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Fitch assigns Romania's Transgaz a first-time 'BBB-' rating, outlook stable

Fitch assigns Romania's Transgaz a first-time 'BBB-' rating, outlook stable Transgaz. Author (Transgaz.ro) License: all rights reserved.

BUCHAREST (Romania), July 17 (SeeNews) - Fitch Ratings said on Wednesday it has assigned Romanian gas transmission company Transgaz [BSE:TGN] a long-term issuer default rating (IDR) of 'BBB-' with a stable outlook.

Transgaz's 'BBB-' IDR mainly reflects its solid business profile as a concessionaire and operator of the gas transmission network in Romania as well as the expectation of a progressive contraction of international gas transit business deriving from traditional routes, Fitch said in a press release.

The rating is supported by Romania's regulation for gas transmission and Fitch's expectation that a significant current investment related to the Bulgaria-Romania-Hungary-Austria corridor (BRUA) will be added to Transgaz's regulated asset base (RAB), supporting future earnings, the rating agency explained.

Transgaz's shares traded 0.69% lower at 362 lei as at 1450 CET on Wednesday on the Bucharest Stock Exchange.

Fitch also said in the statement:

"The 6.9% pre-tax real allowed weighted-average cost of capital granted in the fourth regulatory period (September 2019- September 2024) incentivises investment in the network, which at a cumulative gross level of RON5.1 billion in 2019-24, we view as ambitious and with execution risk.

Transgaz's financial profile is currently strong as the company had a net cash position at end-2018. We expect funds from operations (FFO) net adjusted leverage to rapidly increase to around 5.5x at end-2020 due to increased capex and temporarily weaker transmission earnings due to regulatory corrections of past allowances, before reducing to around 3.6x over 2021-2024.

KEY RATING DRIVERS
Transparent Regulation: Fitch evaluates the Romanian transmission regulation as relatively transparent and stable and therefore supportive of Transgaz's rating. Romania is entering the fourth regulatory period (October 2019-October 2024) for gas transmission with key parameters comparable with other regulatory frameworks across Europe. The allowed real rate of return of 6.9% (7.72% in the prior regulatory period) remains in the higher range for European peers and encourages investment in the network and strategic project such as the BRUA pipeline.

Operating Cash Flow Volatility: Transgaz's earnings and operating cash flows are markedly more volatile than most utility peers. The tariff system, based on estimated volume and opex parameters, allows significant discrepancies compensated through ex-post correction adjustments implemented in the tariff of the subsequent years. The return of efficiency gains to customers and historical revenue over-recovery is expected to particularly affect fiscal years 2019 and 2020, resulting in a projected contraction of EBITDA and FFO by over 40% compared with 2018.

The new regulatory period offers broad continuity with the prior regime, but it introduces some changes that we view as supportive of Transgaz's earnings visibility, including the recognition in regulated revenues of certain non-capitalised financial interests, reduced sharing of efficiency gains with customers to 60% and progressive reduction of volume-related tariff components to 15%.

Threats to Traditional Transit: In the medium to long term, we expect operating cash flows from the profitable gas transit activities from Ukraine to the Bulgarian border to gradually contract by more than two-thirds. This reflects the expiry of the current "ship or pay" contracts (T2 in 2019 and T3 in 2023), which we assume will not be replaced in full by short-term bookings as new transit routes for Russian gas export emerge. 

However, we estimate that the expiry of the transit contracts together with the regulator's decision to include transit-related investments into RAB, will lead to a business mix with around 90% stemming from the RAB regulation, in the long term positioning Transgaz closer to pure-play domestic transmission system operator peers, with higher debt capacity.

Ambitious Investment Programme: Transgaz is implementing a far-reaching investment plan that targets an extensive development of the national transmission system improving the interconnectivity with neighbouring countries (especially Hungary, Bulgaria, Moldova, Ukraine). The major projects under the Ten Year National Development Plan (TYNDP) are the development of the gas transmission corridor, which will enable the transmission of Caspian gas through Romania (BRUA), as well as the connection of the Black Sea discoveries (the latter is not yet included in Fitch's projections).

Fitch estimates that the major projects that have already obtained the final investment decision (FID), together with the recurring network investment, will reach a cumulative value of around RON4.4 billion over 2019-24 netted by the already secured EU grants for around RON650 million. The remaining part will largely be financed by long-term institutional financing or operating cash flow. European Investment Bank (EIB), European Bank of Reconstruction and Development (EBRD) and Banca Comerciala Romana (BCR) already contracted more than RON0.9 billion funding for BRUA.

