OREANDA-NEWS. June 16, 2015. Fitch Ratings says that its view on Endesa S.A.'s (BBB+/Stable) strong creditworthiness and its alignment with parent Enel S.p.A.'s ratings (BBB+/Stable) remains unchanged after deeper disclosure of Endesa's industrial plan for 2015-2019. We view Endesa's strategy as soundly integrated within the broader Enel group's business plan and we expect the existing strong legal and operational links between the companies to persist.

The company's update shows a coherent approach to growth for 2015 and 2016, given still weak short-to medium-term market fundamentals in Spain, with positive net free cash flow (FCF) of around EUR0.8bn up to 2017, including revised dividends policy. Beyond 2017, unless value-adding business opportunities are available, extraordinary dividends may be distributed, according to management.

Endesa's strategy for the next five years prioritises extracting full earnings potential from its portfolio of existing assets over asset expansion, which Enel in turn is pursuing in Latam. In Fitch's view, this is coherent with the Spanish operating environment over the short- to medium-term, which is characterised by overcapacity in electricity generation and a perceived lack of attractive incentives for further investments in electricity distribution.

Low planned capex to be added to the regulatory asset base (RAB) over the five-year period will not offset natural regulatory depreciation of existing assets, leading to a decreasing RAB base for distribution and non-mainland generation. The company will seek to compensate lower revenues on the asset base with higher regulatory incentives and cost efficiencies. Maintenance capex for regulated activities is around 38% of total EUR4.4bn. In mainland generation, no capacity additions are planned, with 1.3GW plant closures expected over the period. Maintenance capex for liberalised generation accounts for 23%.

In a low-growth scenario, Endesa's existing asset base should generate higher returns through targeted - and EU-required - operational investments (ie smart meters deployment, environmental investments in imported coal plants and selective plant repowering), technology-driven cost efficiencies and potential additional regulation-driven revenues (ie to outperform standard unitary costs and to maximise allowed incentives).

Organic revenue growth, albeit limited, would eventually come from a higher supply market share and additional value-added services (VAS) contribution. Endesa plans to expand its supply market share in Iberia significantly up to 2019, particularly in gas supply in Spain and in both electricity and gas supply in Portugal. In addition, the company is targeting an aggressive 60% gross margin growth for VAS up to 2017, although this activity represented a low 1.2% of total gross margin in 2014. Capex allocated to supply is EUR0.4bn for 2015-2019 (10% of total capex).

In Portugal, market share targets are quite ambitious given the dominant position of EDP - Energias de Portugal, S.A. (BBB/Stable) while for gas supply in Spain Gas Natural SDG, S.A. (BBB+/Stable) also benefits from its incumbent position in most of Endesa's areas of operation. Increased competition could put pressure on current supply margins, in our view.

A target of nominal 13% cash costs (opex and maintenance capex) reduction up to 2019 is higher than the targeted 8% cut for the overall Enel group. Even at a more appropriate 4% reduction if the 2014 base cost is adjusted for a EUR0.25bn one-off extra cost, Fitch views the planned cost reduction as ambitious. This is because cost reductions made in in the past few years could have limited the scope for further cost efficiencies.

Finally, a new provision for 2015 and 2016 dividends has been included. Dividends will be defined as the maximum amount per share between a 100% pay-out and a minimum 5% dividend per share annual growth.

Management expects to achieve stable EBITDA of EUR3bn-EUR3.1bn each year and positive net FCF generation of around EUR0.8bn for 2015-2017 when a 100% pay-out is considered for the period. Fitch's own assumptions include a reduced integrated margin for liberalised market activity and lower cost efficiencies across the company, leading to an average funds from operations (FFO) adjusted net leverage of 2.2x and FFO interest coverage of 9.9x. We further assume in the credit metrics the benefits of the current low interest rate environment (but also our standard assumption of higher cost of new debt) and of a proactive approach towards debt management.