08.07.2016, 22:45

Fitch Affirms Iberdrola S. A. at 'BBB+'; Outlook Stable

OREANDA-NEWS. Fitch Affirms Iberdrola S. A. at 'BBB+'; Outlook Stable London Fitch Ratings has affirmed Iberdrola S. A.'s Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB+. The Outlook is Stable. A full list of rating actions is below.

The affirmation reflects our view that Iberdrola has made good progress enhancing the group's long-term sustainability and financial strength since 2013, taking into account forecasted growth for 2016-2020, largely funded with internal cash generation that will improve Iberdrola's business mix. However, we acknowledge that persistent tough market conditions in generation and supply, markedly in the UK, FX volatility (although mitigated by the company's hedging policy) and political uncertainty in main geographies will continue to represent a challenge for the company.

We consider the financial leverage and coverage metrics comfortably placed within the guidelines for a 'BBB+' rating, including significantly increased capex programme that does not fully translate into earnings within the rating horizon until 2020 and our expectation of higher dividend per share from 2019.

KEY RATING DRIVERS

Advantageous Diversification

Iberdrola's ratings reflect its solid business model, with a geographically diversified business mix across the vertically integrated electricity and gas supply chain. Iberdrola benefits from a footprint in highly-rated countries and limited minorities leakage within the structure.

In 2015, regulated networks accounted for 49% of EBITDA, while 28% was contributed by renewables and regulated generation. 27% of its 2015 EBITDA was generated in the US and Latam (largely in networks and renewables). The defensive business mix and geographical diversification allows the company to effectively mitigate downturns in a single country or business.

Increased Long-term Visibility

The 2016-2020 strategic plan has brought additional visibility on organic growth beyond 2016 - 92% of the capex plan is committed or under construction - and an increasing contribution from regulated or long-term contracted EBITDA to 84% (from 77%) by 2020 as per Fitch's expectations.

Announced net capex was EUR24bn (EUR27.3bn including capitalised costs), of which a large EUR22bn is either allocated (EUR9bn) or under construction (EUR13bn). By business line, 46% will be allocated to networks, 33% to renewables, 12% to generation and supply and 9% to regulated generation (in Mexico).

Stable Leverage

We estimate stable metrics for funds from operations (FFO) adjusted net leverage at 4.1x by 2020 (4.1x 2015 pro-forma excluding UIL's 16-day EBITDA contribution and debt) and FFO interest coverage at 5.0x by 2020, both supportive of a 'BBB+' rating. This stability is despite significant capex growth, including around EUR1bn of non-productive debt at the end of 2020 (linked to Tamega's hydro pumping project, to be commissioned by 2023) and increasing dividend per share from 2019 with pay-out at the high-end of Iberdrola's guidance (65%-75%). We also view positively the company's financial target of net debt to EBITDA at 3.6x by 2018.

Higher Political Risk

We consider the group's regulatory risk exposure across regions is fairly stable including moderate upsides in some geographies. However, this is in the context of increasing political uncertainty in the main countries of operation, namely Spain and UK, which could affect energy policies being debated, and higher scrutiny on utilities.

Approved long-term regulatory frameworks for electricity distribution in Spain and the UK support 72% of networks EBITDA in 2015. In addition, there is visibility on supportive schemes for renewables fleet in Spain until 2019 (although around 50% of the fleet is no longer receiving an investment remuneration component) and renewable obligation certificates (ROCs) or contracts for differences (CfDs) in the UK for the existing capacity and new projects coming on stream in 2016-2020. On the other hand, the extension of US tax credits (extended at the end of 2015) for solar and wind power projects would lead to longer-term stability for the solar and wind sectors in the US, where Iberdrola targets growth with a strong pipeline of projects.

In late June 2016, the UK Competition and Markets Authority (CMA) published the results of its two-year investigation into wholesale and retail energy markets. The CMA's findings did not put into question the market functioning and structure, therefore the remedial measures are relatively benign for suppliers. We expect a marginally negative impact on Scottish Power's retail supply margins in the long term.

Uncertainties Associated with Brexit

There is an increased level of political and economic uncertainty stemming from the Brexit vote. We estimate that the impact stemming from GBP depreciation versus the EUR is limited to a maximum 0.1x in terms of increase in FFO adjusted net leverage increase over the period to 2020 due to well-balanced cash-flows and debt denominated in GBP (Scottish Power swaps the EUR-denominated intercompany loans from Iberdrola to GBP). In addition, according to the company, the contribution to the group's net income for 2016 is 100% hedged.

Although high uncertainty is likely to persist in the next two years as political negotiation advances, Scottish Power's overall earnings mix benefits from the high proportion of regulated and quasi-regulated earnings, which provide relative visibility until end-2020. Current regulatory frameworks for the electricity transmission and distribution networks are set to run until March 2021 and March 2023, respectively. Cash flow coming from renewables is supported by the ROCs regime for the existing wind capacity and new on-shore capacity coming on stream in 2016 and 2017 and new off-shore capacity to be introduced in 2019-2020 is supported by CfDs.

The long-term impact on Scottish Power in particular will depend on a number of variables, including whether Scotland will remain part of the UK.

