Research Update: France-Based Energy Company ENGIE Affirmed At 'A-/A-2' Amid Its Transformation; Outlook Primary Credit Analysts: Pierre Georges, Paris (33) 1-4420-6735; pierre.georges@spglobal.com Karl Nietvelt, Paris (33) 1-4420-6751; karl.nietvelt@spglobal.com Secondary Contact: Massimo Schiavo, Paris +33 144206718; Massimo.Schiavo@spglobal.com Table Of Contents Overview Rating Action Rationale Outlook Ratings Score Snapshot Related Criteria Related Research Ratings List WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 28, 2017 1
Research Update: France-Based Energy Company ENGIE Affirmed At 'A-/A-2' Amid Its Transformation; Outlook Overview ENGIE is rapidly changing its business risk profile with substantial disposals in its power merchant activities in recent quarters, and it has announced plans to dispose of its exploration and production activities in 2017. We believe the group's business portfolio has become increasingly regulated and focused on long-term contracts, supporting increased visibility and predictability of cash flows. In our view, the transformation process should also contribute to moderate debt reduction in 2017 and 2018, bearing in mind that the company's asset-rotation plan also involves important investment outlays. We anticipate a mild recovery of ratios in 2017. We are therefore affirming our 'A-/A-2' ratings on ENGIE. The negative outlook indicates that we could downgrade ENGIE over the next 12-18 months if the company struggles to deleverage and our adjusted funds from operations to debt figure does not improve to 20% or higher in 2018. Rating Action On April 28, 2016, S&P Global Ratings affirmed its 'A-/A-2' long- and short-term corporate credit ratings on global multi-utility ENGIE SA and its subsidiary GIE ENGIE Alliance. The outlooks on both companies are negative. At the same time, we affirmed our issue ratings on ENGIE's senior debt at 'A-' and those on the deeply subordinated hybrid securities at 'BBB'. Rationale The rating affirmation reflects ENGIE's rapidly changing business risk profile stemming from substantial disposals of its merchant activities: some already completed (U.S. and Asian assets) or announced for this year (the oil and gas exploration and production [E&P] activities). The resulting increase in regulated activities to almost 40% of operations will support a more visible and resilient cash flow stream, which we view as positive for ENGIE's business risk profile. Simultaneously, we expect the transformation process will result in lower debt in 2017 and 2018. Last year, ENGIE's ratio of funds from operations (FFO) to debt was 17.5%, which was below our expectations, but we WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 28, 2017 2
expect it will improve to close to 20% this year and strengthen further in 2018. In 2016, ENGIE reported consolidated EBITDA of 10.7 billion. From 2018 onward, we foresee an increasing relative contribution from ENGIE's French gas distribution and transportation network activities to about 35% from about 25% in 2015. We also anticipate continued growth in long-term contracted infrastructures (other regulated networks, gas pipelines, gas storage, and heating and cooling networks), which together account for an additional 8%-10% of the business portfolio, and in long-term contracted generation assets (thermal and renewables; about 25%). Together, these businesses should largely support stronger cash flow resilience and the group's credit quality. With a regulated asset base (RAB) worth about 24 billion, the French gas distribution and transmission regulated networks, and to a lesser extent regulated liquefied natural gas (LNG) terminals, represent a major driver of ENGIE's strong business risk profile. We see the regulatory framework in France as strong, providing a good degree of earnings stability. We expect ENGIE's RAB will expand moderately in the coming years. These networks are further complemented by expansion into a portfolio of heating and cooling networks, transmission pipelines in Latin America that benefit from long-term contracts, and gas storage activities that may benefit from new regulation in the coming years. These activities further support the group's strategy to reduce risk in the portfolio. We also view as a positive factor that the group's power generation assets are newer than those of most peers. They are low carbon dioxide assets that could eventually benefit from more-stringent environmental rules, including the introduction of a carbon floor price, and a political push to accelerate the exit of coal energy sources. In addition, ENGIE has a significant pipeline of new assets that it will commission during the coming years. The remaining part of ENGIE's portfolio will mainly comprise energy services with industrial and public entities, and energy supply to its large residential customer base in France and Belgium. The industrial and public entities business consists of energy solutions (such as cogeneration or renewables) and facility management. These activities represent a major part of the division's EBITDA and of the group's growth strategy. We