OREANDA-NEWS. S&P Global Ratings said today that it had raised its corporate credit rating and issue ratings on Alinta Energy Finance Pty Ltd. (Alinta Energy) to 'BB' from 'BB-'. The recovery rating on the senior secured debt issues remains at '3'. The outlook on the long-term rating is stable.

Alinta Energy owns and operates power plants, transmission lines, natural gas pipelines, and energy retailing in the western as well as eastern parts of Australia.

"The upgrade reflects our view that Alinta Energy's business risk profile has improved following the exit and separation of the old, coal-fired Flinders Power station and Leigh Creek coal mines (collectively Flinders) from Alinta Energy's asset portfolio as at June 30, 2016," said S&P Global Ratings credit analyst Meet Vora.

Despite providing some electricity market hedges, Flinders has weighed on Alinta Energy's cash flows over the past few years. As such, the exit will significantly reduce the company's operational and investment demands.

Alinta Energy now has no direct or indirect liabilities toward the decommissioning of Flinders. The company has agreed all associated costs related to the decommissioning with the South Australian government and funded them prior to separating Flinders.

Barriers to entry remain high for its dominant Alinta West business, which contributes 55%-60% of group EBITDA. Near-monopoly gas retailing business in Western Australia (market share of about 90%) and long-term contracted generation assets provide a reasonably strong market position. Even so, the retail segment can face some volume and limited price risk. Even if we assume subdued gas volumes, EBITDA should at least see a modest growth due to inflation-linked tariff increases allowed by the regulator.

Competition is likely to be modest. We also believe that Alinta Energy's long-term gas purchase profile, improved flexibility in its gas portfolio, and the stable operation of its power plants should enable it to sustain its market position in Western Australia. We do not expect competition in the mass-market gas retailing in Western Australia over the next three to five years, unless the introduction of market-based pricing for retail electricity accelerates.

Supporting Alinta Energy's merchant businesses are its medium-to-long term contracts, the majority of which are 'take or pay'. Over the past couple of years, Alinta has renewed contracts on its various assets, albeit with some pressure on pricing. The contracts' exposure to a few large iron ore mines in Western Australia is a risk. However, these miners are large and significantly low-cost commodity producers. Counterparty risk, contract renewal risk, and possible pricing pressure will constrain Alinta Energy's business risk profile. Mitigating this is the fact that over 40% of the EBITDA from merchant assets comes from investment-grade counterparties.

Alinta Energy's East Coast retail business forms less than 10% of EBITDA; however, it could entail high risk if Alinta Energy doesn't sufficiently hedge the business. Alinta Energy represents that it will maintain its prudent risk management as it pursues growth in east coast retailing and solar energy. As such, we expect Alinta Energy to maintain rolling hedges with minimal exposure to spot prices. Likewise, we expect the company's growth into solar to be slow and subject to adequate returns.

Mr. Vora added: "The outlook on the long-term rating is stable, reflecting Alinta Energy's relatively stable earnings and cash flows from its dominant Alinta West business and reasonable length of contract on its other major assets."

Furthermore, we expect Alinta Energy to maintain its cautious and relatively conservative approach to risk management and expansion. We also expect the company's debt-to-EBITDA ratio to remain below 4.0x over the next couple of years.

We could lower the ratings if deterioration in financial metrics were to occur, such that its debt to EBITDA were to track above 5x. This could occur primarily from aggressive shareholder distributions or debt-funded expansion. Significant pressure on operating margins due to intense competition, a higher-risk business strategy, and rapidly weakening counterparties could also affect the rating.

Upward rating momentum is highly unlikely while the company remains under private-equity ownership and we continue to expect that the shareholders will seek to maximize returns.