December 22 (SeeNews) - S&P Global Ratings said that it has raised its long-term issuer credit rating on Bulgaria's National Electricity Company (NEK) to 'BB-' from 'B+' with stable outlook.
"The parent of NEK, state-owned Bulgarian Energy Holding (BEH) has accumulated a track record of improving operating performance and risk management, and we estimate consolidated earnings before interest, taxes, depreciation, and amortisation (EBITDA) will exceed 2 billion levs ($1.1 billion/1 billion euro) in 2021 and 1.4 billion-1.5 billion levs thereafter," S&P said in a statement earlier this week.
The ratings agency added that it expects NEK's standalone performance to remain healthy, thanks to regulatory coverage of its public policy mandate and electricity market liberalisation in Bulgaria, with legacy debt being the key factor keeping projected funds from operations (FFO) to debt below 12%.
The stable outlook on the company's rating reflects S&P's expectation that after record, strong credit metrics of 2021, the group's FFO to debt will stabilize at about 20%, and debt to EBITDA at about 4x, with risk management and liquidity remaining prudent and spending on any new large projects offset with state support.
According to its most recent interim financial statement, NEK recorded a net profit of 278.3 million levs in the first nine months of 2021, as compared to just 596,000 levs in the like period a year earlier. The surge is predominantly due to a 48% rise in NEK's revenues, to 2.71 billion levs in the period under review.
S&P also said in the statement:
"The upgrade reflects ongoing improvements in the group's credit quality. We believe that BEH has accumulated a track record of healthy operating performance. Under very favorable electricity market conditions in 2021, we expect the group's consolidated EBITDA to exceed BGN2.1 billion (€1.1 billion) and FFO to debt to be 25%-30%. Assuming normalized electricity prices and volumes in 2022-2023, we expect consolidated EBITDA to stabilize at BGN1.4 billion-BGN1.5 billion, with FFO to debt at about 20% and debt to EBITDA at about 4x. After commissioning the BGN2.5 billion (€1.3 billion) Balkan Stream gas pipeline in 2021, we expect BEH's capital expenditure (capex) to reduce to BGN600 million-BGN700 million annually, leading to positive free operating cash flow (FOCF). We believe the group's track record of strategic direction and risk management has been improving, and liquidity has stabilized after a successful €600 million Eurobond issue earlier this year.
We expect NEK's stand-alone performance to be healthy, with credit metrics constrained by legacy debt. We expect NEK to generate record high EBITDA in 2021, thanks to a combination of high electricity prices and favorable hydrological conditions. Even assuming normalized market prices and generation volumes close to historical levels, we expect NEK's EBITDA to stabilize at a healthy BGN220 million-BGN250 million, which alongside low capex needs results in positive FOCF and gradual debt reduction. NEK benefits from the liberalization of Bulgaria's electricity sector, which reduces its public policy mandate and leaves a higher share of low-cost hydropower available for profitable free market sales. Although Bulgaria's electricity regulations remain somewhat politicized and unpredictable, the track record shows that payments from the Security of Electricity Supply Fund have broadly covered the difference between regulated electricity prices and NEK's high electricity procurement costs. Also, NEK benefits from the recent increase in regulated prices to BGN108.37 per megawatt hour (/MWh) from BGN92.93.
Nevertheless, NEK remains relatively small and highly leveraged. NEK is still vulnerable to volatile power prices and hydrological conditions, and is relatively small compared with other rated European utilities. In addition, NEK's debt remains high, reflecting historical tariff deficits and litigation. Given the size of this debt (BGN3.7 billion on June 30, 2021), we don't expect NEK to deleverage quickly. We recognize that almost all NEK's debt is to its parent BEH and to the government of Bulgaria (BGN2.6 billion and BGN1 billion, respectively of BGN3.6 billion total debt on June 30, 2021), which are unlikely to trigger a default, and NEK's debt to banks is limited (only BGN8.5 million on June 30, 2021). Also, we believe that the ongoing extension of NEK's short-term loans to its parent BEH supports the company's liquidity. As a result, we continue to assess NEK's stand-alone credit quality at 'b'.
The rating on NEK continues to depend on BEH's credit quality. We view NEK as a highly strategic subsidiary (from strategically important before) of BEH, given the former's very important role in Bulgaria's energy system as a hydropower producer and supplier of last resort and public supplier of electricity, as well as NEK's transformation from a loss-making operation historically to a contributor of 14%-20% of BEH's EBITDA. Despite robust ongoing profitability, NEK has large legacy debt and therefore higher leverage than BEH. In 2022-2023, we expect NEK's FFO to debt to be 6%-8%, compared with more than 20% for BEH. Our rating on NEK therefore includes two notches uplift for parental support above our 'b' assessment of NEK's credit quality and is capped one notch below our 'bb' assessment of BEH's group credit profile.
The stable outlook reflects our view that our rating on NEK will continue to depend on BEH's credit quality, due to the strong ties between the subsidiary and the parent and a two-notch differential between the rating and our assessment of NEK's stand-alone credit profile at 'b'.
We expect BEH's performance to remain profitable as regulation and liberalized markets mature. We anticipate that the group's FFO to debt will not fall materially below 20%, debt to EBITDA will not increase materially above 4x, capex and financial policy will be prudent (with no new large debt-financed projects), and liquidity will remain adequate.
In addition, we expect that NEK's stand-alone performance will remain robust, thanks to resilient EBITDA, ongoing tariff deficits being covered by the Security of Electricity Supply Fund, positive FOCF, and manageable liquidity, with most debt being to the parent and the government. After record-high 2021 metrics, we expect NEK's FFO to debt to stabilize at 6%-8%.
Downside scenario
We would likely lower the rating on NEK if BEH's credit quality deteriorates below 'bb', which could happen if the group's FFO to debt falls and stays materially below 20%, and debt to EBITDA increases and stays materially above 4x, or if the group's liquidity is stretched. In turn, this could stem from large debt-financed capex at the group level that is not offset with government or EU support. We could also lower the rating if NEK's liquidity pressures increase significantly, which is unlikely in the near term, given recent improvements in the performance of NEK and its parent, supported by regulatory changes and refinancing.
Upside scenario
Given the recent upgrade and metrics improvement being already captured in our base case, ratings upside is currently remote. In the longer term, we could consider a positive rating action if NEK's stand-alone credit profile improved to 'bb'. We believe such a significant improvement would likely take time and could stem from the combination of NEK strengthening its business profile and reducing debt, such as through resolution of historical tariff deficits or conversion of loans from the parent and government into equity. Rating upside could be supported by the group's credit profile improving to 'bb+', reflecting a sovereign upgrade, greater stability of the group's profitability, and deleveraging at the group level."
(1 euro = 1.95583 levs)
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