Fitch Affirms Italy's Terna S.p.A. at 'BBB+'/Stable despite Sovereign Downgrade
(The following statement was released by the rating agency) Fitch Ratings-Milan-April 30: Fitch Ratings has affirmed Terna S.p.A's Long-Term Issuer Default Rating (IDR) at 'BBB+' with a Stable Outlook. The senior unsecured rating is also affirmed at 'BBB+'. The ratings of Terna are affirmed despite Fitch's recent downgrade of the Italian sovereign rating (BBB-/Stable), reflecting its nearly full insulation from the macro-economic shock stemming from the coronavirus pandemic. This is due to negligible volume and price risk, good regulatory visibility (the current regulatory period for Terna covers 2020-2023), and the long record of the regulator in Italy (since 1995). We expect Terna to meet its financial targets notwithstanding the coronavirus and economic crises. Nevertheless the weakening socio-economic environment increases the risk of adverse policy and regulatory measures, as happened in the past for example with the Robin Hood Tax (which however has been ruled by the Constitutional Court as unconstitutional) and some revisions to the incentive scheme for renewables. However, the Stable Outlook also reflects Terna's importance for the sector's energy transition with the company's large capex plans and wider implications for the economy in Italy. Key Rating Drivers Limited Impact from Pandemic: Given the essential nature of Terna's services, the company has continued to operate its assets, without reporting any major problems. We expect the large drops in electricity and gas demand, and in related spot prices, to have negligible impact on the financials of Terna, which is mostly insulated from these developments. We expect extraordinary costs related to the pandemic to be limited, while counterparty risk is fairly low, and we therefore do not foresee large working capital outflows at year-end. We expect Terna to confirm their strategic and financial targets, although some re-phasing of the capex plans may be possible. Regulation is Key: The Italian regulator ARERA has around 25 years of history. The allowed return on RAB (regulated asset base) will be reviewed at the beginning of 2022, but we do not expect the related formula to see major changes. We consider regulatory stability more important than the sovereign rating for Italian network companies. Although we recognise that the weakening economy could increase political and social pressure on utilities to share the burden, we believe that their strategic role and sizeable capex plans mitigate the risk of material unexpected cuts to Terna's returns. Moderate to Limited Headroom: Our rating case estimates average funds from operations (FFO) net leverage at 6.5 (vs. 6.7x negative rating sensitivity). Terna's headroom will become limited from 2022, due to expected large capex for renewables development and energy transition. The Stable Outlook on the IDR also reflects Terna's consistently lower leverage relative to our expectations. Derivation Summary Terna has a robust business profile with similarly negligible price and volume risk to its most direct local peer, Snam S.p.A. (BBB+/Stable), which shares the same regulator, country of operation and reference shareholder, CDP RETI SpA (BBB/Negative). Snam has a slightly higher international exposure, which however is related to mature countries and allows some diversification. Overall Fitch defines the same rating guidelines for both of them (FFO net leverage above 6.7x, net debt / (RAB+Associates) above 65% as negative sensitivities). Italgas S.p.A. (BBB+/Stable) is an Italian gas distributor with tighter guidelines for the same rating (6.5x) due to its smaller size and higher cash flow volatility underscored by renewal risk pertaining to local gas distribution tenders. Red Electrica Corporacion S.A. (A-/Stable) has higher business risk, due to a less mature regulatory system and diversification into less solid businesses, but its rating is higher due to a more conservative financial profile. Redes Energeticas Nacionales, SGPA, S.A. has a lower rating (BBB/Stable), as a consequence of higher business risk and leverage. Key Assumptions - EBITDA broadly aligned with company's expectations, with main differences being weighted average cost of capital (WACC) of 5.3% for 2022-2024 and slightly lower contribution from non-regulated and international activities - Tax rate of 29% up to 2024 - Cost of new debt at around 1.5% up to 2024 - Cumulative net capex of EUR7.3 billion up to 2024; no MA activity or disposals - Broadly neutral working capital trend (cumulative cash flow generation below EUR100 million) for the next four years - Dividends in line with the company's policy, with slightly higher pay-out in the outer years of the business plan RATING SENSITIVITIES Factors that could, individually or collectively, lead to positive rating action/upgrade: An upgrade is unlikely, as we expect FFO net leverage to be close to our negative sensitivity. However, future developments that could lead to a positive rating action include: - FFO net leverage declining below 6.0x on a sustained basis and net debt / RAB below 58% Factors that could, individually or collectively, lead to negative rating action/downgrade: - Deterioration of FFO net leverage above 6.7x, FFO interest coverage below 4.0x, net debt/RAB approaching 65% over a sustained period, for instance as a result of worse-than- expected free cash flow, debt-funded acquisitions or adverse political measures - Growing exposure to unregulated activities or regulated activities under less predictable regulatory frameworks - Significant deterioration of the operating environment Best/Worst Case Rating Scenario International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit Link Liquidity and Debt Structure Healthy Liquidity: At end-2019, Terna's cash and cash equivalents amounted to EUR1,571 million and undrawn committed lines to EUR3,146 million. This is compared with short-term debt maturities of around EUR151.5 million with an expected negative free cash flow of around EUR370 million after acquisitions and divestures in 2020. REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria. ESG Considerations The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit Link Terna S.p.A.; Long Term Issuer Default Rating; Affirmed; BBB+; RO:Sta ; Short Term Issuer Default Rating; Affirmed; F2 ----senior unsecured; Long Term Rating; Affirmed; BBB+ Contacts: Primary Rating Analyst Antonio Totaro, Senior Director +39 02 879087 297 Fitch Italia Società Italiana per il rating, S.p.A. Via Morigi, 6 Ingresso Via Privata Maria Teresa, 8 Milan 20123 Secondary Rating Analyst Carlos Baeta, Analyst +44 20 3530 2616 Committee Chairperson Josef Pospisil, CFA Managing Director +44 20 3530 1287 Media Relations: Adrian Simpson, London, Tel: +44 20 3530 1010, Email: email@example.com; Stefano Bravi, Milan, Tel: +39 02 879087 281, Email: firstname.lastname@example.org. Additional information is available on Link Applicable Criteria Corporate Hybrids Treatment and Notching Criteria (pub. 11 Nov 2019) Link Corporate Rating Criteria (pub. 27 Mar 2020) (including rating assumption sensitivity) Link Corporates Notching and Recovery Ratings Criteria (pub. 14 Oct 2019) (including rating assumption sensitivity) Link Parent and Subsidiary Rating Linkage (pub. 27 Sep 2019) Link Short-Term Ratings Criteria (pub. 06 Mar 2020) Link Applicable Model Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s). Corporate Monitoring & Forecasting Model (COMFORT Model), v7.9.0 1-Link Additional Disclosures Dodd-Frank Rating Information Disclosure Form Link Solicitation Status Link Endorsement Status Link Endorsement Policy Link ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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