Municipality Owned Utilities and Stadtwerke

Municipality Owned Utilities and Stadtwerke Moody s view on the Utilities sector and its approach to determine Credit Ratings 1. Stadtwerke-Finanzforum, 27th November 2014, Frankfurt Matthias Heck, Vice President Senior Analyst

Agenda 1. Key market drivers and political environment 2. Moody s rating approach for unregulated utilities and government ownership 3. Summary Municipality Owned Utilities and Stadtwerke, November 2014 2

1 Key market drivers and political environment Municipality Owned Utilities and Stadtwerke, November 2014 3

Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 Nov-14 Moody s EU utilities universe Moody s utilities universe is mainly Investment Grade» Moody s rates 86 European utility groups - approximately $456 billion of rated debt; 66% by largest 10 issuers» Subsidies continue to support further deployment of renewables» Over-supplied coal market, weak CO2 and high reserve margins negative for power prices» Affordability concerns keep political and regulatory risk high» Easing sovereign peripheral pressures Unreg Utilities: Outlook distribution, November 2014-2 EMEA E&G Utilities: Ratings Migration Aa1 European Utilities: Ratings Distribution -3-4 -5-6 -7-8 -9-10 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Source: Moody s Investors Service Slowing shift towards Baa Municipality Owned Utilities and Stadtwerke, November 2014 4

Moody s EU utilities universe Falling profitability keep financial metrics tight Sector indebtedness has fallen from 2009 peak» Debt has declined» asset disposals, capex cuts, hybrids, dividend cuts»... but financial flexibility limited» Metrics tight vs guidance» Cash flows still pressured» Fewer non-core assets to sell Source: Moody s Financial Metrics Limited financial headroom despite lower debt levels Municipality Owned Utilities and Stadtwerke, November 2014 5

Political Environment in the EU EU and National Policies: Areas of Conflicts» European unregulated utilities find themselves at a political and regulatory crossroad EU policy has driven the expansion of renewables and the closure of older coal plants Response of EU member states to these challenges has given rise to a number of conflicts Creates uncertainty and thus risk for unregulated utilities» Conflict 1: Capacity payments versus interconnection for security of supply Some countries prefer capacity payment mechanisms (e.g. UK, Italy, France) but the EU prefers interconnection Capacity payments could fall foul of EU state-aid legislation and may not be a game-changer» Conflict 2: Affordability concerns versus the cost of decarbonisation Renewables continue to drive electricity tariffs upwards across Europe Exposes to utilities to political / regulatory interference Tariffs are increasingly fixed-cost in nature undermines EU energy efficiency efforts Political uncertainties persist Municipality Owned Utilities and Stadtwerke, November 2014 6

Political Environment in Germany Germany: little support, little intervention» Generation: Debate about capacity market and new market design» Government is reluctant on implementing a broad capacity market, given related costs and intervention into existing system» Publication of Green Book on German power market design in October 2014: Possibility of capacity payments, but implementation unlikely before 2017» Given their exposure to (old) conventional thermal generation, German Stadtwerke would likely be winners of capacity payments. Impact on large integrated players could be positive or negative» Networks: Need for investments limits political pressure» Government is generally supportive regulated networks, given their role to safeguard security of supply and integrate renewables (especially offshore wind) into the German electricity network» Supply: Affordability concerns lower than in other countries» Affordability of energy bills in Germany remains above EU average» Political pressure remains modest, little risk of price regulation» Energiewende on top of political agenda» Energiewende strategie envisages further expansion of renewables» EEG reform aims to control renewables expansion, limit price increases and improve allocation of cost to end consumers» The allocation of renewable cost has virtually no impact on utility companies. It is only a pass-on from the perspective of network operators. Energy policy is more favourable for Stadtwerke as opposed to large players Municipality Owned Utilities and Stadtwerke, November 2014 7

Conventional Generation in Germany Commissioning of New Generation Capacity Will Keep Power Prices Low, Despite Nuclear retirements» Ongoing pressure on power prices Small additions to generation capacity (renewables and conventional thermal, partially offset by nuclear and thermal retirements) Wholesale power prices expected ~ 30-35/MWh» Current market design provides little protection for power plants Government reluctant to intervene Implementation of capacity mechanisms unlikely before 2017» What could change our view on power prices Upside: tightening of the carbon market, reform of the emission trading scheme, stronger economic growth, increase of commodity markets Downside: decline of commodity prices, stronger than expected growth in renewables, implementation of capacity markets German power prices (1-year baseload forward) Sources: Bloomberg, Moody s Investors Service Development of German Installed Capacity Sources: BDEW, BNetzA, Moody s Investors Service Municipality Owned Utilities and Stadtwerke, November 2014 8

