March 28 (SeeNews) - Fitch Ratings said that it has upgraded state-owned Bulgarian Energy Holding's (BEH) long-term foreign and local currency issuer default ratings (IDR) to 'BB+' from 'BB' with a stable outlook.
Fitch also upgraded to "BB+" from "BB" BEH's foreign-currency senior unsecured rating, including the rating of BEH's 600 million euro ($649.8 million) bond due 2025 and the 600 million euro bond due 2028, the ratings agency said in a statement on Friday.
BEH most recently raised 600 million euro after placing a seven-year Eurobond issue in July 2021.
The positive ratings action follows the revision of BEH's standalone credit profile (SCP) to 'bb' from 'b+' in light of a solid financial performance and substantially reduced leverage as well as improvements in the regulatory framework, with the prospect of market liberalisation, the ratings agency noted. The energy holding's SCP is being notched up once to the current rating as a result of strong links with its sole owner, the Bulgarian state (BBB/Positive).
Commensurate with the rise in energy prices, BEH reported a 92% annual surge in standalone net profit to some 1.4 billion levs ($775.2 million/715.8 million euro) for the first nine months of 2022, according to its most recent financial report.
Fitch Ratings also said in its statement:
"KEY RATING DRIVERS
Improved SCP: Fitch has revised up BEH's SCP to 'bb' from 'b+' based on higher earnings, lower net debt and, as a result, substantially reduced financial leverage. This was driven by progressive liberalisation of the energy market and its full integration with neighbouring countries', allowing the group to benefit from a high power-price environment. We expect net leverage to remain solid for the rating in 2023-2025.
Better Regulatory Framework: The higher SCP also reflects an improved regulatory framework, which is relevant to a substantial part of BEH's business mix as on average 19% of EBITDA comes from regulated gas and electricity transmission. In our view, its SCP may further strengthen in the medium term, given the planned full liberalisation of the energy market, albeit also subject to BEH's financial policy and capex plan.
High Electricity Prices: An increase in the average energy sale price due to a growing share of free-market transactions (around 80% of generated volumes sold on unregulated market in 2022, compared with 75% in 2021, 65% in 2020) is the primary driver of our record EBITDA expectations for 2022. Our rating case assumes EBITDA to peak in 2022 at around BGN4.4 billion before it trends lower to about BGN2.5 billion in 2025, which is still well above the long-term average, as markets normalise. In our view, BEH's merchant position allows for short-term profit maximisation, but is a rating constraint as it exposes the group to price risk and introduces volatility and unpredictability to cash flow.
Liberalisation on Track: After the completion of the planned liberalisation of the energy market in Bulgaria, we expect BEH will be able to sell its entire generated volumes in the competitive market, which should be beneficial for profitability given the favourable position of most of its generation assets, particularly nuclear and hydro power plants, in the country's merit order. Bulgaria's wholesale electricity market is fully liberalised since June 2021, and the remaining retail part of the market should transition to market terms by 2025. We view the ongoing liberalisation as beneficial for BEH's future financial profile, especially given recent day-ahead market coupling, which enables Bulgarian energy prices to follow EU electricity market price dynamics.
Eliminating Public Supplier Burden: We expect the planned abolition of BEH's subsidiary NEK's public supplier function to improve the visibility of the group's financial results and enhance the transparency of regulations. The regulatory framework has already improved through establishing the Security of the Electricity System Fund (SESF), which successfully covered deficits arising from purchasing energy at regulated prices from producers and selling it to consumers at times of lower tariffs. After withdrawing the public supplier function, NEK will become a purely hydro energy generator, which we deem positive for BEH's credit profile.
Windfall Tax Limits Profits: The Bulgarian government introduced a generation price cap that differs for each energy source to limit the increase in electricity prices for customers. If the selling price exceeds the limit, the generator will pass the additional revenue to a special fund created to finance capped tariffs for end-customers. We expect around BGN1.1 billion of contribution from BEH to SESF in 2023 compared with BGN3.2 billion in 2022, assuming the price cap remains in place until June 2023 and wholesale prices decline thereafter. The measure aims to limit extraordinary profits of generation companies that benefit from high market prices.