Manageable Exposure to Merchant Activities

Falling power prices in Europe will hit Iberdrola's generation business in the region, as hedges roll off and are renewed in a worsened scenario. In addition we expect high competitive pressure and regulatory scrutiny for supply margins in Spain and UK. However, we view Iberdrola's exposure to merchant activities as manageable as it represents only 26% of EBITDA in 2015 (falling to 18% by 2020), volatility is partially mitigated by the natural hedge of the production with Iberdrola's long position in supply (in Spain production for 2016-2017 is fully hedged at around EUR60/MWh and 75% at EUR58/MWh respectively) and technologically diversified and low-carbon portfolio generation mix.

Successful Integration of UIL

In December 2015 the integration of Iberdrola USA and UIL Holdings Corporation was completed. According to management, the integration is ahead of schedule and better than expected results in 1Q16 led to an increase in Avangrid's earnings per share guidance. For newly integrated opcos, we view positively relatively short rate freezes ('stay outs') and the cost recovery mechanisms. We take into account around EUR90m of dividends paid to 18.5% Avangrid's minority shareholders annually.

Structural Subordination

The merger with UIL has increased the debt allocated at the opcos level in US (+EUR2.4bn) although the impact is within the limits allowed by our methodology. However, future financial needs to fund growth in the US could increase prior ranking debt to consolidated EBITDA ratio if it is done with external debt raised at the US subsidiaries level, especially if considered in conjunction with a focus on growth outside Europe.

Scottish Power Aligned

SPL and SPUK's IDRs remain aligned with those of Iberdrola based on Fitch's Parent and Subsidiary Rating Linkage methodology as Fitch assesses the operational, strategic and legal links between the two companies to be strong. SPL and SPUK continue to exhibit stronger credit profile than their parent.

On a standalone basis, SPUK and SPL's credit profiles are stronger than Iberdrola's as they benefit from moderate leverage and strong business mix. In 2015, around 58% of consolidated EBITDA came from the regulated electricity distribution and transmission networks and another 22% from the quasi-regulated renewables business. A more volatile competitive supply and generation business contributed the remaining 19%.

Although cash flows generated by the regulated networks are generally stable and predictable, transition to the new, tougher RIIO-ED1 price control from April 2015 will cause downward shift in the distribution networks' EBITDA. This is due to lower allowed weighted average cost of capital and stronger focus on operational performance. According to our estimates, distribution networks' EBITDA went down by around 3% in 2015. One-off legacy adjustments will contribute to a further decline in 2016. On average, we expect networks' EBITDA to grow at around 1.5% per year until 2020 driven by inflation and relatively high transmission capex.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Electricity price average around 46 EUR/MWh in Spain and 40 GBP/MWh in the UK for 2016-2020; reduced supply margin in Spain and the UK for 2016-2020

- Average clean spark spread of 3 GBP/MWh, carbon floor at 18 GBP/MWh and ROCs buy-out price at 45 GBP/MWh in the UK for 2016-2020.

- Around 50% of the cost efficiencies considered by the management.

- Consolidated EBITDA increasing at a CAGR around 4.5% across 2016-2020 with US, Mexico and Renewables contributing well above the average.

- Cumulative capex of EUR27.2bn in 2016-20, including capitalised costs and intangible capex as per Fitch's definition.

- An additional 100 bps added to the average current effective interest rate for new debt issued in the period.

- EUR/GBP at 0.92 stable from 2016

- Gradually increasing dividend to EUR0.31 per share by 2020. A scrip issue is assumed in line with its historical level. However, this will be offset by large treasury stock re-purchase in order to avoid dilution and maintain a stable number of shares.

RATING SENSITIVITIES

IBERDROLA

Positive: Future developments that could lead to positive rating action include:

- Over-performance of our expectations with capital structure targets supporting FFO adjusted net leverage substantially below 3.7x (revised from 3.5x reflecting the increasing share of more predictable earnings) and FFO interest coverage above 5.0x on a sustained basis.

Negative: Future developments that could lead to negative rating action include:

- Underperformance of our expectations with an increase of FFO adjusted net leverage up to and above 4.5x and FFO interest coverage below 4.0x on a sustained basis.

- Deterioration of the operating environment, i. e due to protracted political uncertainty in Spain or the UK, or adverse regulatory changes in the key areas of operation substantially reducing cash flows.

SCOTTISH POWER

Should SPL and SPUK exhibit standalone credit profiles materially weaker than the group we could reconsider our rating approach under the parent and subsidiary methodology.

LIQUIDITY

As of 31 December 2015, Iberdrola had cash and cash equivalents of EUR1.2bn plus available committed credit facilities of EUR7.2bn maturing in 2017 and onwards. This compares with debt maturities of EUR6.9bn and negative free cash flow of EUR4.1bn (including treasury stock re-purchase for EUR2.1bn) for the next 24 months. Since the beginning of the year the company has issued EUR1.3bn of new bonds. At the end of 2015, the liquidity position was equivalent to over 18 months of the company's financing needs.

FULL LIST OF RATING ACTIONS

Iberdrola, S. A.

Long-Term IDR affirmed at 'BBB+', Stable Outlook

Short-Term IDR affirmed at 'F2'