TEXT-S&P summary: Elia System Operator S.A./N.V.
Elia's "excellent" business risk profile is underpinned by the group's strong monopoly position as the owner and operator of the electricity transmission network in the Kingdom of Belgium (unsolicited rating AA/Negative/A-1+) and one of four regional transmission grids in the Federal Republic of Germany (unsolicited rating AAA/Stable/A-1+), and a supportive regulatory framework in both service areas.
About 99% of Elia's EBITDA is regulated, providing for a stable and predictable revenue and cash flow stream. These strengths are moderated by regulatory reset risk. That said, we consider this risk as limited at present. We consider that the regulatory framework in Belgium remains credit supportive, with no major changes to the tariff set methodology from Jan. 1, 2012, compared with the previous regulatory period. We also consider that the new regulatory period starting in Germany on Jan. 1, 2014 is likely to remain credit supportive given positive changes announced over the past year.
We continue to assess Elia's financial risk profile as "significant", given its highly leveraged capital structure and relatively weak cash flow coverage of debt, with limited room for meaningful strengthening in the near-to-medium term due to substantial planned investments. That said, we view positively the group's management of financial risk and note the very stable and cautiously improving credit metrics over recent years. We also consider that Elia's initial end-2001 regulated asset base (RAB) was substantially revalued by the regulator at EUR3.3 billion at the time, well above the accounting value of EUR1.6 billion. The company benefits from a post-tax return on 33% of the RAB, while actual interest charges incurred are passed through as a regulated cost. Depreciation charges, however, are recovered in tariffs only on the EUR1.6 billion nonrevalued amount. This to a large extent accounts for the lower cash flow generation by Elia compared with European peers.
S&P base-case operating scenario
In our base-case assessment, we anticipate that the consolidated Elia group will continue to report gradually improving revenues, following a strong increase in revenues in 2011 and the first half of 2012. At the same time, we believe that Elia's consolidated EBITDA margins, which are in line with peers', will remain at about 34% reported in 2011 over the medium term, however, with the potential to strengthen due to the removal of a time lag for recovery of certain costs under the German regulatory framework from Jan. 1, 2012. Consolidated revenues as per June 30, 2012, increased by more than 15% on a rolling 12-month basis and the EBITDA margin strengthened marginally to 35%.
S&P base-case cash flow and capital-structure scenario
In our base-case scenario, we forecast gradually increasing earnings and funds from operations (FFO) in 2012 and 2013. At the same time, however, we anticipate that Elia's substantial capital expenditure (capex) requirements in the near-to-medium term will likely result in negative free operating cash flow and gradually increasing debt. We also consider that the company's aggressive dividend policy limits its financial flexibility and, in combination with the large capex program, would result in negative discretionary cash flows over the medium term. In our base-case scenario, we project that Elia's cash flow coverage of debt will remain largely stable over the next two years, and that the ratio of Standard & Poor's-adjusted FFO to debt will remain comfortably in line with our minimum guideline for the rating of 10%. This ratio was 11.1% in 2011, and had strengthened to 12.4% by June 30, 2012, on a rolling 12-month basis. We believe that it is likely to remain well above 10% over the next two years.
The short-term rating is 'A-2'. We assess Elia's liquidity position as adequate under our criteria, supported by our view that Elia's liquidity resources will exceed its funding needs by over 1.3x in the next 12 months.
For the 12 months from Sept. 30, 2012, we estimate Elia's consolidated liquidity sources to be about EUR1.6 billion under our base-case scenario. These include:
-- A cash balance of about EUR140 million.
-- Funds of more than EUR1.1 billion available under Elia's EUR780 million committed revolving credit facilities expiring in June 2015 and Eurogrid GmbH's EUR350 million committed credit facility expiring in May 2016. The latter is only available to Eurogrid, as per its terms and conditions, and therefore does not benefit Elia. However, in our view, it is supportive for the credit quality of the consolidated group.
-- Access to EUR65 million available through a bank line with the European Investment Bank (AAA/Negative/A-1+), which Elia can use to fund investments.
-- Annual consolidated FFO of close to EUR350 million.
Elia's credit lines do not include any financial covenants or material adverse change clauses. Eurogrid's credit facility contains financial covenants that are applicable to Eurogrid GmbH, as the borrower, although these would only be tested if Eurogrid is rated 'BBB' (or equivalent) or lower.
We estimate that Elia's consolidated liquidity needs over the next 12 months from Sept. 30, 2012, will be close to EUR1.2 billion under our base-case scenario, including:
-- Capex of about EUR580 million.
-- The repayment of a EUR500 million Eurobond falling due in April 2013.
-- Dividend payments of EUR90 million.
The stable outlook reflects our view that Elia's excellent business risk profile will continue to support stable cash flows and sound profitability under our baseline scenario. We anticipate that Elia's adjusted FFO-to-debt ratio will remain above 10% on a consolidated basis in the near-to-medium term, which is in line with our assessment of the group's financial risk profile.
Downward rating pressure could arise if Elia's operating and financial performance were to weaken unexpectedly to undermine its business and financial risk profiles. Such weakening could result from a detrimental reset of the electricity transmission regulation in Germany from Jan. 1, 2014. It could also result from higher investment levels and increased funding needs, or a large-scale acquisition. Pressure on the ratings could arise from a sustained decline in Elia's FFO-to-debt ratio below 10%.
We consider an upgrade to be unlikely over the medium term, due to Elia's substantial capital investment plans in coming years and our opinion that there is limited rating headroom--in terms of debt capacity--under our baseline assumptions. However, we would consider taking a positive rating action if Elia's financial risk profile were to strengthen substantially, especially if the group were to maintain its consolidated adjusted FFO-to-debt ratio at 13%-15% and generate neutral to positive discretionary cash flows on a sustainable basis, all else remaining equal.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 17, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008