Large Capex Plans: We expect BEH's capex (already high in 2021 at BGN1.7 billion) to remain large over 2023 and 2024 at BGN1.2 billion and BGN1.6 billion, respectively. This will be driven by spending on the construction of a gas interconnector between Bulgaria and Serbia, the expansion of underground gas storage in Chiren and the construction of a liquefied natural gas (LNG) terminal in Alexandroupolis. We expect it to normalise at around BGN0.8 billion-BGN0.9 billion per year from 2025.
Support from State: The IDR of BEH reflects a one-notch uplift from its SCP for strong links with the Bulgarian state (BBB/Positive). Based on Fitch's Government-Related Entities Rating Criteria, we view the status, ownership and control links between BEH and the Bulgarian state as 'Strong', and the support track record and socio-political and financial implications of a BEH default as 'Moderate'. These all lead to a support score of 17.5, which allows a one-notch uplift to BEH's SCP as it is not constrained by a cap defined as the sovereign rating minus one notch given the current rating differential between the state and BEH.
Corporate-Governance Limitations: BEH's corporate-governance limitations include a qualified audit opinion for the group's 2009-2021 consolidated financial statements, a fairly complex group structure, and lower financial transparency than EU peers'. These limitations are reflected in an ESG Relevance Score of '4' for group structure and financial transparency.
BEH has a leading position in the Bulgarian gas and electricity market through its ownership of most of Bulgaria's power generation assets (including a nuclear power plant, lignite-fired and hydro power plants), the country's largest mining company, the country's electricity transmission network, gas transmission and transit networks and through its position as the public supplier of both electricity and gas in Bulgaria.
BEH's integrated business structure and strategic position in the domestic market makes the group comparable to some of its central European peers such as MVM Zrt. (MVM, BBB/Negative) and PGE Polska Grupa Energetyczna S.A. (PGE, BBB+/Stable). However, BEH is a negative outlier in the peer group in corporate governance and cash-flow predictability resulting from the high merchant exposure of its generation assets, which is not mitigated through quasi-regulated capacity payments, as is the case for PGE, or through a substantial regulated business. The progressive liberalisation of the Bulgarian energy market, combined with its coupling with neighbouring countries' energy markets, substantially increases BEH's profitability in the current price environment, and in our view improves regulation transparency.
BEH's rating includes a one-notch uplift from its SCP to reflect links with the sovereign, whereas this is not the case for MVM or PGE.
Fitch's key assumptions within our rating case for the issuer:
- Group EBITDA averaging BGN3 billion a year over 2022-2026
- Total capex at BGN6.1 billion over 2022-2026
- Dividends at 100% of net income during 2023-2026
- State-provided financing to subsidiary Bulgargaz (BGN800 million) in 2022
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- Stronger SCP due to funds from operations (FFO) net leverage falling below 3.5x on a sustained basis, and supported by an internal corresponding leverage target, lower regulatory and political risk, higher earnings predictability, and better corporate governance
- Further tangible government support to BEH, such as additional state guarantees materially increasing the share of state-guaranteed debt, or cash injections, which would more tightly link BEH's credit profile with Bulgaria's stronger credit profile
- Upgrade of Bulgaria by two notches
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- Weaker SCP, for example due to FFO net leverage exceeding 4.5x on a sustained basis, escalation of regulatory and political risk, or insufficient liquidity
- Weaker links with the Bulgarian state
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 https://www.fitchratings.com/site/re/10111579.
LIQUIDITY AND DEBT STRUCTURE
Healthy Liquidity: At end-June 2022 BEH had BGN3.2 billion of unrestricted cash and equivalents and BGN0.4 billion of Fitch-projected negative free cash flow (FCF) after acquisitions in the next 12 months starting from July 2022. This compares with short-term debt maturities of BGN0.4 billion. The next large debt maturity is in June 2025, when a EUR600 million (BGN1.2 billion) bond matures.
BEH is a 100% state-owned, integrated utility operating in Bulgaria. It is involved in electricity generation, electricity transmission, public supply of electricity, gas transmission and transit, public supply of gas, lignite mining and telecommunications.
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.
BEH has an ESG Relevance Score of '4' for Group Structure and Financial Transparency due to a qualified audit opinion, a fairly complex group structure, and lower financial transparency than EU peers'. These factors have a negative impact on the credit profile, and are relevant to the ratings in conjunction with other factors."
($ = 0.9233 euro)