The rating reflects Electrica's resilient business profile with 80%-85% of EBITDA coming from regulated and fairly predictable electricity distribution and a strong financial profile, Fitch said in a press release.
"The rating is above the sovereign rating of Romania (BBB-/Stable), due to Electrica's weak links with its main shareholder, the Romanian state, assessed under Fitch's Government-Related Entities (GRE) and Parent and Subsidiary Linkage (PSL) Rating Criteria," it added.
Fitch also said in the statement:
Focus on Distribution: Electrica's main area of operations is electricity distribution, conducted via three regional subsidiaries (SDTN, SDTS and SDMN) operating in the Northern Transylvania, Southern Transylvania and Northern Muntenia regions of Romania. Electricity distribution accounts for 80%-85% of EBITDA in our rating case, contributing to cash flow stability and supporting Electrica's credit profile.
Concession-Based Distribution: The three subsidiaries are natural monopolies operating electricity distribution networks under long-term concessions granted in 2005 and expiring in 2054. Upon expiry of the concessions, the government may purchase the relevant assets used for the performance of the distribution service from the concessionaires, together with any ancillary rights. We view the long-term nature of concessions and eligibility for compensations if concessions were not renewed as credit-positive. A similar concession-based model has been adopted in other EU countries, e.g. Germany.
Regulated Distribution: Distribution services are regulated by Autoritatea Nationala de Reglementare in Domeniul Energiei (ANRE) by applying a regulatory asset-based methodology to tariff calculations without direct government interference. Regulated revenues are approved for five years and the current fourth regulatory period started in 2019 and will last until 2023. The main changes compared with the previous regulatory period are a lower WACC of 6.9% (7.7% previously) and a higher efficiency factor of 2.00% (1.75% previously) applied to controllable costs.
Overall Predictable Framework: The regulatory framework is fairly stable (its milestones originate from 2005), but we view it as marginally less predictable than for Electrica's foreign peers. Tariffs are set on estimated parameters after which adjustments are made with one or two years delay, including for volumes and non-controllable costs pass-through. In Electrica's case it has led to relatively higher volatility of distribution earnings as indicated by lower results in 2018 and 2017 when compared with 2016 and 2015.
Significant Supply Business: Electrica's electricity and gas supply business is conducted via subsidiary Electrica Furnizare (EFSA). The supply business comprises two sub-segments: the regulated one (in which EFSA acts as a supplier of last resort) and the competitive one in which EFSA competes freely with other suppliers throughout the whole country. The supply business accounts for an average of 15% of EBITDA, but is more volatile and does not provide for much debt capacity.
Regulated and Competitive Supply: Electrica has an overall 19% market share in supply in Romania, which includes 51% in the regulated and 11% in the competitive part of this segment. There is a methodology approved by ANRE for setting and approving the regulated tariffs, which can be at different levels until their complete elimination in the future. This was initially scheduled for 2018, but did not work out as a large group of customers did not select a new supplier. The competitive part of the supply business is exposed to standard competition rules.
The supply business is more volatile than distribution. Its regulated part is exposed to tariffs setting by ANRE, where we see some risk of more opportunistic behaviour compared with distribution. The competitive part is exposed to competition and requires activity from EFSA to protect and build up its margins and market share.
Higher Capex: Electrica runs a capital-intensive distribution business, which as per our rating case will account for around 95% of total capex. Capex has been increasing since 2015 up to a peak of RON0.9 billion in 2018 and we expect it to remain on a structurally higher level of around RON0.6 billion to RON0.7 billion until 2023. The main funding sources have so far been internal (mostly from financial investments held by Electrica in the form of sovereign bonds and bills), but also in the form of external long-term bank loans (RON320 million) and bank overdrafts. Due to persistently high capex, Electrica will need to take on new debt, which is reflected in negative free cash flow and higher leverage expectations.
Rising But Low Leverage: Electrica has low leverage (Fitch-calculated funds from operations (FFO) adjusted net leverage of 0.5x in 2018). We expect it to increase to an average of about 1.5x over 2019-2023, which corresponds with net debt to EBITDA ratio of around 1.0x (as per our rating case), which we still deem as low. However, we note that Electrica's leverage target is 3.0x net-debt-to-EBITDA. Should Electrica meet this leverage target, the rating could be downgraded as Fitch-calculated FFO adjusted net leverage would then increase probably to around 3.5x, which is above the negative rating guideline of 3.0x. However, we currently do not expect such a leverage increase over our rating horizon (it could materialise e.g. in case of acquisitions).
Structural Subordination: Fitch does not rate Electrica's existing or prospective debt. We expect most debt to be taken by distribution subsidiaries without guarantees from Electrica, which would make creditors at Electrica level structurally subordinated to those at subsidiaries. A potential future rating of debt at the Electrica level would then consider the ratio of prior-ranking debt at subsidiaries to total debt in Electrica's group and could be notched down from the IDR in case of excess levels of prior-ranking debt.
Weak GRE Linkage: Electrica's status, ownership and control links with the Romanian state is the only factor under the GRE criteria that we assess to be Strong. This is because the Romanian state is Electrica's main shareholder (48.8% by capital, 49.8% by voting rights). However, the support track record and expectations are weak, in our view, as the company has not received any tangible support in the past nor we expect it to receive it.
