TEXT-Fitch affirms SSE at 'A-', outlook stable
Oct 03 - Fitch Ratings has affirmed SSE plc's (SSE) Long-term Issuer Default Rating (IDR) at 'A-', senior unsecured notes at 'A-', subordinated notes at 'BBB' and Short-term IDR at 'F2'. The Outlook for the Long-term IDR is Stable.
The rating affirmation reflects SSE's solid business profile as well as its high leverage for the rating level, given management's commitment to dividend growth in times of high capital expenditure and weak earning dynamics of thermal generation capacity in the UK.
SSE is an integrated utility, focused on the UK and Ireland. Business activities include almost all stages of the energy value chain, including a diverse generation portfolio and regulated energy networks.
Fitch calculates funds from operations (FFO) adjusted net leverage of 4.3x and FFO fixed charge cover of 4.0x for the year ended March 2012 (FY12). Over the period from 1 April 2012 to 31 March 2013 Fitch expects gearing to reduce to or below 4.0x again, reflecting tariff increases for residential customers implemented over time and restoring the profitability of the combined generation and supply activities. In the medium-term the agency expects gearing to remain at or below 4.0x.
Such ratio forecasts include 50% equity credit for USD700m and EUR750m of hybrid securities issued in September 2012. In contrast, the previous issuance in September 2010 of EUR500m and GBP750m of hybrid securities was based upon different terms and conditions, including a look-back provision, i.e. following payment of a dividend on ordinary shares the coupon on the hybrid securities cannot be deferred, which negates equity credit under Fitch's methodology.
Considering some of the market fundamentals, for example the low clean spark spread in comparison to healthy clean dark spread, trading conditions for UK integrated utilities are difficult. However, the following aspects need to be taken into account:
- Plant closures related to the Large Combustion Plant Directive and competitive pressures will reduce reserve capacity margins over the next three years and provide for a more favourable supply demand balance of thermal generation capacity.
- The rising carbon price floor will support electricity prices in the coming years and facilitate a permanent switch in the merit order from coal to gas.
- SSE has a diversified generation portfolio and is upgrading a number of gas-fired power stations for more flexible operation; the latter will allow the group to react quicker to market pricing and optimise the procurement of electricity through the use of its own generation capacity or alternative wholesale purchases.
- Around a third of SSE's EBITDA is derived from economically-regulated network activities in the UK with an increasing trend.
- SSE has only limited exposure to trading risk with electricity generation of 46Twh in FY12, compared to supply of 20.7Twh to residential customers and 31.2Twh to commercial customers.
Fitch considers that management continues to have adequate means to manage the group's financial profile. These include the discretionary nature of around 15% of capital expenditure over the next three years to March 2015 and the possibility to opt for scrip dividends. Changes in product or pricing strategy in the generation and supply business can also be used to enhance earning dynamics. At the same time, the agency notes that further hybrid issuance would be unlikely to provide material support to the ratings. While equity credit for such instruments reduces gearing, the cash interest is still taken into account for fixed charge cover. Given the higher pricing of hybrid capital, reliance on such instruments increases the annual financing need/leads free cash flow even further into negative territory and puts pressure on fixed charge cover.
As at March 2012, the group held GBP189.2m in cash and cash equivalents and had available undrawn revolving credit facilities of GBP1bn, maturing in 2015. Additional funding was raised following the financial year end, with USD700m through a US private placement as well as USD700m and EUR750m through hybrid securities. Hence, the group is funded until the end of 2013, in line with the board's policy to have available committed borrowings and facilities equal to at least 105% of forecast borrowings over a rolling 12-month period.
WHAT COULD TRIGGER A RATING ACTION
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
- Given continued weak earning dynamics for thermal generation in the UK and the sizeable capital expenditure programme, there is no real prospect of positive rating action over the rating horizon. If cash flow generation improved materially or the group decided to follow a capital restructuring to achieve FFO adjusted net leverage of 3.0x and FFO fixed charge cover of 4.5x an upgrade would be considered.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
- If cash flow generation were to weaken in comparison to FY12 levels, negative rating action should be expected; such circumstances could include difficulties to pass on additional carbon costs from 2013 onwards; credit metrics should not exceed FFO adjusted net leverage of 4.0x and fall below FFO fixed charge cover of 3.0x on a sustainable basis.
- If investment into the transmission network turns out to be substantially below Ofgem's Best Case and SSE were to invest equivalent funds into market based activities with longer lead-times or material execution or earnings risk, then negative rating action should be expected
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