while the robust operating cash flow (“OCF”) coverage of net interest is expected to be sustained over the rating horizon. OCF coverage of debt dipped below the 50% threshold in FY19, although ETH is expected to achieve levels of at least 50%-55% going forward, on the back of the improved working capital cycle. Counteracting the sound leverage is the current counterparty concentration and lack of access to capital markets, which could both be addressed by the entrenchment of the DMTN programme to be launched for the first half the 2020 calendar year.
Liquidity is underpinned by demonstrated prudence in planning, which has supported reasonable unencumbered cash coverage levels. That said, cash days on hand have declined over the years, as the largely static tax base continues to sustain rising operational requirements amidst slow progression in grant income. GCR expects unencumbered cash coverage to trend within the 55 to 65 day range, from an average of approximately 80 days achieved prior to FY18. However, the materialisation of sizeable contingencies and other claims could curtail unrestricted cash coverage, and this tempers GCR’s overall financial profile assessment somewhat.
The Stable Outlook reflects the view that continued strong operating performance and conservative financial policies should support a robust credit risk profile despite weak economic growth and pressure on trading services.
Negative rating action could arise from a deterioration in audit outcomes or sustained procurement irregularities, even if these do not immediately result in weaker credit protection metrics. A deterioration in liquidity that sees unrestricted cash coverage sustained below 50 days could also result in a downgrade. Conversely, an upgrade could arise if internal efficiencies support sound OCF levels, enabling the City to sustain prudent leverage and adequate liquidity.
|Primary analyst||Patricia Zvarayi||Deputy Sector Head: Corporate & Public Sector Ratings|
|Johannesburg, ZA||Patricia@GCRratings.com||+27 11 784 1771|
|Committee chair||Sheri Morgan||Senior Analyst: Corporate & Public Sector Ratings|
|Johannesburg, ZA||Morgan@GCRratings.com||+27 11 784 1771|
Related Criteria and Research
|Criteria for the GCR Ratings Framework, May 2019|
|Criteria for Rating Local and Regional Governments, June 2019|
|GCR Country Risk Scores, June 2019|
|Rating class||Review||Rating scale||Rating class||Outlook||Date|
|Issuer Long Term||Initial||National||AA-(ZA)||Stable||Oct 2001|
|Issuer Short Term||National||A1(ZA)|
|Issuer Long Term||Last||National||AA+(ZA)||Stable||Nov 2018|
|Issuer Short Term||National||A1+(ZA)|
RISK SCORE SUMMARY
|Country risk score||7.50|
|Sector risk score – approximates country risk||7.50|
|Management and governance||-0.50|
|Leverage & Capital Structure||0.50|
|Funding & Liquidity||0.00|
|Government support floor||0.00|
|Capital Markets||The part of a financial system concerned with raising capital by dealing in shares, bonds, and other long-term debt securities.|
|Country Risk||The range of risks emerging from the political, legal, economic and social conditions of a country that have adverse consequences affecting investors and creditors with exposure to the country, and may also include negative effects on financial institutions and borrowers in the country.|
|Credit Rating||See GCR Rating Scales, Symbols and Definitions.|
|Debtor||The party indebted or the person making repayments for its borrowings.|
|Downgrade||The rating has been lowered on its specific scale.|
|DMTN||Domestic Medium Term Notes.|
|Issuer Ratings||See GCR Rating Scales, Symbols and Definitions.|
|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.|
|Operating Cash Flow||An entity’s net cash position over a given period, i.e. money received from customers minus payments to suppliers and staff, administration expenses, interest payments and taxes.|
|Rating Horizon||The rating outlook period, typically a period of 18-24 months.|
|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||Current; ordinarily less than one year.|
|Upgrade||The rating has been raised on its specific scale.|
|Working Capital||Working capital usually refers to the resources that a company uses to finance day-to-day operations. Changes in working capital are assessed to explain movements in debt and cash balances.|
SALIENT POINTS OF ACCORDED RATINGS
GCR affirms that a.) no part of the rating process was influenced by any other business activities of the credit rating agency; b.) the rating was based solely on the merits of the rated entity, security or financial instrument being rated; c.) such rating was an independent evaluation of the risks and merits of the rated entity, security or financial instrument; and d.) the validity of the rating is for a maximum of 12 months, or earlier as indicated by the applicable credit rating document.
The credit ratings have been disclosed to eThekwini Municipality. 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.
eThekwini Municipality participated in the rating process via face-to-face management meetings, teleconferences and other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible. The information received from eThekwini Municipality and other reliable third parties to accord the credit ratings included:
- The unaudited financial results up to 30 June 2019
- Four years of comparative audited numbers
- Budget reports to the 2021/22 fiscal year
- The Integrated Development Plan, 2019/20 review