The socio-political and financial implications of Electrica's hypothetical default are weak, in our view. This is because a default should not lead to disruption in delivery of company's services due to their strategic character for the economy and society. Such a default would also not impact the Romanian sovereign funding ability as Electrica operates independently from the state, is one of several distribution companies and its existing and expected debt exposure is relatively small.
We overall assess the links with the Romanian state as weak under the GRE rating criteria and not constraining Electrica's SCP of 'bbb'.
Weak PSL Linkage: Electrica operates independently from the government with four out of seven members of the supervisory board being independent members and a large free float with the European Bank for Reconstruction and Development among the shareholders (6.1% by capital, 6.2% by voting rights). Fitch expects Electrica to continue to finance its operations independently without cross-defaults or guarantees from the government.
We therefore assess the legal and operational links with the Romanian state as weak under the PSL rating criteria and not constraining Electrica's SCP of 'bbb'.
Capped Standalone Approach: Neither the GRE nor the PSL linkage with the Romanian state constrain Electrica's SCP of 'bbb', but some linkage exists through the Romanian state shareholding at Electrica. We therefore cap Electrica's rating at one notch above that of the Romanian state, which corresponds with the 'BBB' Long-Term IDR. Electrica's rating is not constrained by the Romanian Country Ceiling which is 'BBB+'.
Electrica's closest peer is Transelectrica SA (BBB/Stable), which is an electricity transmission system operator in Romania. Electrica shares the same regulatory environment as Transelectrica, but its business profile is more risky due to Electrica's distribution vs. Transelectrica's transmission operations. However, Electrica's leverage is lower (FFO adjusted net leverage up to 1.5x) than Transelectrica's (up to 3.5x), which leads to the same rating for both companies.
Another Romanian peer is SNTGN Transgaz SA (BBB-/Stable), which is a gas transmission and transit company. Transgaz also shares the same regulatory environment, but has a large gas transit business (which is more risky than transmission and distribution) and higher FFO adjusted net leverage close to that of Transelectrica. Therefore, Electrica's rating is one notch above the rating of SNTGN Transgaz.
Another peer is Polish Energa S.A. (BBB/Stable), an integrated utility with a large electricity distribution business (around 75% of EBITDA vs. 80-85% for Electrica). Energa operates in a marginally more predictable regulatory environment, therefore we allow higher debt capacity of up to 3.5x FFO adjusted net leverage for Energa for the same rating (BBB/Stable).
Some further peers include German e-netz Suedhessen AG (BBB/Stable), which is an electricity and gas distribution company, and Czech Severomoravske vodovody a kanalizace Ostrava, a.s. (SmVaK, BB+/Stable), which is a water company. Both companies operate in a more predicable regulatory framework, but have significantly higher leverage than Electrica.
Fitch's Key Assumptions Within Our Rating Case for the Issuer
- Stable EBITDA at RON0.6 billion to RON0.7 billion per year over 2019-2023
- Distribution accounting for 80%-85% of EBITDA, supply for around 15% and electricity services for the remainder
- Capex totalling RON3.2 billion over 2019-2023, with around 95% in distribution
- Lower dividends at RON0.1 billion to RON0.2 billion per year over 2019-2023
- New debt interest of 3.5%
Developments That May, Individually or Collectively, Lead to Positive Rating Action
- Fitch views Electrica's rating as capped at 'BBB', one notch above the Romanian state due to links with the state. Therefore, positive rating action could occur only if Electrica's SCP improves and the Romanian sovereign is upgraded.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
- Less predictable regulatory environment, e.g. persistent tariff deficit in the distribution or supply business
- FFO adjusted net leverage above 3.0x, e.g. due to higher capex, excess dividends or negative outcome of litigations
- Stronger links with the government, or a downgrade of the Romanian sovereign rating as it would move down the cap for Electrica's rating
Rating sensitivities for the Romanian sovereign as per the rating action commentary dated 10 May 2019:
Developments That May, Individually or Collectively, Lead to Positive Rating Action
- Reduced risks of macroeconomic instability and improved macroeconomic policy credibility
- Implementation of fiscal consolidation that improves the long-term trajectory of public debt/GDP
- Sustained improvement in external finances
Developments That May, Individually or Collectively, Lead to Negative Rating Action
- Persistent high fiscal deficits leading to a rapid increase in government debt/GDP
- An overheating of the economy or hard landing that undermines macroeconomic stability
- A sharp deterioration in the balance of payments
LIQUIDITY AND DEBT STRUCTURE
Adequate Liquidity: At end-2018 Electrica had RON666 million of cash and cash equivalents and a RON211 million unused portion of committed credit lines against RON131 million of short-term debt maturities and Fitch-calculated negative free cash flow of RON203 million forecast for 2019.
At end-June 2019 liquidity remained adequate with RON385 million of cash and cash equivalents and RON356 million of unused portion of committed credit lines against RON339 million of short-term financial liabilities.
Electrica borrows all debt in local currency, which is coherent with operations also held locally. All existing debt is borrowed at the regulated distribution companies' level, but RON320 million (out of total debt of RON452 million at end-2018) is guaranteed by Electrica with cash collateral.
We view Electrica's plans to launch a centralised cash pool mechanism as credit-positive as it would integrate the group and could provide for interest savings. Currently bank overdrafts are taken and excess cash is invested individually by respective subsidiaries."