Moody s Sector Outlook EMEA unregulated utilities sector outlook changed to stable in November 2014» We think underlying business conditions overall underpin a weak but stable outlook for the sector over the next 12-18 months» Earnings from generation have further to fall as hedges roll off; but steepest declines are behind us and should be offset by profitability growth in other businesses» We expect conventional generation output volumes to stabilise, helped by slowly recovering economies, and a slowdown in the pace of renewables installations» We expect power prices will trade in a narrow range, based on our commodity price views and narrowing reserve margins» Political uncertainties persist in certain markets, but measures taken to address tariff deficits and signs of recovery in euro-periphery economies reduce risk of adverse intervention in the sector» Sector s longer-term challenges remain Municipality Owned Utilities and Stadtwerke, November 2014 9

2 Moody s rating approach for unregulated utilities and government ownership Municipality Owned Utilities and Stadtwerke, November 2014 10

Moody s Rating Approach Moody s Rating approach Rating methodology for unregulated utilities Baseline Credit Assessment ( BCA ) + Joint Default Analysis Rating methodology for Government Related Issuers ( GRIs ) = Final issuer rating to be determined by Rating Committee Municipality Owned Utilities and Stadtwerke, November 2014 11

Moody s Rating Approach Overview Unregulated Utilities Methodology» Methodology provides guidance on Moody s approach to assigning credit ratings to unregulated utilities and power companies» Published in October 2014 Factor Sub-Factor Weighting Scale Business Profile Market Diversification 10 % Hedging and Integration Impact on Cash Flow Predictability 5 % Market Framework and Positioning 10 % Capital Requirements and Operational Performance 5 % Business Mix Impact On Cash Flow Predictability 10 % 10 % 40 % Financial Policy 10 % Leverage & Coverage (CFO Pre-W/C + Interest) / Interest Expense (CFO Pre-W/C) / Debt RCF / Debt 10 % 15 % 15 % 40 % Municipality Owned Utilities and Stadtwerke, November 2014 12

Moody s Rating Approach Consideration of other factors Other rating considerations include, but are not limited to:» Management Strategy» Corporate Governance» Liquidity Management» GRI Methodology» Event Risk Stadtwerke specific factors are also taken into consideration, if applicable:» Quasi-regulated activities, e.g., water supply, subsidised renewables» Non-regulated but low risk activities, e.g., district heating» Specifics of power generation assets, e.g., CHP subsidies or other exception rules» Long-term contracts, e.g., at waste-to-energy, power generation» Concessions on distribution networks Stadtwerke may have a lot of specifics, which are not explicitly captured by our global Methodology but taken into account within the analytical process Municipality Owned Utilities and Stadtwerke, November 2014 13

Moody s Rating Approach GRI-Methodology: Joint Default Analysis ( JDA ) BCA Probability of support Dependence Probability of support driven by: Ownership structure & Corporate Governance Strategic relevance of utility company for municipality / city Ability to support Political implication of a potential insolvency of the utility company Final Rating Dependency between municipality / city and utility company driven by: share of revenues generated locally strong correlation of risks Rating of government Many utility companies are Government-related issuers (GRIs) and quite often benefit from a rating uplift. The rating of the owner is usually the key driver Municipality Owned Utilities and Stadtwerke, November 2014 14

3 Summary Municipality Owned Utilities and Stadtwerke, November 2014 15

Summary» Weak but stable Sector Outlook for EU utilities» Fundamentals for Stadtwerke are particular driven by Political environment» Usually strong political support from municipality as the main shareholder» Well positioned for concession renewals» Potential benefits from GRI uplift» Financial situation of municipality could also weigh on credit profile Higher level of diversification» Vertically (i.e., to regulated networks but also supply)» Horizontally ( multi utility ) Specifics of the business model» Long-term contracts» Quasi-regulated activities, e.g., water supply, subsidised renewables» Non-regulated but low risk activities, e.g., district heating Credit analysis of Stadtwerke needs to consider many company specifics Municipality Owned Utilities and Stadtwerke, November 2014 16

Appendix Municipality Owned Utilities and Stadtwerke, November 2014 17

Moody s Sector Outlook Political uncertainties persist, but downside has reduced» Fiscal/regulatory measures have cut energy system tariff deficits: Spain, Portugal» Sovereign crisis has eased, reducing need for measures to support public finances in euro-periphery countries: Italy s Robin Hood tax lowered from 10.5% to 6.5%» Policy makers listen more, but direct support for generators still limited» Affordability concerns remain high on the political agenda: France and UK; government ownership can mitigate risks» Risks remain: Weaker than expected demand could cause tariff deficits to re-emerge Underlying contradiction between market liberalisation and decarbonisation Merchant generation EBITDA* decline should flatten from 2015 102.4bn 111.0bn 105.1bn 109.3bn 103.3bn 95.1bn 96.3bn 44% 40% 38% 37% 34% 31% 30% 56% 60% 62% 63% 66% 69% 70% Source: Moody s Investors Service * Based on15 leading unregulated utility groups Municipality Owned Utilities and Stadtwerke, November 2014 18

