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S&P revises outlook on Croatia's HEP to positive

Author Maja Garaca
S&P revises outlook on Croatia's HEP to positive Source: Iskraemeco

ZAGREB (Croatia), September 26 (SeeNews) - S&P Global Ratings said on Wednesday it has revised its outlook on Croatian power utility Hrvatska Elektroprivreda (HEP) to positive from stable, while affirming its 'BB' long-term issuer credit rating on HEP and its 'BB' rating on the company's senior unsecured debt.

The outlook revision reflects that on the sovereign rating, with S&P having changed outlook on Croatia's 'BB+' long-term ratings to positive from stable on September 21.

"We are revising our outlook on HEP to positive from stable to reflect our view of the government's potentially increased capacity to support HEP," S&P said in a statement.

The ratings agency also said:

"Because of our analysis of HEP being very important to Croatia and having a strong link with the government, we believe that the Croatian government is highly likely to provide extraordinary support to HEP in the event of financial distress. HEP is currently 100% owned by the Croatian government and we do not expect it to be privatized in the medium term.

HEP is a Croatian state-owned utility and operates under the form of a holding company with several wholly and mixed owned subsidiaries.

HEP has been a vertically integrated and unrivalled utility in the Croatian electricity market for more than a century. At year-end 2017, the group's S&P Global Ratings-adjusted EBITDA and net debt amounted to about Croatian kuna (HRK)4.2 billion and HRK3.2 billion, respectively. The group benefits from the monopoly ownership and operation of the transmission and distribution networks, from which it derives around half of its EBITDA.

The other half of HEP's EBITDA stems from its dominant position in electricity generation supply and retail markets, with a market share of more than 80%. HEP has a dominant retail market share (about 85%). Since market opening in 2014, only about 15% of the retail market has moved to competitors. HEP has limited geographic diversification as the group's activities are largely focused on Croatia, a relatively small market with uncertain long-term growth prospects. Although the transparency and clarity of the Croatian regulatory framework are improving, we continue to view the regulatory support as weaker than in many other Western European jurisdictions.

HEP maintained solid metrics, with funds from operations (FFO) to debt of 95% in 2015, and 115%-116% in 2016-2017. Despite relatively stable cash flows over the last three years, HEP's credit metrics are exposed to volatility because of its hydro electric activity. The group's credit metrics are vulnerable to drought episodes, as observed in 2011 and 2012 when HEP's EBITDA declined by more than 50%. This potential volatility weighs on our assessment of the company's financial risk profile. Indeed, despite recently improving metrics, we still see a risk that HEP's cash flows could be volatile and credit metrics remain exposed to adverse hydrological conditions. We understand that recent regulatory changes could increase stability and predictability of cash flows and reduce historical volatility. If we observe such a change over a sustained period, we would likely revise upward our stand-alone credit profile (SACP) on HEP.

Another risk factor in our assessment of HEP's financial risk profile is the company's negative discretionary cash flow (DCF)-to-debt ratio, which reflects the risk of large investments committed by the group, dividend payments to the state, and potential acquisitions. That said, we understand that HEP has some financial flexibility, as it can defer and cancel investments. In addition, the state has rescheduled dividends in the past.

The positive outlook on HEP reflects that on the sovereign rating on Croatia and the possibility that if we were to upgrade Croatia it could lead us to raise the rating on HEP. It also reflects our opinion that the company's SACP will remain at least at 'bb-' (currently 'bb'). This assumes in particular no material changes to the group's structure and that HEP will continue to proactively manage its liquidity position to avoid any liquidity pressures.

We would likely raise our ratings on HEP if we raised our ratings on Croatia.

Upside could also stem from improvements in the SACP. Our 'bb' assessment of HEP's SACP is based on our base-case forecasts, which demonstrate S&P Global Ratings-adjusted FFO to debt above 60%. We may revise upward our assessment of the company's SACP to 'bb+' if we see a track record of less volatile cash flows and more predictable liquidity and leverage. That said, given HEP's 100% state-ownership and the risk of potential negative extraordinary government intervention, our rating on HEP is unlikely to exceed that on the sovereign.

We would revise the outlook to stable if we revised the outlook on Croatia to stable. Assuming no change to our expectation of a high likelihood of extraordinary state support, a downgrade of HEP by one notch would require the SACP to move down by two notches to 'bb-', which is unlikely in our current base case."