Negative FCF and Leverage Peak: Our rating case for Transgaz foresees significantly negative free cash flow (FCF) in 2019 and 2020 (RON1.2 billion and RON1.0 billion, respectively) largely attributable to the combined effect of high capex and lower EBITDA due to the large ex-post regulatory corrections. Reflecting this, we expect FFO net adjusted leverage to peak around 5.5x at end-2020 compared with a net cash position at end-2018. With normalised capex and regulatory corrections as well as larger RAB after 2020, we expect leverage to fall to around 3.6x during 2021-2024. 

Standalone Approach: Transgaz's majority shareholder is the Romanian state (BBB-/Stable) with a 59% stake, and the remainder publicly listed. Applying our criteria for Government Related Entities (GRE), Transgaz's IDR reflects its Standalone Credit Profile. 

The government has strategic and operational oversight of Transgaz's activities and we view the control factor as strong. However, we do not expect financial support for Transgaz (albeit the 50% payout dividend policy is not onerous compared with peers) and view the support track record factor as weak, similarly to the financial implications of the GRE's potential default factor. We view the socio-political implications of the GRE's potential default as moderate, reflecting our view that the infrastructure would remain largely operational even in a financial distress scenario.

DERIVATION SUMMARY
Transelectrica S.A. (BBB/Stable) is Transgaz's closest rated peer, since both companies share the same country, majority shareholder, regulator as well as a significant degree of cash flow volatility, mainly resulting from ex post adjustments of effective transported volumes and achieved opex efficiencies. The one-notch rating differential reflects that with a steeper increase in capex, Transgaz has higher projected FFO net adjusted leverage (2019-24 average of 3.7x) than Transelectrica (2018-23 average of 2.6x), while Fitch views Transgaz's debt capacity for a given rating as comparatively lower, considering currently significant exposure to the gas transit activities with higher counterparty risk and long-term volume risk after current "ship or pay" contracts expire.

Both NET4GAS, s.r.o. (BBB/Stable) and eustream, a.s. (A-/Stable) own and operate the national gas transmission businesses in the Czech republic and Slovakia, respectively, and are also exposed to the Russian gas transit to Europe with concentrated counterparty risk. NET4GAS has higher leverage offset by longer-term transit contract visibility and flexible dividend policy. Eustream's higher rating reflects lower leverage and strong cash flow generation.

KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
- International transit revenues based on 100% Transgaz contracted capacity, and a more prudent view once the current bilateral contracts expire.
- Cumulative gross capex in 2019-24 of almost RON5.1 billion reflecting recurring network investments and mainly the major TYNDP FID projects such as:
Development on the territory of Romania of BRUA (RON1.7 billion)
Development of NTS transmission capacity to ensure gas flow from Romania to Moldova (RON 0.8 billion)
Interconnection with T1 and reverse flow Isaccea (RON0.35 billion)
Upgrading Isaccea 1 and Negru Voda 1 (RON 0.1 billion)
- Already committed EU grants for more than RON 650 million.
- Domestic regulated transportation transit revenues following the integration into RAB of the above investments and 6.9% rate of return defined for the fourth regulatory period.
- Current interest on committed loans and new debt interest rate set at 4.5%.
- Profits paid as dividend at around 58%.

RATING SENSITIVITIES
Developments That May, Individually or Collectively, Lead to Positive Rating Action:
- FFO net adjusted leverage decreasing to below 3.5x on a sustained basis.
- Reduced cash flow volatility from the ex-post correction mechanism and reduced execution risk related to the heavy investment.

Developments That May, Individually or Collectively, Lead to Negative Rating Action:
- FFO net adjusted leverage above 4.2x on a sustained basis.
- Adverse changes to gas regulation in Romania and/or negatively revised expectations for international gas transit
flows.
- Failure to deliver major investment projects leading to material financial implications.

LIQUIDITY
Satisfactory Liquidity: As of 31 December 2018, Transgaz had cash and cash equivalents for RON0.7 billion (75% of which is euro-denominated), and a committed undrawn capex facility dedicated to BRUA for RON0.7 billion (equivalent). This will be sufficient to cover the expected negative 2019 FCF projected in our rating case at RON1.2 billion and almost zero debt maturing within 12 months of RON3 million.

Debt Structure: Transgaz benefits from various institutional sources of funding namely EIB, EBRD and BCR would grant most of the debt that is (and would be) all unsecured placed at Transgaz's level. The average life of debts stands at more than 10 years."

(1 euro=4.7345 lei)

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