OREANDA-NEWS. Fitch Ratings has affirmed NET4GAS, s.r.o.'s Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB'. The Outlook on the IDR is Positive.

NET4GAS's rating is supported by its strong business profile as the sole national gas transmission system owner and operator (TSO) in the Czech Republic, and its long-term ship or pay transit contracts for Russian gas to Europe, with limited exposure to the route across Ukraine.

The Positive Outlook reflects the regulatory proposal for 2016-2018 and stronger than expected performance in 2015 that would allow NET4GAS to maintain credit metrics commensurate with our positive rating guideline. We may upgrade the rating if the final regulatory determination expected by the end of 2015 largely reflects the current proposal.

We consider that NET4GAS's business risk may increase in the long term as short-term transit bookings increase in importance. We could consequently tighten our leverage guidance for the rating.

KEY RATING DRIVERS
Refocused Transit Business
We expect NET4GAS's transit business, representing around 80% of its revenues, to remain the company's key cash flow driver. Since 2013, around 85% of its long-term booked capacities are in north-south or west-east directions, limiting its exposure to the traditional east-west route across Ukraine.

Long-term Contract Expiry
Two of NET4GAS's long-term contracts expire by 2020. Although there appears to be a growing demand for short-term capacity bookings, cash flow visibility may decrease from 2020 increasing the company's business risk, reducing the company's debt capacity for a given rating, in our view.

Concentration of Contracts
Significant counterparty concentration is a risk for NET4GAS, reflecting the company's direct exposure to Gazprom (BBB-/Negative) as the largest counterparty. This does not represent a constraint for the ratings due to historical performance under the contracts, the higher unconstrained credit profile of the counterparty and the continued importance of the NET4GAS route in reaching the shippers' ultimate customers and source of cash flows.

Other counterparties include large European utilities. All counterparties (transit or domestic) have to meet the criteria of the network code and payments are typically made on advance invoices. The regulatory framework allows recovery of revenue deficits in the domestic business.

Final Determination Likely Positive
While the consultation process to determine the regulatory parameters for RP4 (2016-2018) is ongoing, the proposals presented in 2015 are favourable, notably with pre-tax nominal WACC at 7.94%, fixed for the entire regulatory period. Historically, volatile WACC has been a rating risk. A final determination in line with the proposal would support an upgrade despite the expected increase in capex for 2017-2019, as the related investment would increase the regulatory asset base or support remuneration without volume risk. We expect positive free cash flow before and after the investment spike.

FX Exposure
Much of the transit capacity is contracted in US dollars, followed by Czech koruna (which is also the currency for the domestic business) and euros. In total, including domestic transport and transit businesses, the company receives more than half of its revenue in Czech koruna followed by US dollars and euros. Costs are largely in koruna with some capex in foreign currency. NET4GAS targets cash flow hedge of FX using debt issued across the currencies and cross currency swaps. However, balance sheet ratios are impacted by currency fluctuations.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for NET4GAS include
- Regulatory returns in line with the current proposal for RP4, including WACC fixed at 7.94%
- Short-term bookings of 45 GWh/day annually for 2017-2019
- Partial utilisation of long-term contracts
- Total capex of CZK13bn for 2015-2019

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to an upgrade:
- RP4 determination in line with the current proposals, supporting expected funds from operations (FFO) net adjusted leverage sustainably below 5.25x and FFO coverage above 3.5x.

We expect to tighten the FFO-based rating sensitivities as the cash flow visibility is likely to reduce from 2020. An upgrade would be predicated also on our view of the company's performance in view of the new sensitivities.

Negative: The Outlook is Positive, future developments that may nonetheless, individually or collectively, lead to negative rating action include:
- Projected FFO net adjusted leverage at above 6.0x and FFO coverage at below 2.5x on a sustained basis.
- Adverse change in NET4GAS's contract portfolio or failure to of counterparties to perform under the contracts.
- Significant weakening of the unconstrained credit profile and increase in exposure to NET4GAS' key counterparty.
- Materially worse than proposed RP4 determination would likely lead to a revision of the Outlook to Stable.

LIQUIDITY
Liquidity is adequate with CZK1.6bn of cash at YE14 and no debt maturing until 2018. NET4GAS expects to maintain cash of at least CZK277m (EUR10m) with liquidity supported by EUR100m RCF due 2019 and expected positive cash flow generation.