Fitch Affirms KOGAS at 'A+'; Outlook Stable

(Fitch Ratings-Hong Kong/Seoul-24 March 2011)--Fitch Ratings has affirmed Korea Gas Corporation's (KOGAS) Long-term Foreign Currency Issuer Default Rating (IDR) and foreign currency senior unsecured rating at 'A+' respectively. The Outlook on the IDR is Stable.

"KOGAS's inability to pass through higher fuel costs onto tariffs between 2008 and Q310 affected the company's cash generation and credit metrics significantly," say Shelley Jang, Associate Director in Fitch's Energy & Utilities team. "However, Fitch expects KOGAS's links with the government to remain very strong for the foreseeable future, which the agency considers to be the key driver for the company's ratings."

Fitch has applied its parent-subsidiary methodology to KOGAS's ratings and rates the entity on a top-down basis, ie by notching from the rating of its parent, the government of Korea ('A+'/Stable). The top-down approach is based on the agency's assessment that the legal, operational and strategic ties between KOGAS and the Korean government are very strong. In Fitch's view, KOGAS's strategic importance to the government is sufficiently significant to warrant an equalisation of its ratings with the sovereign parent.

KOGAS's revenue remains regulated; the company benefits from a tariff structure that allows the pass-through of changes in raw material costs to the wholesale price. However, due to economic difficulties and inflationary pressures, the government temporarily suspended the cost pass-through mechanism in early 2008. As a result, KOGAS's other receivables, representing fuel costs which could not be passed through, increased substantially to KRW4.2trn, and the company's credit metrics suffered accordingly. Although the tariff formula was reinstated in Q310, the recovery of these other receivables through tariff increases will be challenging given ongoing inflationary pressures. Fitch believes the full recovery of the other receivables may take at least three years.

KOGAS is actively seeking investment opportunities in overseas gas exploration and production (E&P) projects, in line with government policy to increase the country's energy self-sufficiency. Such backward vertical integration will lower the company's exposure to gas market price and supply risks. These investments have potentially higher returns than KOGAS's domestic business but carry higher execution risk.

Although KOGAS's capex will be partially funded through internal cash flow generation and recovery of other receivables, Fitch expects external financing requirements will be high in the short-to-medium term. The agency expects that KOGAS's funding will continue to be driven by more domestic bond issuances than overseas bonds. Fitch considers liquidity risk to be limited, reflecting KOGAS's exceptionally strong funding ability in the domestic capital market, supported by its quasi-sovereign credit profile.

As Fitch takes a top-down approach in rating KOGAS, any changes to Korea's sovereign rating or Outlook would immediately affect the company's ratings. Although Fitch expects KOGAS's links with the government to remain consistent over the next 12-18 months, any evidence of weakening links with the government, such as substantial dilution of government ownership, significant divestment of existing businesses or adverse revisions to related laws could lead to negative rating action. (ends)