OREANDA-NEWS. Fitch Ratings has affirmed SPP - distribucia, a. s.'s (SPPD) Long-Term Issuer Default Rating (IDR) at 'A-' and senior unsecured rating at 'A'. The Outlook on the IDR is Stable.

The affirmation is supported by the strong expected credit metrics of SPPD, assuming steady gross debt and dividends that will continue to be maximised and by the regulated nature of its cash-generative business as a national distribution system operator (DSO) in Slovakia. Potential upward revaluation of the regulatory asset base (RAB) for the new (fourth) regulatory period (2017-2021) would be an upside, but we do not assume this in our forecast as it may be hindered by social considerations.

Fitch views the Slovak regulatory framework as less mature than in western European regimes, with less robust tariff-setting and some volume risk. The rating is constrained by the consolidated profile of SPP Infrastructure, a. s. (SPPI), which we view as commensurate with the low end of the 'A' rating category.

KEY RATING DRIVERS

Similar Regulatory Parameters Expected: Fitch takes a conservative view on the possible RAB revaluation from EUR1.8bn to EUR2.3bn, given the social considerations the government has always taken into account. The higher value would be closer to its net book value of EUR2.4bn and may result in significantly higher tariffs for the next regulatory period. Traditionally, a low RAB fixed for the regulatory period, at a level lower than the net book value of fixed assets has given little incentive for investment. By the end of August 2016, the Slovak Regulatory Office for Network Industries (RONI) is to set the parameters for the next five-year regulatory period. Following the consultation period with the company, the price determination will be finalised in December 2016. Should the RAB or other parameters be significantly improved, it would be credit-positive for SPPD's standalone profile, but its IDR would remain constrained by the consolidated profile of SPPI. We do not expect the new regulatory period to be significantly more challenging for the company.

Regulation Entails Volume Risk: Distribution tariffs aim to cover operating costs and also secure a fair profit margin for the DSO. However, there is notable volume risk in the household and SME segments, which represent 67% of total revenue. This is due to variable (volume-linked) tariff components of at least 40% depending on the particular tariff, and the lack of a subsequent correction mechanism. The weighted-average cost of capital (WACC) and volume assumptions are updated annually, somewhat limiting the volume risk. Revenues from large (industrial) customers do not vary significantly with volume changes.

Developed Asset Base: Other than little incentive from undervalued RAB, low capex also reflects the high infrastructure penetration in the country (over 94% of population has access to piped natural gas) and a relatively modern network (54% polyethylene). Eligible depreciation is commensurate with accounting depreciation and adjusted annually for assets put into operation. SPPD meets its legal quality standards and has never been required to pay state fines or customer compensation.

SPP Infrastructure Constrains Rating: The shareholder agreement put in place for SPPI, which also defines its dividend policy and maximum leverage for SPPI and each of its subsidiaries, in our view provides some ring-fencing from its ultimate shareholders (51%, Slovak Republic through Slovensky plynarensky priemysel, a. s. (SPP), and 49% with management control, Energeticky a prumyslovy holding, a. s. (EPH)). This can be changed without the consent of the creditors of SPPI and its subsidiaries, but there is an emerging record of shareholders' agreement. The key financial and strategic policies, including cash-pooling from each subsidiary, are set by the shareholder agreement for SPPI as a whole and we therefore view its consolidated profile as a credit factor for the subsidiaries and a limiting factor for SPPD's IDR.

Strong Business Profile: SPPD's unconstrained credit profile is supported by its strong business profile as the national DSO, the regulated nature of its operating cash flows and expected credit metrics (funds from operations (FFO) adjusted net leverage up to 3.0x). Fitch assumes steady gross debt, with dividends to continue to be maximised in the forecast period. Fitch views the Slovak regulatory framework as less mature than in western European regimes, with less robust tariff-setting and volume risk.

Concentrated Counterparty Risk: Shippers are responsible for billing and the collection of receivables in Slovakia, while SPPD requires either a bank guarantee or a deposit covering at least two months of distribution fees from each shipper to minimise its credit risk. SPP remains the dominant supplier in Slovakia and SPPD's key counterparty representing around 64% of its revenues for 2015. We view the company's receivable collection risk as low, despite the concentration.

KEY ASSUMPTIONS

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

- No material changes for the fourth regulatory price control staring in 2017, including a flat RAB with small increase due to additional capital expenditure and a flat allowed regulatory return. This does not reflect any particular expectations about the ongoing discussions with the Slovak regulator, RONI, the outcome of which should be published by the end of 2016. We will review our estimates in line with the regulatory outcome once published.

- Capital expenditure of EUR30 to EUR40m per annum, in line with SPPD's own expectations

- All profits paid as dividends to SPPI to the extent that the leverage ratio of either SPPD or SPPI does not exceed 2.5x net debt/EBITDA as stipulated in the shareholders' agreement.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

- SPPI's credit profile strengthening and/or weaker links with SPPI.

- SPPD's unconstrained credit profile could improve if FFO adjusted net leverage decreased to below 1.5x on a sustained basis assuming the current business risk profile. An improved regulatory framework could be positive for the company's business profile.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- A weaker credit profile of SPPI affecting SPPD.

- SPPD's unconstrained credit profile would worsen should FFO adjusted net leverage increase to above 3.0x on a sustained basis assuming the current business risk profile. Any deterioration in regulatory predictability would be negative for SPPD's business profile.

LIQUIDITY

Cash Pooling Net Contributor: All available cash is upstreamed into the cash pool as "receivables" which are later on netted off against dividends. In line with the shareholders' agreement, SPPD has the authority to determine the level of "all available cash". We treat deposits in the pool as dividends and thus focus on cash balances in its own accounts only (EUR30m-45m).

External Funding Increases Leverage: SPPD is closer to Fitch's negative guideline for its unconstrained profile after having received a EUR135m loan from the EIB (of which, EUR55m matures in 2020 and EUR80m in 2024) along with the EUR500m bond issuance in 2014 (maturity 2021) whose proceeds were upstreamed to the ultimate parents to cover dividend payments. However, SPPD's net debt/EBITDA should be kept below 2.5x as stipulated in the shareholders' agreement and the dividend adjusted accordingly. Consequently, in our forecast SPPD is unlikely to trigger the negative rating sensitivity.