Feb 10 (The following statement was released by the rating agency)
Fitch Ratings has affirmed Ireland-based Electricity Supply Board's (ESB) Long-term Issuer Default Rating (IDR) at 'BBB+'. The Outlook on the Long-term IDR is Stable. A full list of rating actions for ESB and its subsidiaries is provided at the end of this commentary. The affirmation reflects Fitch's expectations for ESB's credit metrics to remain within current rating guidelines over the forecast period, a comfortable liquidity position and reliable access to capital markets. We believe cash flows for 2013 would have been stronger than our previous expectations as a result of efficiencies achieved through ESB's cost control programme, capex reductions, and improved performance in the generation and supply business divisions. Rating upside is limited due to expected lower remuneration for the networks and higher dividends.
KEY RATING DRIVERS
ESB's significant portion of regulated earnings, which mainly includes transmission and distribution networks in the Republic of Ireland and Northern Ireland, supports its business profile. In 2013, these regulated assets are expected to generate around 60% of total EBITDA, providing ESB with higher earnings visibility compared with most integrated utilities in EMEA.
Earnings derived from ESB's networks businesses are expected by Fitch to be lower as a result of the decision by the Irish regulator published on 31 January 2014 to set a real pre-tax weighted average cost of capital (WACC) of 5.2% for 2014-2015 as part of the mid-price review of WACC. This is compared with the 5.95% applied over the first three years of the price review. For ESB's subsidiary, Northern Ireland Electricity (NIE) we forecast earnings to be lower due to the impact of the proposals included in the provisional determination published by the Competition Commission (CC) and a likely reduction in capex as the company awaits the resolution of the price control.
-Improved Generation and Supply
Improved performance in the generation business is driven by an increase in ESB's market share while the supply business is supported by increases in customer numbers as well as by increases in prices and average consumption. For the remainder of the forecast period 2014-2017 we expect lower system marginal prices (SMP) for the generation segment to be mitigated by the solid position of ESB's plants in the Irish merit order (including exposure to coal) and by the system's capacity payments. We also expect electricity demand to remain stable in Ireland, but the generation and supply businesses to continue to be subject to competitive pressures.
-Dividend Payments to Increase
We expect the revised dividend policy - higher ordinary pay-out and significant distributions of disposal proceeds - to have a negative impact on ESB's financial profile, due to the reduction in free cash flow. However, this will be mitigated by stronger-than-expected earnings in the supply segment, leaving its credit ratios little changed. The dividend policy was revised following a request by the Irish government in October 2013. The government also requested ESB to consider payment of an additional dividend of EUR65m in 2013. The target dividend pay-out ratio will remain at 30% for 2013 and 2014, in addition to the agreed targeted special dividends from the disposal of non-strategic assets. The target pay-out ratio will be increased gradually to 40% by 2017, including minimum interim dividends of 60%.
-Disposal of Non-Strategic Assets
In November 2013, ESB completed the sale of its 50% stake in the Marchwood CCGT power plant located in the UK to insurance company Munich Re. This sale forms part of the disposal of non-strategic assets decision by the Irish government to raise EUR400m in special dividends by 2014. The company is in the process of selling its 50% shareholding in the Bizkaia CCGT plant in Spain and has also indicated its intention to sell its two peat stations, West Offaly Power and Lough Ree Power in Ireland. Fitch expects these asset disposals to have a negative impact on ESB's financial profile in the short- to medium-term given that the government is likely to use more than 40%-50% (which would reflect ESB's current gearing of 50%-60%) of net disposals proceeds to increase ESB's dividend pay-out. However, we expect the negative impact to be mitigated by stronger-than-expected earnings in 2012-2013 and slightly lower leverage due to capex reduction in 2012-2013.
-Diversified Generation Portfolio
We view the disposals as neutral for ESB's business profile because it will retain a balanced position in power generation compared with supply, and its plants remain-well positioned in the merit order. ESB has a diversified generation portfolio by fuel source (including wind power benefiting from feed-in-tariffs). We believe that this diversification protects ESB during periods of low demand while allowing it to maximise returns during peak periods.
- NIE's Provisional Determination by CC
NIE faces tough regulatory determination that is likely to lead to a downgrade of NIE's senior unsecured rating to 'BBB+' from 'A-' (see 'Competition Commission's Provisional Determination Negative for Northern Ireland Electricity', dated 27 November 2013, available on www.fitchratings.com). At this stage, we do not believe there will be a significantly negative impact on ESB's ratings as a result of NIE's provisional determination given that NIE's contribution to ESB's EBITDA is around 15%.
-Adequate Credit Metrics
We forecast funds from operations (FFO) adjusted net leverage to be below 4.5x in 2013-2015 and FFO interest coverage to be above 4.1x. We continue to expect gearing (defined as net-lease adjusted debt to regulatory asset base) to remain below 60%. ESB's FFO-based credit metrics remain slightly weaker compared with most of its EMEA peers although this is mitigated by its strong earnings profile with a dominant share from regulated network assets.
Positive: Future developments that may lead to a positive rating action include:
- Stronger performance than expected leading to stronger metrics with FFO adjusted net leverage around 4.0x, FFO interest coverage of 4.5x and gearing below 55% on a sustained basis
Negative: Future developments that could lead to a downgrade:
- Business underperformance with increase in debt leading to an FFO adjusted net leverage well above 4.5x, FFO interest coverage below 4.0x and gearing above 60% on a sustained basis
- Significant deterioration in the operating environment in Ireland due to adverse regulatory or political decisions or structural changes in the generation and/or supply markets that would affect ESB's financial metrics and could lead to revised ratio guidance for the current IDR
- Downgrade of Ireland's sovereign rating to 'BB+'
LIQUIDITY AND DEBT STRUCTURE
As of 30 June 2013 ESB had EUR1.539bn of undrawn committed credit facilities and EUR121m of available cash and cash equivalents. Fitch expects ESB to report negative free cash flow in 2014-2017. However, the issuer's liquidity is sufficient to cover scheduled debt maturities, capex, operating requirements and dividends for at least the next 48 months.
In November 2013 ESB issued a EUR300m 3.494% fixed bond maturing in January 2024 and in December 2013 it obtained EUR100m of EIB committed facilities with a 20-year tenor.
FULL LIST OF RATING ACTIONS
Electricity Supply Board
-Long-term IDR affirmed at 'BBB+', Stable Outlook
-Short-term IDR affirmed at 'F2'
-Senior unsecured rating affirmed at 'BBB+'
ESB Finance Limited
-Senior unsecured guaranteed notes (EMTN programme) affirmed at 'BBB+'