The downgrade reflects our belief that Acea will struggle to recover credit metrics in line with a ‘BBB+’ rating in the near term. At the beginning of this year, we revised our base-case expectation of funds from operations (FFO) to debt to 16%-17%, from 20% for 2012 and 2013. So far this year, Acea has substantially underperformed our base-case scenario, posting FFO to debt on June 30, 2012, below 15% on a Standard & Poor’s adjusted basis. Amid the currently tough economic conditions in Italy, a substantial recovery for Acea, in our view, is unlikely in the near term unless it unexpectedly overcomes its main structural weakness: the collection of receivables, in particular toward its main shareholders, the City of Rome and its controlled companies. We understand that receivables toward the City of Rome and its related companies further increased to EUR289.9 million on June 30, 2012, from EUR272.8 million at year-end 2011. Meanwhile, we do not see significant progress in the recovery of past dues for Acea’s water companies, Gori SpA and Acea Ato 5.
We believe that in light of deteriorated funding conditions for banks in Italy, Acea’s increasing reliance on receivables sales schemes in recent years to keep working capital under control is in question and may generate increasing costs for the company. The factors we mention above have been increasing ACEA’s debt beyond our expectations. Standard & Poor’s adjusted debt for Acea, which includes our estimate of trade receivables sales outstanding, exceeded EUR3 billion on June 30, 2012, versus EUR2.8 billion one year earlier.
For the above reasons, we are revising Acea’s business risk profile to “satisfactory” from “strong.” According to our criteria, this revision is associated with a lowering of the long-term corporate credit rating by two notches.
We continue to assess Acea’s financial risk profile as “significant.” This reflects our view of the company’s high leverage and relatively aggressive equity-friendly strategy, evidenced in recent years by a generous dividend policy. We currently see little headroom for improving credit metrics. According to our base-case scenario, Acea will post negative cash flow after capital expenditure (capex) and dividends over 2012-2015.
The ‘BBB-’ rating on Acea is based on the group’s stand-alone credit profile, which we now assess at ‘bbb-'. In addition, we consider Acea to be a government-related entity (GRE) under our criteria. In accordance with the criteria, we believe there is a “moderate” likelihood of timely and sufficient extraordinary government support based on our assessment of Acea‘s:
-- “Important” role as the largest local utility in central Italy. The group mainly operates the water and electricity distribution concessions for the City of Rome and the surrounding area, the Region of Lazio (BBB+/Negative/--).
-- “Limited” link with the City of Rome, which owns 51% of Acea. As a shareholder, Rome has the ability to influence the company’s management and strategy.
The short-term is ‘A-3’. In our view, available cash, committed credit lines at year-end 2011, and our expectation of FFO of 1.2x in the following 12 months will just cover the company’s planned cash outlays--mainly capex, debt service, and dividends.
Our assessment is underpinned by:
-- Access to unrestricted cash of EUR140 million;
-- Available committed credit lines of EUR350 million on June 30, 2012, with a maturity longer than 12 months; and
-- And our estimate of FFO of approximately EUR390 million over the next following 12 months.
This compares with our forecast that over the next 12 months, Acea faces:
-- Average capex of EUR500 million,
-- Estimated dividend outflow of approximately EUR40 million, and
-- Short-term debt maturities of EUR202 million.
In our view, Acea will manage its liquidity proactively to secure an adequate liquidity position after the 12 months where we see potential funding gaps. We acknowledge that Acea has received a EUR100 million loan from the European Investment Bank and replaced maturing committed credit lines with new ones with maturities of 18-36 months. We also understand that Acea plans to dispose of some of its photovoltaic assets, which despite current tough market conditions could attract interest from investors as these secure a stable and relatively high remuneration. We will continue monitoring liquidity management because our base-case scenario projects negative cash flow after capex and dividends over 2012-2015, which in our view will weigh on Acea’s funding needs.
We understand that some of Acea’s financing agreements contain no covenants but are rating-sensitive: the downgrade to speculative grade would trigger immediate repayment.
The negative outlook reflects the possibility of a downgrade if Acea cannot recover credit metrics in line with our expectations for a “significant” financial risk profile, namely Standard & Poor’s adjusted FFO to debt in the 15%-20% range over the next 24 months.
We could lower Acea’s corporate credit rating by one notch if we failed to see the company progressing toward the abovementioned target. This could happen, in our view, if the company failed to shift its strategic focus to deleveraging in the near term. However, this could also happen if, as a result of a substantial deterioration of its operating conditions, Acea’s collection capacity didn’t improve markedly.
We could revise the outlook to stable if we were of the opinion that Acea was progressing substantially toward deleveraging and corporate governance supportive of a greater insulation from political interference from the City of Rome regarding its business strategy, collection policies, and dividend policy.
Related Criteria And Research
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology: Short-Term/Long-Term Ratings Linkage Criteria For Corporate And Sovereign Issuers, May 15, 2012
-- Italian Utility Acea Downgraded To ‘BBB+’ On Weakened Financial Risk Profile; Outlook Negative, March 16, 2012
-- 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
-- Methodology And Assumptions: Standard & Poor’s Standardizes Liquidity Descriptors For Global Corporate Issuers, July 2, 2010
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- Understanding Standard & Poor’s Rating Definitions, June 3, 2009
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Downgraded; CreditWatch Action
Corporate Credit Rating BBB-/Negative/A-3 BBB+/Negative/A-2
Senior Unsecured BBB- BBB