OREANDA-NEWS. S&P Global Ratings today lowered its long-term issuer credit rating on Belgium's electricity transmission system operator (TSO) Elia System Operator S. A./N. V. (Elia) to 'BBB+' from 'A-'. At the same time, we affirmed the 'A-2' short-term issuer credit rating on Elia. The outlook is stable.

We also lowered our long-term rating on Elia's senior unsecured debt to 'BBB+' from 'A-'.

Our rating action primarily reflects the heavy investment program that Elia is facing over the coming years in both Belgium and Germany, which has already resulted in negative free cash flows and weaker credit metrics.

Our rating on Elia reflects our consolidated view on the Belgian and German businesses. For this reason, we fully reconsolidate 50 Hertz (not rated), one of Germany's four electricity TSOs, into Elia's reported numbers.

Our view of the group's excellent business risk profile reflects the predictability of cash flows generated by regulated operations in Belgium and Germany and our opinion of a solid regulatory framework in the two areas. Despite improvements in the remuneration of Belgian investments, driven by the regulator allowing higher revenues via incentives that remunerate efficiency gains, the difference in the profitability of operations in the two jurisdictions is significant, shown by return on equity (ROE) of 11% in Germany and 4% in Belgium at year-end 2015. Remuneration in Belgium is driven by the interest-rate environment, and the decline of rates has been uninterrupted in the past three years. In Germany, remuneration is benchmarked to capital expenditure (capex). We expect the remuneration of investments in Germany to decline in the power transmission regulatory period that will start in 2019. In its consultation with stakeholders, Bundesnetzagentur, the German regulator, announced a revision of ROE to 6.91% down from 9.05%. If confirmed, the review would weaken the group's profitability since the German operations are as important as the Belgian ones in the consolidated business mix. However, we expect the change to affect credit metrics only after 2018, which is beyond our outlook horizon.

Other weaknesses of the group's business risk profile include Elia's obligation to purchase green certificates at a minimum price from renewables generators in Belgium. The timeliness of recovery of this cost item by the electricity tariff remains at this stage untested.

While we maintain our view of the group's financial risk profile as significant, we observe a trend of decreasing credit metrics over 2016-2018. We expect our three-year average adjusted funds from operations (FFO) to debt to decline to the 9%-10% range down from approximately 14% for 2014-2015. The decline is driven by an acceleration of investments in the Belgian grid, coupled with still sizable investments programmed in Germany. We understand that, while some technical delays in the execution of investment are possible, the improvement of interconnections at Belgian borders (projects NEMO and Alegro), the upgrade of the coastal grid (Stevin), the connection of the offshore wind farms to the grid, and the completion of the South-West Interconnector in Germany cannot be delayed. Thus, Elia has little opportunity to smooth the financial impact of capex. For this reason, we apply a one-notch negative modifier to reflect our view of this diminished financial flexibility versus peers with similar financial risk profiles, which include Italian power TSO Terna and the U. K.'s National Grid PLC.

Our stable outlook reflects our view that the group should sustain adjusted FFO to debt above 9% on average over 2016-2018.

Rating upside is limited by our expectation of persistently high negative cash flows after capex and dividends. An upgrade would be contingent upon recovery of credit metrics, for example adjusted FFO to debt above 12%, which in our view is more in line with peers like Terna and National Grid.

We could lower the rating if we saw credit metrics falling significantly below 9% on a sustained basis. This could occur, we believe, in the case of adverse regulatory decisions, with investments exceeding our projections and not being adequately remunerated.