EU and National Policies: Areas of Conflict Decarbonization policies have created new problems» Around 90GW of renewables have been added since 2009» Reserve margins have widened out significantly» Thermal generation has decreased by 17% on average (gas -35%) since 2009 European Reserve Margins Renewable additions in Western Europe since 2009 Gas and coal generation output in Western Europe since 2009 Municipality Owned Utilities and Stadtwerke, November 2014 19

EU and National Policies: Areas of Conflict Conflict 1: Capacity payments vs. interconnection» Capacity payment mechanisms conflict with EU Target Model given impact on flows» May potentially fall foul of State aid laws» EU s preferred solution is interconnection» TEN-E regulation / Projects of Common Interest have removed some barriers» but national energy policies create uncertainty around costs and benefits Import interconnection capacity remains below EU targets Capacity payment mechanisms vary greatly in their design and complexity United Kingdom France Italy Implementation date 2014-1st delivery 2018/19 2014-1st delivery 2016/17 2014-1st delivery 2017/18 Mechanism Auction Model Capacity Certificate Market Auction Model Centralised / de-centralised Centralised De-centralised - obligation is placed on Centralised supply companies Manager of scheme Government (amount of capacity) Government (amount of capacity) Terna (amount of capacity / auction National Grid (auction admin) RTE (auction admin) AEEG (regulation) Power Plant Eligibility All plants (excl. subsidised) All plants All plants (excl. subsidised) Demand Side Response Yes Yes No Length of contract Existing capacity - 1 year (default) 1 year 3 years Existing capacity - 3 year (refurbishment) New-build - 15 years Funding of scheme Interconnected participation Electricity consumers - costs are passed Electricity consumers - provided that onto retail suppliers in-line with their the tariff formula reflects costs at the market share outset No in 2014 Implicitly at the outset No Longer-term - potentially / tbc Final mechanism is uncertain although existing scheme allowed for passthrough CO2 as an example of policy uncertainty that affects interconnection investment Municipality Owned Utilities and Stadtwerke, November 2014 20

EU and National Policies: Areas of Conflict Conflict 2: Affordability vs. cost of decarbonisation Power prices have fallen, particularly in Europe» Increase in electricity tariffs has outstripped disposable incomes across much of Europe» This trend is likely to continue given 2020 targets» Existing policies have not been watered down since the credit crisis / sovereign debt crisis» Future tariff increases (renewables, networks & capacity payments) fixed-cost in nature with variable element of tariffs decreasing» Reduces the financial benefit to consumers of efficiency measures / decreasing consumption» In the long term this issue becomes worse as more customers go off-grid who pays?» Could lead to a change in the market design or risk the wide-scale stranding of electricity assets but end user tariffs have continued to rise (e.g. DE) Municipality Owned Utilities and Stadtwerke, November 2014 21

Moody s Rating Approach Factor 4 Leverage and Coverage Methodology Factor 4 Leverage and Coverage (40% weight in total) (CFO Pre-W/C + Interest) / Interest (CFO Pre-W/C) / Debt RCF / Debt The weights of the subsectors are: 10%, 15% and 15% for Utilities Aaa > 18x > 90% > 60% Aa 13x - 18x 60% - 90% 45% - 60% A 8x - 13x 35% - 60% 25% - 45% Leverage and coverage measures are indicators for a company s financial flexibility and long term viability. Financial flexibility is critical to unregulated utilities and unregulated power companies given the cyclical and capital intensive nature of the business and potential for volatility in cash flows. Baa 4.2x - 8x 20% - 35% 15% - 25% Ba 2.8x - 4.2x 12% - 20% 8% - 15% B 1x - 2.8x 5% - 12% 3% - 8% Caa < 1x < 5% < 3% Municipality Owned Utilities and Stadtwerke, November 2014 22

Moody s Rating Approach Calculation of key ratios FFO (Funds from Operations) Interest Coverage: (CFO Pre Working Capital + Interest Expense) / Interest Expense FFO / Net Debt: CFO Pre Working Capital / ( Gross Debt Cash) RCF (Retained Cash Flow) / Net Debt: (CFO Pre Working Capital Cash Dividends) / (Gross Debt Cash) Municipality Owned Utilities and Stadtwerke, November 2014 23

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