Credit Opinion: Eurogrid GmbH

Transcription

1 Credit Opinion: Eurogrid GmbH Global Credit Research - 06 Apr 2016 Berlin, Germany Ratings Category Outlook Bkd Senior Unsecured -Dom Curr Bkd Other Short Term -Dom Curr Moody's Rating Stable Baa1 (P)P-2 Contacts Analyst Phone Paul Marty/London Helen Francis/London Neil Griffiths-Lambeth/London Key Indicators [1]Eurogrid GmbH 12/31/ /31/ /31/ /31/ /31/2011 FFO Interest Coverage 12.8x 14.4x 12.9x 9.5x 5.2x Net Debt / Fixed Assets 27.2% 1.1% 10.2% 40.8% 11.8% FFO / Net Debt 41.8% % 87.3% 28.6% 41.7% RCF / Net Debt 31.6% 772.5% 53.5% 21.4% 9.0% [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. Source: Moody's Financial Metrics Note: For definitions of Moody's most common ratio terms please see the accompanying User's Guide. Opinion Rating Drivers - Developed regulatory framework underpins relatively stable and predictable cash flow generation - Evolution of regulatory regime expected to have limited impact on low business risk electric transmission activities - Risks associated with significant investment programme mitigated by strong financial profile Corporate Profile Eurogrid GmbH (Eurogrid) is the holding company of 50Hertz Transmission GmbH (50Hertz), one of four electricity transmission system operators in Germany. 50Hertz operates Germany's third-largest electricity transmission network by network length (it is the second largest by area) in the Eastern German states. Besides its core network operations, Eurogrid also provides ancillary services, such as system management

2 and electricity load balancing within its area and in cooperation with neighbouring grids, and holds a 8.66% stake in the European Energy Exchange (EEX), where it trades renewable electricity as part of its off-take obligation. For the financial year ended 31 December 2015, Eurogrid reported revenues of EUR9.8 billion, of which around EUR8.4 billion related to pass-through costs associated with the sale of renewable energy. Eurogrid is ultimately owned 60% by Belgian transmission system operator Elia System Operator NV/SA (Elia) and 40% by an infrastructure fund advised by IFM Investors Pty Ltd. (IFM), an investment management company that invests on behalf of a number of pension funds. SUMMARY RATING RATIONALE Eurogrid's Baa1 rating is supported by the low business risk profile of the electricity transmission business operated by its main operating subsidiary (50Hertz) and the relatively stable and predictable cash flows it generates under a developed regulatory framework. However, the rating is constrained by 50Hertz's continued large investment programme, around EUR3.5 billion over the next five years or 13% of net fixed assets per annum during this period, to deliver the required offshore network connections to wind farms in the Baltic Sea, over half of planned investment, and enhancements to the onshore network. The Baa1 rating takes into account the expected deterioration in the financial profile, from a very strong starting position, due to the planned investment programme. We expect Eurogrid's long-term financial profile to converge towards leverage of around 50-60% of Net Debt to Fixed Assets (defined by Moody's as net property, plant and equipment) and Funds From Operations (FFO) to Net Debt in line with guidance levels for the current rating, low teens in percentage terms. DETAILED RATING CONSIDERATIONS LOW BUSINESS RISK PROFILE UNDERPINNED BY WELL DEFINED BUT EVOLVING REGULATORY REGIME We consider the German regulatory regime to be well-defined, with key aspects of the revenue building block enshrined in law, and designed to provide adequate and fair remuneration for operating expenditure and investments. Introduced in 2009, the German incentive-based regime has a shorter track record than other Western European jurisdictions and regulatory principles are still evolving. In January 2015, the Federal Network Agency (Bundesnetzagentur, BNetzA), the economic regulator for the German energy networks, published its review of the incentive-based approach to-date and proposed incremental improvements for consideration by the German government in updating the underlying legislations in preparation for the third regulatory period (commencing in 2019 for electricity transmission). Over the past five years, the regulatory framework has seen changes to improve the timeliness of investment cost recovery for the transmission networks, and the German regulator is now also proposing to enhance investment recovery for distribution networks and simplify the overall tariff setting approach. While the proposed simplifications will help to reduce the complexity of the model going forward, we believe that public disclosure of company-specific information on regulatory building blocks will remain less detailed than in other European jurisdictions. 50HERTZ HAS INCREASED CERTAINTY OVER CASH FLOWS FOR NEXT THREE YEARS The regulatory framework provides Eurogrid with relatively stable and predictable cash flow generation. Moreover, 50Hertz has increased certainty over revenues and thus cash flows for the next three years under the regulatory settlement for the current price control period for electricity transmission, which runs from 1 January 2014 to 31 December Typically, the main scope for out- or underperformance versus regulatory targets for a network operator is against cost allowances, both capital and operating. However, as over half of the costs in the cost base for the current period (2011 base year) are passed through in full and 50Hertz has a 100% efficiency value this exposure is limited. In addition, although the volume and timing of capex during the control period may deviate from that forecast, the specific remuneration regime for transmission network investment, investment measures (IM), provides for cost pass through without any time delay into the RAB for approved projects. The revenue contribution from this source is already significant, EUR232 million in 2015 (EUR139 million in 2014) compared to base year revenue of EUR299 million, and is expected to grow further during the remainder of the current control period. As at 31 December 2015, 50Hertz had approval for investment projects totalling around EUR6.1 billion, with further projects pending approval. The allowed return is an important aspect of a regulatory price determination due to its impact on operating

