LJUBLJANA (Slovenia), December 29 (SeeNews) – S&P Global Ratings said it has assigned its 'BB' long-term corporate credit rating to Slovenian state-owned electricity generation company Holding Slovenske Elektrarne (HSE), with a stable outlook.
"Our 'BB' rating is based on our view that HSE has a weak business risk profile and a highly leveraged financial risk profile, leading to a stand-alone credit profile (SACP) of 'b+,'" S&P said in a statement earlier this week.
The ratings agency also said:
"The rating is two notches above the SACP to reflect our view of the moderately high likelihood that the Slovenian government would provide timely and sufficient extraordinary support to HSE in the event of financial distress. In accordance with our criteria for government-related entities, this view reflects our assessment of HSE's:
- Important role for the Slovenian government as both a provider of an essential service and a key player in the implementation of state energy policies. The company produces more than 70% of the domestic power output. The default of HSE for any reason would lead to serious power generation disruptions in Slovenia and jeopardize customers' power supply. Therefore, the state is likely to step in to ensure HSE continues its operations; and
- Strong link with the government, as Slovenia is the 100% shareholder. This enables the government to maintain control over all important decision making. There are no planned ownership changes and a legal ordinance directs that HSE is a strategic investment that has to remain in majority state ownership. All of HSE's major decisions require the validation of the Supervisory Board and, in most cases, also shareholder or Ministry of Finance approvals. However, we also factor into our assessment HSE's shift in financing strategy to the capital markets based on the group's inherent strengths, instead of credit facilities guaranteed by the state as previously.
HSE's production capacity is limited and diversification is relatively low with only a few hydro and thermal plants. Even though the company holds about 68% of the electricity market in Slovenia in terms of production, its installed capacity is about 1.8 gigawatts, which is relatively low in comparison with its rated peers. In addition, HSE's thermal business is not profitable--unit costs exceed electricity prices--but the company expects that the introduction of the new coal plant Unit 6 will improve efficiency in its thermal business from 2017. Our business risk assessment also factors in earnings volatility stemming from the group's inherent exposure to power prices and, to a lesser extent, hydrology risks.
At the same time, HSE benefits from its dominant market position and highly efficient hydropower business, which helps to improve the group's overall efficiency. We also believe the Slovenian power market is somewhat protected, as reflected by the high electricity prices in the country. The group also owns coal mines which support its thermal business. We also factor some ongoing government support into our assessment. The company has good relationships with the government, which takes part in regulatory discussions to properly align HSE's strategy. We expect that the government will continue to provide ongoing support and back HSE's continuing restructuring and deleveraging.
Our view of HSE's financial risk profile as highly leveraged reflects the group's high debt and still weak cash flow generation, mainly due to its large and mostly debt-financed investment in the newly built thermal power plant. We understand that one of the group's key strategic objectives is to reduce debt as heavy investments are now completed and maintenance investments will be limited until the end of the decade. HSE reached its weakest point in 2015 with S&P Global Ratings-adjusted ratio of funds from operations (FFO) to debt at 8.1% on the back of the test and trial period for the new Unit 6 plant. After that, we forecast that FFO to debt will be close to 12% in 2016 and will remain above 12% thereafter. Our expectation of an improvement in HSE's financial profile is based on the ramp up of Unit 6, its implementation of a cost cutting program, and the absence of further large investments, which we expect will result in positive free operating cash flows (FOCF). This should in turn support the group's financial policy which is skewed toward financial debt reduction. We expect HSE to make no dividend payments in the medium term while leverage remains elevated and the market environment weak.
We apply a positive comparable rating analysis modifier to reflect our assessment that HSE's business risk profile is at the higher end of the weak category. Compared with its peers, HSE benefits from ongoing government support and the likely prospect of improved operating efficiency.
Our base case assumes:
- Repayment of contractual debt maturities, mainly the bridge to bond facility using proceeds from the syndicated loan facility.
- Average annual amortization of about €70 million in 2017-2020.
- Completion of the capital expenditure (capex) cycle, meaning limited future capex with free cash flow used for deleveraging. We anticipate that the group's investments will be about €200 million over 2016-2020.
- Average production volumes over 2016-2020 planned at 7,800 gigawatt hours (GWh). - Average production from renewable sources (hydro) over 2016-2020 planned at 3,500 GWh, which represents 45% of electricity production in the HSE Group and about 63% of electricity produced from renewable energy sources in Slovenia.
- Trading volumes planned above 27 terawatt hours.
- €8 million annually that we have accounted for as ancillary revenues from a new contract agreed in December 2015.
- Slovenian power prices aligned with Hungarian prices at about €37 and €35 per megawatt hour in 2017 and 2018, respectively.
- No scheduled dividend payments.
Based on these assumptions, we arrive at the following credit measures:
- FFO to debt to increase to close to 12% in 2016 and improve above 12% from 2017 onward.
- Positive FOCF from 2016 onward.
The stable outlook reflects our view of HSE's strategic focus on debt reduction and its prudent financial policy, including the absence of dividend payments, which we expect will support the maintenance of the current financial profile. We believe that HSE's adjusted FFO to debt of above 12% is commensurate with the current SACP of 'b+'. The outlook also incorporates our expectation that HSE will generate free cash flow on a sustainable basis from 2016 and will maintain sufficient headroom on its financial covenants.
We would lower the rating on HSE if we revise the SACP by one notch. This could happen if the debt reduction that we expect no longer looks likely. We could also take a negative rating action if we anticipate constraints to HSE's SACP, in particular, if adjusted FFO to debt falls below 12% for an extended period or if HSE breaches its financial covenants. This could result from potential operational difficulties at one of its plants or a further decline in power prices, especially if combined with a decision to exercise a call option to buy back a 36% stake in Hidroelektrarne na Spodnji Savi d.o.o.
We could raise the long-term rating by one notch if financial debt starts to materially reduce on the back of stronger free cash flow generation, resulting in sustainable improvements in credit metrics, with adjusted FFO to debt reaching 15%. This improvement is likely to result from the effective ramp up of Unit 6, which should generate positive margins from its thermal production business. Chances of an upgrade could also arise from any potential political measures to improve HSE's profitability, including the remuneration of ancillary services.
At this stage, we do not see this financial improvement materializing over the next 12 to 18 months. A one-notch upward revision of the SACP would also translate into a one-notch uplift of the long-term rating. If we raise the sovereign credit rating on Slovenia by one or more notches, the rating on HSE will not change, all else being equal."