March 15 (SeeNews) - Moody's Investors Service has changed the outlook on Croatian national electricity company Hrvatska Elektroprivreda (HEP) to stable from negative, while affirming its long-term Ba2 corporate family rating (CFR), the company said on Wednesday.
The rating action follows the outlook change to stable from negative on the Croatian government's Ba2 rating, HEP said in a Zagreb bourse filing.
"We are extremely pleased with the outlook upgrade to stable from negative and the affirmation of HEP's long-term credit rating. In this regard we will continue actively managing our finances", Tomislav Rosandic, member of HEP's management board, is quoted as saying.
In a separate statement, issued late on Monday, Moody's said it has also affirmed the Ba2-PD probability of default rating (PDR), and the Ba2 senior unsecured ratings of HEP.
"The change of outlook on HEP's rating to stable from negative reflects that the rating is positioned at the same level as Croatia's sovereign rating", the ratings agency explained. "Moody's does not currently envisage that the rating could be higher than that of the sovereign due to (1) HEP's strong domestic focus; (2) its 100% ownership by the Croatian government; and (3) the one notch uplift incorporated into its rating to reflect the high likelihood, in Moody's view, of extraordinary support from the government in case of financial distress at the company, in view of its strategic importance to the Croatian economy".
The ratings agency also said in the statement:
"The stabilisation of the outlook on the sovereign rating removes the potential downward pressure on HEP's rating.
Given its full ownership by the Government of Croatia, HEP's Ba2 rating incorporates a one-notch uplift from the group's standalone credit quality, expressed by Moody's as the baseline credit assessment (BCA) of ba3. The aforementioned uplift reflects HEP's beneficial relationship with the government, which has bolstered its ability to access the debt market. In addition, the government has provided guarantees to support the company's debt in the past.
HEP's Ba2 CFR continues to reflect (1) its vertically integrated position in the Croatian electricity market, where the group enjoys around 85% market share; (2) its electricity generation mix, with a high share of low cost and low CO2 hydro and nuclear output; and (3) the group's sound financial profile with low leverage levels and strong credit metrics.
However, the ratings are significantly constrained by (1) HEP's lack of diversification in terms of market presence; (2) the developing profile of the regulatory framework in Croatia, with a limited track record of transparent and consistent application; (3) HEP's underlying earnings volatility driven by its dependence on volatile hydro-based electricity generation; (4) its considerable investment programme, which includes potential new generation capacity and investments to upgrade its aging asset base; and (5) a variable dividend policy.
The rating also reflects the significant financial flexibility that HEP has at its current rating level, with key ratios of funds from operations (FFO)/interest cover of 12.9x and FFO/net debt of 102% for the financial year ending 2015, versus Moody's guidance of a minimum of 4.0x and 20% respectively.
RATIONALE FOR THE STABLE OUTLOOK
The rating outlook is stable, in line with that of the sovereign and reflecting Moody's expectation that HEP will continue to operate with a business and financial profile commensurate with the current rating.
WHAT COULD CHANGE THE RATING UP/DOWN
Given that the ratings of HEP and the Government of Croatia are currently aligned, Moody's does not expect any upward rating pressures in the near term. Nevertheless, HEP's BCA of ba3 could come under positive pressure through a combination of the following: (1) increased visibility over the company's ability to cope in the evolving market environment; (2) an improvement in the regulatory environment, once Moody's sees evidence of consistent and transparent application of economic principles to the business of the group; and (3) maintenance of a low leverage profile.
HEP's earnings remain exposed to a number of factors outside of management control, most notably domestic rainfall, as well as commodity and regional power prices. Being the dominant energy company in the country, HEP is also exposed to a potential loss of market share in the supply segment as a result of market liberalisation. Downward pressure could develop if any of these risks translate into a weakening of HEP's liquidity and/or financial position, which could be evidenced by credit metrics of FFO/net debt of less than 20% or FFO interest cover below 4.0x. In addition, a downgrade of the sovereign rating of Croatia, would eliminate the one-notch uplift currently applied to HEP's BCA of ba3.
The methodologies used in these ratings were Unregulated Utilities and Unregulated Power Companies published in October 2014, and Government-Related Issuers published in October 2014. Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
A corporate family rating is an opinion of the HEP group's ability to honour its financial obligations and is assigned to HEP as if it had a single class of debt and a single consolidated legal structure. The Ba2/LGD4 senior unsecured rating of HEP's outstanding global notes is the same rating level as HEP's CFR, and reflects the absence of structural and contractual subordination of the global note creditors to the claims of other HEP group lenders.
Headquartered in Zagreb, Croatia, HEP is the holding company for Croatia's incumbent vertically-integrated utility group. HEP operates across three main segments: (i) electricity generation, transmission, distribution and supply; (ii) district heating generation, distribution and supply; as well as (iii) natural gas distribution and supply. In accordance with the EC Third Energy Package, HEP unbundled its electricity transmission operations under the "independent transmission operator" model. The legally and operationally separate subsidiary, HOPS d.o.o., is part of the consolidated group. In the twelve month period ended 30 June 2016, around 83% of sales and almost all of EBITDA within HEP group was derived from electricity activities."