OREANDA-NEWS. July 06, 2015. Fitch Ratings has affirmed Czech Republic-based CEZ a.s.'s Long-term Issuer Default Rating (IDR) at 'A-', with Stable Outlook, and its Short-term IDR at 'F2'. Fitch has also affirmed CEZ's foreign currency senior unsecured rating at 'A-'.

The rating affirmation reflects our projections of CEZ's credit metrics remaining within the guideline for the ratings in 2015-2016 as the company maintains its prudent financial policy amid a challenging operating environment.

Our projections are based on the assumption that declining funds from operations (FFO) in 2015-2016, primarily due to lower wholesale electricity prices, will be matched with reduced capex, resulting in leverage remaining within the company's guidance (net debt/EBITDA below 2.3x).

We expect that FFO adjusted net leverage will remain below our negative guideline of 3x despite a higher dividend payout ratio from 2015, in line with its more generous dividend policy from May 2015.

KEY RATING DRIVERS

Leverage Mitigates Weaker Business Profile
The company's financial leverage is low compared with its western European peers, with a FFO adjusted net leverage of 2.5x at end-December 2014. However, CEZ has also a higher exposure to the more volatile conventional power generation business (53% of 2014 EBITDA) compared with its European peers. This business is under pressure from declining margins and a rising share of renewables supported by subsidies.

At the same time, the company has a fairly low share of more predictable, regulated income from distribution (27% of EBITDA in 2014) and quasi-regulated from renewables compared with many of its European peers.

Lower FFO and Capex
We expect CEZ's FFO to decline by 4% in 2015 mainly due to declining selling prices of electricity as forward hedges roll off and the average selling price of electricity moves closer to low wholesale electricity prices.

The impact of lower prices on EBITDA and FFO is mitigated by an expected increase in electricity production in 2015 due to the commissioning of new units and modernisation capex spent in the past few years. CEZ's cost-cutting programme also mitigates the impact of lower electricity prices.

Decreasing FFO is matched with lower capex - by almost 20% for 2015-2016 versus 2013-2014 - supporting free cash flow (FCF). Fitch expects FCF to be slightly negative to neutral in 2015-2016, following highly negative FCF in 2010-2012 due to heavy capex.

More Generous Dividend Policy
In May 2015 CEZ changed its dividend policy by increasing the dividend payout ratio to 60%-80% of consolidated net profit adjusted for extraordinary items from the previous 40%-60% range. The more generous dividend policy means that CEZ will pay stable dividends of CZK21.5bn in 2015 (73% of net profit) compared with CZK21.3bn in 2014 (56% of net profit) despite consolidated net profit adjusted for extraordinary items for 2014 being lower by 23% year-on-year. According to our projections, FFO adjusted net leverage will remain below the negative guideline of 3x despite the higher dividend payout ratio from 2015.

No Binding Bid for SE
We believe that CEZ has limited rating headroom for large debt-funded acquisitions. CEZ decided in May 2015 not to make a binding bid for a 66% stake in Slovenske elektrarne, a.s. (SE), Slovakian dominant electricity generation company, from Enel S.p.A. (BBB+/Stable).

The company said that negotiations between Enel and the Slovak government, which owns a 34% stake in SE, had prompted the government's interest in increasing its stake in SE and led the government to call on Enel to prioritise the completion of the construction of Units 3 and 4 at the Mochovce nuclear power plant in Slovakia. CEZ also said that it remains ready to discuss ways on how to support the development of the Slovak energy sector with both the Slovak government and Enel.

If the SE acquisition materialises and is fully debt-funded, it would likely increase CEZ's leverage above our rating guidance for the 'A-' rating, and also above the company's leverage guidance (net debt-to-EBITDA of up to 2.3x). Such an acquisition would also lead Fitch to tighten its leverage guidance for the rating, underlining SE's weaker business profile and additional risks stemming from the unfinished nuclear project in Mochovce, despite synergies between the two companies.

Capex for New Nuclear Plants
The Czech government has recently updated its long-term energy strategy. It wants to build new nuclear units in CEZ's two existing Dukovany and Temelin nuclear plants to replace the units that will be decommissioned. The first construction project in Dukovany (1.2GW-1.7GW) should be started around 2025 and new nuclear capacity should be commissioned around 2032, thus falling outside of our five-year rating horizon.

Rated on Standalone Basis
CEZ is 69.8%-owned by the Czech state (A+/Stable), but Fitch rates it on a standalone basis with no consideration for potential state support. This is because the company operates on a wholly commercial basis and we assess legal, operational and strategic links with the state as moderate in line with our Parent and Subsidiary Linkage criteria.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
-FFO declines by 4% in 2015 due to lower achieved electricity prices and despite rising electricity production
-A dividend payout ratio of 80%, at the upper end of the company's guidance
-Capex for 2015-2018 in line with the company's public guidance
-No large debt-funded acquisitions

RATING SENSITIVITIES

Positive: Rating upside is limited due to the company's leverage and business profile. Future developments that could nonetheless lead to positive rating action include:
- Stronger business risk profile, for instance, due to markedly increased share or regulated and quasi-regulated businesses in EBITDA
- Projected FFO adjusted net leverage below 2x on a sustained basis, supported by management's more conservative leverage target

Negative: Future developments that could lead to negative rating action include:
- FFO adjusted net leverage above 3x and FFO fixed charge cover below 5x, both on a sustained basis
- Unfavourable regulatory changes or substantially increased sector risk in CEZ's main markets
- Substantially less predictable cash flows due to large acquisitions in higher-risk countries
- Substantial capex in new nuclear power plants in the environment of low electricity and CO2 prices if it is not mitigated by a cash flow support mechanism, for instance, contracts for price difference, or state guarantees for funding

LIQUIDITY

CEZ's liquidity was sufficient at 31 December 2014. At this date, short term debt of CZK23.2bn was covered by CZK36.2bn of cash and cash equivalents (including CZK16.2bn of financial assets considered by Fitch as highly liquid) and unused committed medium-term lines of CZK24.4bn. We expect CEZ to report negative FCF of about CZK4bn in 2015. The outstanding amount of long-term loans and bonds is CZK176.5bn, out of which CZK27.4bn matures in 2016-2017, including a convertible bond of CZK12.6bn maturing in 2017.