OREANDA-NEWS. Fitch Ratings has revised the Outlook on Gas Natural SDG, S. A.'s Long-Term Issuer Default Rating (IDR) to Negative from Stable and affirmed the IDR at 'BBB+'. A full list of rating actions is at the end of this rating action commentary.

The Negative Outlook reflects our expectations that Gas Natural's financial leverage will be above our negative rating guideline in 2016 and 2017, reflecting weaker than previously expected free cash flow (FCF) in these two years.

The affirmation reflects the company's integrated strong business profile in both gas and electricity with a substantial portion of regulated EBITDA (about 60% of 2015 EBITDA) providing cash flow visibility. We expect that the business mix could gradually improve by 2020 given the capex plan focused on networks and contracted (or subsidised) electricity generation.

KEY RATING DRIVERS

Leverage Above Guideline

The Negative Outlook reflects our expectations that Gas Natural's funds from operations (FFO) adjusted net leverage will be above our negative rating guideline of 4x in 2016 and 2017. This largely stems from weaker than previously expected FCF in these two years, as we project FFO will be negatively affected by adverse foreign exchange changes for the Latam's exposure and weaker margins in the gas supply segment (12% of 2015's EBITDA) and power generation in Spain (14%). At the same time capex and dividends are higher than in our previous forecasts.

We previously expected that Gas Natural would reduce its financial leverage to below 4x in 2016-2017 following the acquisition of Chile's largest utility company Compania General de Electricidad SA (CGE; AA-(cl)/Stable) completed in late 2014, which temporarily increased leverage.

Improvement Expected from 2018

The Outlook could be revised to Stable if Gas Natural's net leverage ratio returns to below 4x and projected FCF returns to a positive territory on a sustained basis. We project the company could achieve net leverage below 4x in 2018 based on its business plan for 2016-2020, announced in May 2016, and positive FCF could be achieved by 2020. For 2018, the company expects its main financial target, defined as net debt to EBITDA, at 3.0x (net debt excluding hybrid bonds, finance leases and factoring), the same as 2015, which would be consistent with our 4x FFO adjusted net leverage guidance.

Balanced Business Profile

The ratings are supported by Gas Natural's integrated strong business profile in gas and electricity and solid geographical diversification. A significant portion of the company's earnings (about 60% of 2015 EBITDA) are regulated and mainly derived from its gas and electricity distribution activities in Spain and Latam, providing cash flow visibility.

Capex Ramp Up

The business plan for 2016-2020 assumes net capex of EUR14bn (or EUR2.7bn on average per year), including EUR1.3bn investment in new tankers, well above the previous plan of EUR1.5bn, which is largely due to the inclusion of CGE on the new perimeter. The main drivers of growth are new generation capacity additions (renewables in Spain and CCGT's and wind largely in Latam under PPA's), investment in networks (mainly gas networks in Chile, Mexico and Peru) and returns from the operation of the new vessels. There is visibility on around 70%-80% of the capex targets, although there is a degree of uncertainty from the regulatory framework for renewables in Spain after 2019 and gas networks in Chile (under review).

According to management, 80% of the plan will be allocated to regulated or contracted assets. This will be positive for the business risk as it will increase the share of regulated and quasi regulated EBITDA to 75% in 2020 from 69% in 2015 and the geographical diversification.

Gas Supply and Spanish Generation Under Pressure

The gas supply business including LNG supplies is challenged by decreased margins, partly due to lower gas prices and reduced gas price differential between Europe and Asia. In addition to the commodities challenge, there is an element of changing market dynamics due to current gas market oversupply (mainly due to US shale gas but also due to weaker global demand) that is putting additional pressure on the margins. Lower margins are partially offset by new gas volumes and increased fleet flexibility after 2018.

In addition, we expect profitability of power generation in Spain to be under pressure in 2016-2017 given expected low baseload prices and potentially higher competitive pressure and regulatory scrutiny on the supply margins and ancillary services market in Spain.

KEY ASSUMPTIONS

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

- EBITDA of around EUR4.9bn in 2016 with a CAGR of around 2% for 2016-2020 from 2015. This is considering significant growth in Latam regulated and quasi regulated activities, fairly stable performance of current regulated business in Europe; weak baseload electricity prices and lower margins in LNG supplies to be mitigated by higher volumes (new procurements contracts and higher fleet activity).

- Depreciation for all the Latam currencies against EUR and flat EUR/USD

- A halved efficiency programme by 2018 compared with management expectations and no further efficiencies.

- Dividends paid to minorities around EUR200m per year.

- New debt issued with an additional 100bps over the average cost of debt at end 2015.

- Capex of EUR2.5bn on average for 2016-2020.

- A total net EUR200m cash outflow as a result of the company's asset rotation plan.

- Dividends as per the company's current strategic plan based on a 70% pay-out ratio and EUR1 per share floor announced by the company in March 2016. We assume this policy to remain in place until 2020.

RATING SENSITIVITIES

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

- FFO adjusted net leverage above 4.0x and FFO interest coverage below 4.5x on sustained basis and failure to generate positive FCF within this business plan.

- Substantial deterioration of the operating environment or further government measures substantially reducing cash flows.

- Substantial decrease in the share of regulated and quasi-regulated EBITDA leading to lower cash flow visibility.

Positive: The Outlook is Negative and we therefore do not expect an upgrade. Future developments that may nevertheless lead to positive rating action (revision of Outlook to Stable) include:

- Expected FFO adjusted net leverage returning to below 4.0x and the projected FCF returning to positive territory.

LIQUIDITY

As of 30 June 2016, Gas Natural had cash of EUR2.8bn plus available committed credit facilities of EUR7.1bn, with EUR6.8bn of those maturing beyond 2017, plus EUR0.7bn of other undrawn and committed loans and neutral cumulated FCF projected by Fitch up to end-2017. This is sufficient to meet debt maturities of EUR6.5bn over the next 24 months. Since January, EUR900m has been raised in the capital markets at very competitive interest rates.

FULL LIST OF RATING ACTIONS

Gas Natural SDG, S. A.

Long-Term IDR affirmed at 'BBB+', Outlook revised to Negative from Stable

Short-Term IDR affirmed at 'F2'

Gas Natural Fenosa Finance BV

Senior unsecured rating affirmed at 'BBB+'

Euro commercial paper programme rating affirmed at 'F2'

Subordinated hybrid capital securities' rating affirmed at 'BBB-'

Gas Natural Capital Markets, S. A.

Senior unsecured rating affirmed at 'BBB+'

Union Fenosa Preferentes, S. A.

Subordinated debt rating affirmed at 'BB'