TEXT-S&P places DONG Energy 'A-' L-T rating on creditwatch negative
(The following statement was released by the rating agency)
Aug 13 -
-- Danish power producer DONG Energy A/S's second-quarter results and 2012 outlook were somewhat below our previous expectations, mainly owing to weak power prices and gas markets, and we see downside risk in its key credit metrics over the near to medium term.
-- We believe DONG Energy's thermal electricity generation and gas operations face increasingly challenging business conditions that could reduce profitability.
-- We are placing our 'A-' long-term corporate credit rating on the company on CreditWatch with negative implications.
-- We aim to resolve the CreditWatch placement within the next three months.
On Aug. 13, 2012, Standard & Poor's Ratings Services placed its 'A-' long-term corporate credit rating on Danish integrated power and gas company DONG Energy A/S on CreditWatch with negative implications.
The rating action reflects the likelihood of a downgrade in the near term because we believe weaker electricity and gas market conditions are weighing on DONG Energy's profitability. This, in combination with a growing contribution to earnings from high-risk oil and gas exploration and production (E&P) activities, could weaken our assessment of the company's business risk profile. We believe that the weaker market conditions for electricity and gas could undermine our current base-case forecast for 2012 and 2013. This is in spite of our continued assumption that management will undertake debt reduction over the next few years through disposals, cash conserving measures such as scaling back on planned investments over the longer term, and further cost efficiencies. If our assessment of DONG Energy's business risk profile weakens, our financial credit metric expectations for the currently "intermediate" financial risk profile (FFO-to-debt ratio of 25%-30% on a sustainable basis) could be revised upward, even if the company is downgraded.
The ratings on DONG Energy reflect the company's stand-alone credit profile (SACP), which we currently assess at 'bbb+', on the basis of its "satisfactory" business risk profile and "intermediate" financial risk profile as our criteria define those terms. They further reflect our opinion that there is a "moderate" likelihood that the Danish government (AAA/Stable/A-1+) would provide timely and sufficient extraordinary support in the event of financial distress, based on our assessment of DONG Energy's "strong" link with the government (80% ownership and "limited" role. This results in the ratings benefiting from one notch of uplift above the SACP.
DONG Energy's business risk profile benefits from the company's strong position in the Danish energy market and the stability offered by its regulated gas and power distribution operations, which, together with other partly regulated and monopoly-like activities, contribute 25%-30% of the company's EBITDA. We consider these strengths to be offset by challenging power and gas market conditions, growing exposure to E&P activities, weak market conditions, and earnings volatility in the company's competitively exposed gas supply and power generation operations. We further believe that DONG Energy will continue to benefit from the completion of ongoing investments over the medium term, which should improve the competitiveness of its electricity generation portfolio. Its current generation portfolio is largely thermal-based and, consequently, uncompetitive when compared with the portfolios of its large Nordic peers, whose generation portfolios include very cost-competitive hydropower and nuclear plants.
DONG Energy's financial risk profile benefits from adequate financial policies and liquidity, with the company pre-financing upcoming investment needs well in advance, as well as flexibility with regards to investment levels. The financial risk profile is, however, constrained by negative free operating cash flows owing to a significant capital expenditure program, which makes the company reliant on asset disposals to limit any increase in debt and any weakening of credit measures.
The short-term rating is 'A-2'. We view the company's liquidity as adequate, based on our expectations that available liquidity sources (including funds from operations) will cover anticipated cash outflows by at least 1.2x over the next 12 months. An absence of restrictive financial covenants in the company's loan documentation and sound relationships with banks further support its adequate liquidity position, in our view.
The company's primary liquidity sources are as follows:
-- As of June 30, 2012, the company reported about Danish krone (DKK) 17.9 billion in cash and short-term securities (including DKK7.0 billion in reported securities sold as part of sales and repurchase agreement transactions).
-- At the same time, the company had access to an undrawn EUR1.3 billion (about DKK9.6 billion) revolving credit facility, maturing in 2016, and two undrawn EUR125 million bilateral credit facilities also maturing in 2016.
-- Funds from operations, which we expect to total about DKK10 billion in 2012.
Expected cash outflows consist of:
-- Debt maturities of about DKK7.1 billion between July 2012 and June 2013, and DKK6.3 billion in the subsequent 12 months.
-- Anticipated annual net investments of about DKK15 billion over the near term.
-- Dividend payments in line with the company's dividend policy (40%-60% of earnings after tax and hybrid coupon payments) and hybrid coupon payments of about DKK0.5 billion. Dividend payments in respect of 2011 amounted to DKK1.5 billion.
We believe that DONG Energy's flexibility in terms of its investment levels acts as an additional liquidity cushion. Moreover, we view positively the company's strategy of prefunding on the balance sheet (through conventional bonds and hybrid capital) the majority of a funding gap resulting from high investment levels and dividends.
We aim to resolve the CreditWatch placement within the next three months, after meeting with management and receiving more in-depth information. We propose to discuss with management, in detail, the market environment, the group's financial policy, and investments, as well as plans for operating improvements and disposals. We could affirm the ratings if DONG Energy can demonstrate a satisfactory plan to strengthen its credit metrics through continued deleveraging, or if we take the view that the current weakening of the business environment is only temporary and short term. In contrast, we could lower the ratings if we take the view that the company's business risk profile has weakened and there is no clear path toward stronger credit metrics. We currently believe that any downgrade will be limited to one notch.
Related Criteria And Research
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010
-- Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Ratings Affirmed; CreditWatch Action
DONG Energy A/S
Corporate Credit Rating A-/Watch Neg/A-2 A-/Stable/A-2
Senior Unsecured A-/Watch Neg A-
Subordinated BBB/Watch Neg BBB
Junior Subordinated BB+/Watch Neg BB+
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