understand ENGIE has a much broader spectrum of products and services it can offer to its industrial customer base, including IT systems and data management, which could be an area of growth in the future, notably through cross-selling; but we expect this diversification will remain relatively marginal for the coming years. In addition, given the relatively small size of each contract, we expect the group will find it challenging to replace cash flows lost after asset disposals, and offset the still-subdued performance of its remaining merchant operations (mostly thermal assets in Europe). Our assessment of ENGIE's financial risk remains constrained by the group's extensive investment program and decreasing but still-high shareholder returns, which contribute to the group's high financial leverage. Positive WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 28, 2017 3
factors are management's continuous commitment to financial discipline; the group's high degree of financial flexibility; its proactive and prudent liability management, with a consistently strong liquidity position; and reduction of financial debt, thanks to disposals over the next two years. We also factor in the group's measures to maintain a credit rating in the 'A' category. That said, the 2016 results were well below our expectations for the rating, notably with adjusted FFO to debt at 17.5%. EBITDA was down 5% to 10.7 billion, notably due to weak commodity and power prices in the upstream and merchant generation operations, high restructuring costs related to the transformation plan launched last year, and delayed cash proceeds from the disposal of its U.S. merchant assets (received in February 2017). These negative developments were only partly offset by an increase in tariffs and the contributions from new assets. In addition, our adjusted debt figure includes a substantial increase in pensions and nuclear obligations in Belgium, which neutralized the group's material efforts to reduce net financial debt through disposals. Our adjusted debt figure of 45 billion at year-end 2016 includes notably 10 billion of asset-retirement obligations (mainly in the nuclear operations), 4.7 billion of pensions, and 2.7 billion of operating leases (mainly related to liquefied natural gas activities). In our base case for ENGIE, we assume: Flat to slightly higher EBITDA in 2017 year on year, with organic growth and cost-reduction efforts partly compensating for a still-weak price environment and loss of EBITDA from disposed assets. Decreasing EBITDA in 2018, due to the impact of assumed disposals of E&P and merchant assets over 2017-2018. Continued high capital expenditure (capex) averaging 7 billion per year over 2017-2019. Cash dividends of around 2.3 billion each year, in line with the new dividend policy of 0.7 per share in 2017-2018. Asset disposals of around 10 billion over 2017-2018, including 3.1 billion in proceeds received earlier this year from the U.S. power merchant assets. Improving cost of debt over 2017-2019, thanks to more favorable market conditions upon refinancing. Based on these assumptions, we arrive at the following credit measures: Adjusted FFO averaging around 8 billion over 2017-2018. Adjusted debt reducing by 4 billion- 5 billion by 2018 to about 40 billion, and stabilizing at that level. FFO to debt of 19%-20% in 2017 and 20% or higher in 2018. Liquidity The 'A-2' short-term rating is supported by ENGIE's liquidity, which we consider strong. We project ENGIE's sources of funds will exceed uses by more than 1.7x over the next 12 months and by well above 1x over the subsequent 12-24 months. Our assessment is further supported by the group's ongoing and WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 28, 2017 4
proactive liquidity and debt management, solid relationships with banks, and ample and proven access to capital markets, even under dire market conditions. Principal liquidity sources: About 9.8 billion in available cash at group level as of Dec. 31, 2016. About 12.6 billion in available committed credit lines maturing beyond 12 months, of which 10.5 billion relate to two syndicated facilities maturing in 2021. Our forecast of reported FFO of around 8.9 billion over the next 12 months. Proceeds from asset disposals in 2017, including 3.1 billion received in February 2017. Green bond issuance of 1.5 billion in 2017. Principal liquidity uses: Short-term debt of about 11.7 billion, including 6.3 billion of outstanding commercial paper (2018 debt maturities are substantially lower at 2.6 billion). Our estimate of essentially fixed gross capex of about 7 billion. Dividend cash payments of about 2.3 billion, including dividends of the group's subsidiaries to minority shareholders. Outlook The negative outlook reflects uncertainties regarding improvement in ENGIE's credit metrics and debt reduction over the next 18 months, and the execution risks we still foresee in the group's strategic plan. This is despite our anticipation that management will maintain a high level of financial discipline and tap some of its material financial flexibility if necessary. Notably, we see the