March 27 (SeeNews) - S&P Global Ratings said it has upgraded its long-term issuer credit rating on Croatia's state-owned power utility Hrvatska Elektroprivreda (HEP) to 'BB+' from 'BB'.
The global ratings agency has also upgraded its long-term issue rating on HEP's senior unsecured debt to 'BB+' from 'BB', it said in a statement on Tuesday.
The outlook is stable and reflects S&P's expectation that HEP's stand-alone performance will be solid, with funds from operations (FFO) to debt ratio above 60% in the next 12 months.
The raising of the rating on HEP follows the recent upgrade of Croatia to 'BBB-' from 'BB+', as S&P believes the country now has greater capacity to support the power utility.
The ratings agency also said in the statement:
"HEP plays a very important role for the Croatian government, because its transmission and distribution operations are crucial for the security of the country's energy supply, which in turn is a fundamental input for Croatia's resilience. In addition, the Croatian government's 100% ownership of HEP, and the alignment between the government's energy strategy and that of HEP, reinforce our view that there is a strong link between both entities.
HEP's monopoly ownership and operation of the transmission and distribution networks in Croatia, which account for about 50% of EBITDA generation, are key strengths for the business, in our opinion. Moreover, we believe that HEP's low-carbon generation fleet could provide significant competitive advantages in light of increasing carbon costs and the EU's low-carbon energy directives.
These strengths are counterbalanced by HEP's limited geographic diversification, which is mostly constrained to a small market, with uncertain long-term growth prospects and weaker regulatory support than in other European countries. Although HEP has posted FFO to debt consistently between 100%-110% over the past three years, we still believe that the company's credit metrics are exposed to volatility because of its dependence on hydroelectric activity, and the risk of procurement that would arise under poor hydrological conditions in a given year, as observed in 2011 and 2012.
Therefore, we continue to assess HEP's stand-alone credit profile (SACP) at 'bb'. We observe, however, that volatility has decreased in recent years. The stable outlook on HEP mirrors that on Croatia, and reflects our assumption that HEP will continue to enjoy a high likelihood of extraordinary government support. It also captures our expectation that HEP will continue posting sound financial performance, as a result of stable and monopolized transmission and distribution operations, coupled with its position as the largest electricity provider in Croatia.
We expect that the company will post FFO to debt above 60% over the next 12 months. If we took a positive rating action on Croatia, this would result in a similar rating action on HEP. Rating upside could also stem from a two-notch improvement in HEP's SACP, but we consider this unlikely. We could revise our assessment of HEP's SACP by one notch to 'bb+' from 'bb', if we believe that HEP had sufficient financial policy mechanisms in place to protect its credit metrics from unfavorable hydrological conditions, coupled with a proven track record of lower credit metric volatility, namely FFO to debt and debt to EBITDA.
That said, a one-notch improvement would be insufficient for an upgrade in the absence of a positive rating action on the sovereign. A downgrade of Croatia would result in us taking the same action on HEP. We don't see major downward pressure on the company's SACP, or our rating on HEP, over the next 12-18 months. Assuming no change to our expectation of a high likelihood of state support, we could downgrade HEP if its financial performance deteriorates such that we revised our assessment of its SACP to 'b+', which is far from our base-case scenario."
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