3 cash flows. During the current regulatory period the applicable return on equity is 9.05% nominal pre-tax, post trade-tax, for the majority of investments. However, with the sustained low real interest environment we expect this could be lowered for the third regulatory period and estimate that a one percentage point in the return on equity would reduce EBIT by around EUR25-30 million in We expect further clarity on the BNetzA's intentions later this year. Operating performance in 2016 will also impact operating cash flows for the third regulatory period as 2016 is the cost base year for this period. CONTINUED LARGE INVESTMENT PROGRAMME POSES EXECUTION RISK When assessing the risk posed by the capex programme we consider (1) the size of the programme and the associated funding requirement this generates, (2) the nature of the programme, whether it is challenging in scope with a few large and complex developments accounting for the majority of this, (3) the risk around not delivering the programme on time and/or in line with cost allowances, and (4) the mechanism for cost recovery. In line with the national grid development plans, Eurogrid has seen a very significant step-up in nonmaintenance capex in recent years, which has led to investment levels more than trebling in the last three years. Whilst we expect Eurogrid to have reached the peak of the investment cycle in 2015, EUR902 million of investments with around 90% related to requirements to manage increased renewable electricity flows, we expect investment levels to remain material over the next 5 years. This reflects Eurogrid's guidance of about EUR850 million of investments in 2016 and EUR3.5 billion of investment over the next 5 years ( ) with a slightly higher proportion of offshore than onshore investments. We estimate this equates to capex as a percentage of projected net fixed assets of around 13% over the period, compared to over 20% in 2014 and Offshore projects will connect wind farms in the Baltic sea to the onshore grid. As the wind farms are located some way from the coast, the associated transmission investment costs are high, e.g. the connection to the Westlich Adlergrund cluster of wind farms, approved in 2013, is likely to result in investment of about EUR1.5 billion. However, since these connections are still sufficiently close to the shore to be handled by standard AC connections rather than DC connectors, we consider Eurogrid faces less technical challenges and construction complexity than some peers, eg TenneT. Onshore investments primarily relate to the expansion of the network to accommodate: (1) the integration of new (mainly renewable) generation units; (2) the increasing distances between generation capacity and demand; and (3) improved interconnections with neighbouring grids. Whilst the IM mitigates risk around cost overrun and provides for a mechanism of timely recovery of costs, we consider management of such a large capex programme and meeting the timings set out in the national offshore development plan a key challenge for the group. STRONG FINANCIAL PROFILE ACCOMMODATES INVESTMENT PROGRAMME Currently, Eurogrid exhibits a very strong financial profile with low gearing levels and high FFO based metrics. The very strong metrics in 2015 (FFO to Net Debt over 40%) reflects (1) a number of non-recurring gains, like the commissioning of Baltic 2, that improved operating cash flows (net income under IFRS was EUR148 million excluding these, EUR199 million reported); and (2) transient benefits from its obligation regarding the sale of renewable energy. The costs of the latter are passed through but there can be a mismatch in timing of generating revenues from the surcharge and the respective costs incurred, which has been in Eurogrid's favour in the last three years and also explains the very high cash reserves currently (EUR614 million of the reported EUR1,020 million cash and cash equivalents balance at 31 December 2015 relates to this). Due to the continuation of a large planned capex programme the business is expected to be significantly free cash flow negative generating associated funding requirements of around EUR1.6 billion in the next three years. We therefore expect that the group's financial profile will move towards leverage of around 50-60% of Net Debt to Fixed Assets (Moody's uses net property, plant and equipment to define fixed assets for network operators and applies this when the regulated asset base is not published by the regulator) over the medium to long-term. We consider the risk that some of the capex programme is delayed, e.g. due to timetables for projects slipping, as low reflecting both Eurogrid's track record of delivering projects on time and the systemic importance of a number of these grid development projects for meeting the energy transition and security of supply objectives, reflected in the significant increase in grid re-dispatch costs in We expect Eurogrid to calibrate dividends to match the needs of this extensive capital programme. We take comfort from the presence of Elia as the main strategic partner, which has shown a conservative approach in funding the acquisition of Eurogrid by raising additional equity. In order to retain its Baa1 rating we expect Eurogrid to maintain at least an FFO Interest Coverage ratio of 3.0x, FFO to Net Debt in the low teens and