likely disposal of ENGIE's oil and gas E&P assets during 2017 as a paramount step to shift its business mix toward more regulated activities, which are set to represent substantially more than one-third of consolidated EBITDA. We currently believe that, if combined with mostly contracted unregulated energy businesses and the group's size and diversity, ENGIE's future business profile would allow for maintenance of FFO to debt at 20% or higher at the 'A-' rating level. Downside scenario We could lower the rating by one notch over the next 12-18 months, if we considered that ENGIE could struggle to deleverage and dispose of its merchant and upstream activities at a sufficiently supportive price. We could also downgrade the company if our adjusted FFO to debt figure remains sustainably below 20% in 2017 and does not strengthen to 20% or higher thereafter. This could also result from further deterioration of economic conditions for the group's merchant activities, inability to substantially increase the cash flow base from its customer solutions activities, such as following adverse regulatory measures, or failure to complete its transformation plan in a WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 28, 2017 5
timely manner. Upside scenario We could revise the outlook to stable over the next 12-18 months, if we were confident that FFO to debt could improve to at least 20% in 2018 and ENGIE were able to dispose of a large part of the group's activities exposed to commodity prices. Ratings Score Snapshot Corporate Credit Rating: A-//A-2 Business risk: Strong Country risk: Low Industry risk: Intermediate Competitive position: Strong Financial risk: Significant Cash flow/leverage: Significant Anchor: bbb Modifiers Diversification/Portfolio effect: Moderate (+1 notch) Capital structure: Neutral (no impact) Liquidity: Strong (no impact) Financial policy: Neutral (no impact) Management and governance: Satisfactory (no impact) Comparable rating analysis: Positive (+1 notch) Stand-alone credit profile: a- Group credit profile: a- Entity status within group: parent Sovereign rating: AA Likelihood of government support: Low Related Criteria General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017 General Criteria: Guarantee Criteria, Oct. 21, 2016 General Criteria: Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015 Criteria - Corporates - General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014 Criteria - Corporates - Industrials: Key Credit Factors For The Unregulated Power And Gas Industry, March 28, 2014 Criteria - Corporates - Industrials: Key Credit Factors For The Midstream WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 28, 2017 6
Energy Industry, Dec. 19, 2013 Criteria - Corporates - Industrials: Key Credit Factors For The Oil And Gas Exploration And Production Industry, Dec. 12, 2013 General Criteria: Group Rating Methodology, Nov. 19, 2013 General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013 Criteria - Corporates - Utilities: Key Credit Factors For The Regulated Utilities Industry, Nov. 19, 2013 Criteria - Corporates - General: Corporate Methodology: Ratios And Adjustments, Nov. 19, 2013 Criteria - Corporates - General: Corporate Methodology, Nov. 19, 2013 General Criteria: Methodology: Industry Risk, Nov. 19, 2013 General Criteria: Methodology And Assumptions: Assigning Equity Content To Corporate Entity And North American Insurance Holding Company Hybrid Capital Instruments, April 1, 2013 General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012 General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010 Criteria - Insurance - General: Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008 Criteria - Corporates - General: 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 Related Research Spanish Power Company Iberdrola S.A. 'BBB+/A-2' Ratings Affirmed On Solid Business Fundamentals; Outlook Stable, April 26, 2017 Bulletin: Electricite de France Ratings Unaffected By Sale Of RTE Stake And Capital Increase, April 3, 2017 Ratings List Ratings Affirmed ENGIE SA Corporate Credit Rating A-//A-2 Senior Secured A- Senior Unsecured A- Junior Subordinated BBB Commercial Paper A-2 GIE ENGIE Alliance Corporate Credit Rating A-//-- Senior Unsecured A- WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 28, 2017 7
Additional Contact: Infrastructure Finance Ratings Europe; InfrastructureEurope@spglobal.com Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings information is available to subscribers of RatingsDirect at www.globalcreditportal.com and at spcapitaliq.com. All ratings affected by this rating action can be found on the S&P Global Ratings' public website at www.standardandpoors.com. Use the Ratings search box located in the left column. Alternatively, call one of the following S&P Global Ratings numbers: Client Support Europe (44) 20-7176-7176; London Press Office (44) 20-7176-3605; Paris (33) 1-4420-6708; Frankfurt (49) 69-33-999-225; Stockholm (46) 8-440-5914; or Moscow 7 (495) 783-4009. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 28, 2017 8
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