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April 23 (The following statement was released by the rating agency)
Fitch Ratings has revised Germany-based E.ON SE's (E.ON) Outlook to Negative from Stable and affirmed its Issuer Default Rating (IDR) at 'A-'. Its Short-term IDR was affirmed at 'F2' and its senior unsecured rating at 'A-'.
The Outlook revision reflects mainly weaker-than-expected earnings contributions from E.ON's growth businesses - Russia and exploration & production - as well as guidance on operating cash flow of EUR5.4bn (E.ON EBITDA guidance for 2014 of EUR8bn-8.6bn and cash flow conversion at 60%-70%). These changes have resulted in an increase of forecast leverage that would not be commensurate with an 'A-' IDR in the short- to medium-term, even after taking into account reduced business risk from a change in earnings contributions from the company's various divisions.
KEY RATING DRIVERS
Weaker Earnings from Growth Businesses
A tariff freeze in Russia and a material depreciation of the rouble have led to a reduction in forecast earnings for this division, although operational performance continues to be strong. At the same time, production targets for hydrocarbon assets in the North Sea have been materially revised downwards over the last six months, demonstrating execution risk of E.ON's business plan. In response Fitch has cut forecast EBITDA for these businesses by around EUR700m for the medium-term.
Business Mix Warrants Higher Leverage Guideline
A change in the composition of prospective earnings, ie lower contributions from Russia and exploration & production plus (proportionally) higher contributions from regulated or quasi-regulated earnings, have caused Fitch to raise its leverage guideline to 3.75x on both a lease-adjusted and a nuclear-adjusted funds from operations (FFO) basis, from 3.5x previously.
Credit Metrics Weakly Placed
Under Fitch's calculations E.ON reported a lease-adjusted and nuclear-adjusted FFO net leverage of 3.84x at end-2013, with a corresponding fixed charge cover of 5.61x. The group made sizeable pension deficit repair payments during the year. Normalising cash flow for recurring pension contributions would have brought leverage to within the 3.75x guideline. However, taking into account management guidance for operating cash flow of EUR5.4bn for 2014 gearing is likely to rise and remain above 3.75x for some time. Therefore, the agency has revised the Outlook on E.ON's Long-term IDR to Negative.
Developments on Nuclear Fuel Tax
In 2013 the Hamburg Fiscal Court referred the nuclear fuel tax to the German Constitutional Court and the European Court of Justice, raising expectations that the law enacting the tax may contravene the German constitution and/or European directives. On 14 April 2014 the Hamburg Fiscal Court ruled that E.ON be provisionally refunded for EUR1.7bn in nuclear fuel tax already paid (for the 2011-13 period). An appeal by the government is legally possible and the decision by the Hamburg Fiscal Court to uphold E.ON's motion for refunding does not give any further insights as to how the German Constitutional Court or the European Court of Justice will rule. Hence, the tax burden remains for the time being and Fitch will treat any refunded tax payments as restricted cash.
Well Diversified Business Profile
The group has a well-diversified profile with network and retail activities across Europe, conventional and renewables generation across various jurisdictions, upstream oil and gas interests in Russia and the North Sea, investments into several emerging markets as well as trading operations that can rely on some infrastructure assets. Regulated and quasi-regulated earnings from grids and renewables are expected to represent around 50% of the total in the medium term, contributing to an overall strong business profile.
Government Intervention Remains a Threat
European governments have imposed a variety of additional taxes, regulatory requirements and other measures on utilities in the recent past. The political debate to find a balance between budget consolidation and economically sustainable energy policies remains an ongoing and uncertain process. E.ON's operations have a high degree of diversification across countries, business segments and technology of generation plant. Therefore, E.ON has a lower exposure to potential government intervention than most of its peers.
Continued Investment Discipline
Management has guided towards a lower level of normalised investment activity of around EUR4bn in the medium term, focusing on maintenance of existing assets and selected growth projects with sound earnings and return visibility.
E.ON's liquidity continues to be strong. As of 31 December 2013, the group held EUR4bn of unrestricted cash and cash equivalents, around EUR2.6bn of short-term securities and fixed income deposits and EUR5bn of committed, undrawn credit facilities with a maturity in November 2018. Also, the group expects to complete disposals in Sweden, Denmark and the Czech Republic in 2014 for a consideration of around EUR700m.
The group has debt maturities of around EUR6.5bn-EUR7bn in 2014 and 2015. Negative free cash flow (FCF) in 2014 is expected to be covered by disposal proceeds and management guidance points towards positive FCF from 2015. Hence, the current funding position should be sufficient to sustain the group into 2016.
E.ON also has available another EUR3.8bn of longer-term fixed income securities, which are liquid investments, but do not qualify as cash and cash equivalents under Fitch methodology.
Negative: Future developments that could lead to negative rating action include:
- Lease- and nuclear- adjusted FFO net leverage materially above 3.75x and/or corresponding fixed charge cover materially below 4x on a sustained basis
- Increase in business risk, for example corporate activity or management loosening investment discipline related to capital expenditure or significant cash flow generation from emerging markets and upstream oil and gas
Positive: Future developments that could lead to a positive rating action include:
-Lease- and nuclear- adjusted FFO net leverage at or below 3.75x and corresponding fixed charge cover above 4.0x on a sustained basis
- A court decision leading to the cancellation of the nuclear fuel tax