4 Retained Cash Flow (RCF) to Net Debt in high single-digits (both in percentage terms). Liquidity Profile Eurogrid exhibits a solid liquidity profile, underpinned by (1) the relatively stable cash flows generated from its regulated transmission network activities; (2) unrestricted cash and short-term deposits of over EUR 1 billion at 31 December 2015 following the EUR1.39 billion of issuance in the capital markets in 2015 and continued large EEG cash balance at this time; and (3) an unused and undrawn revolving committed credit facility of EUR750 million to cover the company's working capital and capex requirements. The revolving credit facility does not include any financial covenants and runs for a further five years (until March 2021, although Eurogrid has the option of one further one year extension to this). We note the company also has an uncommitted overdraft facility of EUR150 million. These benefits are tempered by the aforementioned legal off-take obligation on renewable energy which means Eurogrid's intra-year cash flows are subject to significant fluctuations depending on the volumes of renewable energy fed into the network and the market price achievable for electricity sold on the spot market. This is particularly relevant for Eurogrid due to the magnitude of these pass through costs, around 7 times the sum of core grid revenues in However, we believe Eurogrid is well placed to manage both these risk and the associated financing requirements of the capex programme given the size of its liquidity facilities and its track record of raising funds in the capital markets. Rating Outlook The outlook for Eurogrid's ratings is stable. Whilst the group's medium-term financial profile will reflect a gradual increase in leverage from the continued large investment programme, this is expected to be within the minimum financial parameters for the current rating. The stable outlook also takes into account our expectation of ongoing prudent financial policies and liquidity management. What Could Change the Rating - Up An upgrade of Eurogrid's rating is unlikely in the intermediate term, as the rating is constrained by the significant investment programme. Over the medium to long term upward pressure for the rating would develop if, once the non-maintenance capex programme is substantially complete, Eurogrid has strong cash flow based debt metrics, expressed as FFO to Net Debt consistently in the high teens and RCF to Net Debt in the low teens (both in percentage terms), and demonstrated an established track record of prudent financial policy. Any decision to upgrade the rating would take into account the credit quality and financial policy of the majority shareholder. What Could Change the Rating - Down Eurogrid's rating could be lowered if FFO Interest Coverage fell below 3.0x, FFO to Net Debt declined below the low teens or RCF to Net Debt declined below high single-digits (both in percentage terms), due for example to operational underperformance, higher-than-expected dividend payments or a material increases in capex, without offsetting balance sheet measures. Other Considerations Eurogrid is rated in accordance with the methodology "Regulated Electric and Gas Networks" published in November Rating Factors Eurogrid GmbH Regulated Electric and Gas Networks Current As of [3]Moody's Month Industry Grid [1][2] 12/31/2015 Forward ViewAs of 4/6/2016 Factor 1 : Regulatory Environment and Asset Ownership Model (40%) Measure Score Measure Score a) Stability and Predictability of A A A A Regulatory Regime b) Asset Ownership Model Aa Aa Aa Aa

5 c) Cost and Investment Recovery (Ability A A A A and Timeliness) d) Revenue Risk A A A A Factor 2 : Scale and Complexity of Capital Program (10%) a) Scale and Complexity of Capital B B B B Program Factor 3 : Financial Policy (10%) a) Financial Policy Baa Baa Baa Baa Factor 4 : Leverage and Coverage (40%) a) FFO Interest Coverage (3 Year Avg) 13.3x Aaa 5x - 6x Aa b) Net Debt / Fixed Assets (3 Year Avg) 14.5% Aaa 48% - 52% A c) FFO / Net Debt (3 Year Avg) 76.0% Aaa 13% - 15% Baa d) RCF / Net Debt (3 Year Avg) 53.9% Aaa 8% - 11% Baa Rating: Indicated Rating from Grid Factors 1-4 A3 Baa2 Rating Lift a) Indicated Rating from Grid A3 Baa2 b) Actual Rating Assigned Baa1 [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. [2] As of 12/31/2015; Source: Moody's Financial Metrics [3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history Moody s Corporation, Moody s Investors Service, Inc., Moody s Analytics, Inc. and/or their licensors and affiliates (collectively, MOODY S ). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. AND ITS RATINGS AFFILIATES ( MIS ) ARE MOODY S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY S ( MOODY S PUBLICATIONS ) MAY INCLUDE MOODY S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY S OPINIONS INCLUDED IN MOODY S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR COMMENTARY PUBLISHED BY MOODY S ANALYTICS, INC. CREDIT RATINGS AND MOODY S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL, WITH

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