Fitch Affirms Acea S. p.A. at 'BBB+'; Outlook Stable
The affirmation reflects Acea's strategic focus on regulated businesses, the increased visibility of water and electricity distribution stemming from regulatory updates and the balanced financial structure. The affirmation further reflects Acea's favourable metrics in 2014-15 with annual positive free cash flow (FCF) of around EUR150m and an improvement in the receivables dynamic.
Our updated forecasts show average funds from operations (FFO) adjusted net leverage around 4.3x and FFO interest coverage of 6.2x for 2016-20, adequately positioned for the rating. Our projections do not factor in external growth, so potential acquisitions could impact the ratings, depending on the size and activity of the target and funding structure.
KEY RATING DRIVERS
Largely Regulated Multi-utility
Acea is one of the largest Italian multi-utilities, focused on central Italy. The regulated activities (mainly integrated water services and electricity distribution) contributed 77% of its reported EBITDA in 2015, with the balance coming from environment (8%) and energy (15%), which includes both generation (mainly hydro) and supply. The solid business mix and diversification allowed the group to achieve robust results in 2014-15.
Parent and Subsidiary Linkage
Acea is 51%-owned by the City of Rome (BBB/Stable). We view legal, operational and strategic ties between the parent and its subsidiary as overall limited to moderate. Rome appoints five board members of nine. However, Acea's net credit exposure to the city was broadly neutral at year end 2015 (after declining for several years) and the reference shareholder kept a balanced approach to dividend policy, confirmed in the updated business plan of March 2016. Based on these factors, we would allow a two-notch rating differential between the parent and Acea, to the extent that the standalone profile of the company would be unaffected by a downgrade of the city.
The recently elected new major of Rome, Virginia Raggi, has stated that she may consider changes in the company's top management. This would not itself trigger a rating action, but it could reduce visibility on Acea's strategic long-term targets. We would review the rating should the company change the strategic pillars that our rating is based on.
Business Plan Guidance
The updated business plan 2016-2020 presented in March 2016 confirmed the strategic priorities indicated by the company in 2015. In particular, Acea will remain focused on regulated businesses, which will attract 80% of the forecast EUR2.4bn capex in the period.
The target for cumulative efficiencies across the plan has been increased to EUR94m (EUR70m in the previous 2015-19 plan), following completion of the first initiatives related to the digital transformation of the group (project Acea 2.0). Management expects that the updated IT systems will also benefit the collection of receivables.
Acea forecasts EBITDA growth at a 4% CAGR in 2015-20 (EUR158m across the period), with water (EUR69m) and environment (EUR34m) the main contributors, driven by investments in both divisions and the regulatory update for water. The company's business plan includes cumulative negative FCF of almost EUR250m in 2016-20, due to increased capex and a gradual increase in dividends. However, the evolution of EBITDA will likely lead to a reported net debt-to-EBITDA decrease to 2.5x in 2020 from 2.7x in 2015.
Increased Visibility in Water Regulation
Acea's regulated water activities contribute more than 40% of the group reported EBITDA. The framework approved by the regulator (AEEGSI, Autorita per l'Energia Elettrica, il Gas ed il Servizio Idrico) for 2016-2019 follows the same principles applied in 2014-2015, fine tuning the previous methodology. It defines that tariffs should cover both opex and capex (through allowed depreciation and return on capital), with volume risk removed through balance payments.
The allowed (real, pre-tax) return on RAB has been reduced by around 70bp in the second regulatory period (from 6.06%), but the new calculation methodology gives more stability to the return, delinking it from the Italian 10-year government bond yield. Fitch considers the current regulatory framework as reasonably supportive and that it contributes to build a credible track record for the industry. However, we note there is constant political focus on water activities in Italy, bringing more uncertainty than for other regulated businesses (for more details see "Italian Waster Sector: Emerging Track Record" dated 29 February 2016 on www. fitchratings. com).
