OREANDA-NEWS. March 23, 2015. Fitch Ratings has affirmed Spanish utility group Redexis Gas S.A's (RG) Long term Issuer Default Rating (IDR) at 'BBB-' with a Stable Outlook and senior unsecured rating at 'BBB'. Fitch has also affirmed Redexis Gas Finance BV's senior unsecured rating at 'BBB'.

The ratings reflect the neutral impact of new gas distribution and transmission regulation. Although RG has ambitious plans for organic growth, shareholders have shown dividend flexibility with the aim of preserving credit metrics and Fitch expects this to continue. The Stable Outlook reflects improving interest cover and leverage supported by the 2014 tax changes in Spain.

KEY RATING DRIVERS
Regulatory Review Impact Neutral
Reform Law RDL8/2014 addressed the issue of Spain's gas tariff deficit (TD), improving sustainability of the gas system. It also encouraged grid extension to areas without gas. The impact on earnings for RG in 2014 was less than EUR1m, with a small positive impact in distribution offset by a similarly small negative impact in transmission. The impact is limited compared with peers Gas Natural SDG, S.A. (BBB+/Stable) and Madrilena Red de Gas, S.A.U. (BBB-/Stable), mainly because RG has a younger asset base than most and remuneration for assets built after 2002 has been raised.

New regulation raises sensitivity to volume risk and removes revenue indexation to inflation.
However, the impact of a 10% drop in gas volumes is limited to 4% of EBITDA in 2014, already a very mild year. Although a potential longer-term weakness, the lack of revenue indexation is not a current issue. Fitch's rating case does not include potential changes to regulation of regional transmission.

Acquisition of EDP Gas Networks
RG acquired gas distribution & transmission assets from EDP - Energias de Portugal, S.A. (BBB-/Stable) in December 2014. The transaction mainly extends RG's presence to south-east Spain, raises supply points above 500,000 and, additionally benefiting from new regulation, increases exposure to high volume industrial customers threefold. RG funded the acquisition, which adds around EUR20m to EBITDA, out of equity and cash for EUR136m and draw down from the existing capex facility for EUR101m, leaving FFO adjusted net leverage within rating guidelines. FFO interest cover is stronger due to lower cash interest costs and tax.

Dividend Flexibility Protects Credit Metrics
RG has plans for ambitious organic growth in distribution and transmission, requiring total capex of around EUR350m through 2018, and has not ruled out further acquisitions. While this would imply capital growth in equity, shareholders have shown restraint in protecting credit metrics and Fitch expects this policy to continue. More than 50% of the cost of the EDP gas acquisition was funded out of equity and cash, improving interest cover, while the proposed dividend for 2014 of EUR18.5m is within average guidelines.

Spanish Tax Changes Positive
The November 2014 tax reform package lowered cash tax, mainly because the limit on tax amortisation of goodwill was raised from a temporary rate of 1% to a permanent rate of 5% from 2016. The corporate tax rate was also lowered from 30% in 2014 to 28% for 2015 and 25% from 2016 onwards. A corporate reorganisation, merging operating subsidiaries, S.L into Redexis Gas S.A, with effect from February 2015, resulted in additional goodwill, effectively lowering cash tax by around EUR5m from 2016.

KEY ASSUMPTIONS
- Growth in distribution supply points of 3% pa and residential demand growth of 2% pa.
- Haircut of 50% to management assumptions of industrial demand growth from 2016.
- In transmission, we assume an efficiency factor of 0.97 through 2020, average growth in Spanish gas demand of 2% pa and lower capex from 2017, reflecting low project visibility.

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating action include:
-Stronger cash flow generation due to lower cash dividends leading to FFO net leverage below 5.5x on a sustained basis.

Negative: Future developments that could lead to negative rating action include:
-Further acquisitions, especially debt-funded, as part of an ambitious growth strategy.
-Weaker cash flow generation due to further regulatory change leading to FFO net leverage above 6.5x on a sustained basis.

LIQUIDITY AND DEBT STRUCTURE
As of December 2014, RG had cash and cash equivalents of EUR79.4 m plus an available revolving credit facility of EUR50m. Although we expect negative free cash flow of -EUR28m for 2015, Fitch believes liquidity is sufficient to meet operational and financial needs until the maturity of current facilities in 2019.