Regulatory Update for Electricity Distribution
The completion of the regulatory update in Italy for electricity distribution (starting in 2016) has increased visibility on around 35% of the group's EBITDA, confirming the main pillars of the framework. We believe that the reduction in allowed return on capital (from 6.4% to 5.6%) is consistent with the evolution of the interest rate environment and view positively the updated formula for its definition, as it increases the stability of the allowed remuneration.
The time lag for recognition of capex in the regulatory asset base has been reduced to one year, with the elimination of 1% extra remuneration for time lag. The efficiency factor on allowed operating costs is equal to 1.9% (2.8% in the previous period). The regulator has announced that it will move towards a totex approach from 2020, implying increased scrutiny of the sector's capital spending, but also some upside potential for the large players.
Unregulated Businesses
The energy business EBITDA is represented by electricity (and to a lesser extent gas) sales for around 70%, with the remainder coming from energy production and mainly related to hydro plants. Of the electricity sold in 2015 (9.4TWh), around 70% was related to the free market. In the environment business, the waste-to-energy currently represents a large part of EBITDA, but its weight is expected to decline in 2020 when some incentives will expire. In the business plan, the development of this division will mainly derive from investments in treatment plants, which are needed in the company's area of operation.
Positive Current Trading
In 2015 Acea's reported EBITDA (which includes net income of equity-consolidated water companies) increased to EUR732m (up 2% on 2014), mainly driven by tariff increases and cost savings in regulated water services. Positive FCF of EUR152m, broadly aligned with 2014, benefited from working capital cash generation of EUR162m (adjusted to consider factoring evolution). In 1H16 the group achieved healthy growth of EBITDA (+7.7% yoy), driven by water and energy activities and the progressive implementation of the efficiency measures.
Moderate Headroom
In 2015 FFO net adjusted leverage was 4.1x, aligned with 2014 and strong for the rating. Fitch factored into the rating case some conservative assumptions mainly related to the evolution of the unregulated businesses (energy, environment) and the pace of opex savings. As a result, we estimate that FFO net adjusted leverage would average 4.3x for 2016-20.
The rating case does not include external growth initiatives for Acea, due to the lack of visibility on potential transactions and on their funding (mergers vs. debt-funded acquisitions). Management has stated that external growth would make sense from industrial perspective and has identified some potential opportunities, but the approach of the new mayor of Rome in this respect is not yet clear. In case of acquisitions, the City of Rome's willingness to dilute its stake in Acea to limit the impact on the company's financial structure would be credit positive.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Acea include:
- EBITDA of the grids division stable at around EUR250m-260m, with the water division's EBITDA gradually rising to EUR330m-EUR340m (excluding net income from associates)
- Energy division's EBITDA slightly above EUR100m for the whole period, while we forecast mid-single digit annual growth of the environment division in 2015-20
- Corporate tax reduction by 3.5pp from 2017, as foreseen by the 2016 Stability Law
- Capital expenditure of EUR2.4bn across the business plan
- Dividends payout at the upper end of the 50%-60% range
- No major acquisitions
RATING SENSITIVITIES
Positive: Future developments that may lead to positive rating action include:
- FFO net adjusted leverage below 4.3x on a sustained basis
- Shift in the activities' mix towards regulated and proven track record of political support for the water regulation framework
- Projected positive FCF and continuous support by City of Rome for the current strategy
Negative: Future developments that could lead to negative rating action include:
- An increase of FFO net adjusted leverage above 5.0x and FFO interest coverage below 3.5x over a sustained period, for example as a result of debt-funded acquisitions
- Adverse regulatory changes or a shift in the activities' mix towards unregulated, affecting the predictability of cash flows
- A downgrade of the City of Rome leading to a deterioration in the company's credit profile
LIQUIDITY
Acea's liquidity profile is solid. At end-June 2016 the group had readily available cash of EUR583m. This compares comfortably with debt maturities of EUR23m for July-December 2016 and EUR44m for 2017, while FCF is expected to be negative for EUR185m until end of 2017. The first sizeable maturity is the EUR600m bond maturing in September 2018, for which we expect the company to close the refinancing well in advance. The gross debt has an average maturity of 6.4 years, with around 72% fixed rate.
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