Fitch Downgrades Fortum Oyi to 'BBB+'; Outlook Stable
The downgrade reflects Fortum's confirmed strategy of using its cash proceeds from the sale of the distribution networks to grow its existing generation business organically and through acquisitions, with a targeted net debt to EBITDA of 2.5x, which is above our guidance for the previous rating (2.5x funds from operations (FFO) adjusted net leverage). Furthermore, Fortum's profitability is challenged by difficult operating conditions in Russia (EBIT target of RUB18.2bn has been postponed from 2015 by two to three years) but also in Scandinavia where depressed power prices led to an early shutdown of two reactors at Oskarshamn (1.1GW).
KEY RATING DRIVERS
Strategy Drives Weaker Leverage
Following the disposal of its distribution networks, completed in June 2015, we estimate that Fortum will be net cash-positive, compared with a FFO adjusted net leverage of 2.1x in 2014. However, we expect Fortum's credit metrics to deteriorate from the current strong levels as the company invests in external and organic growth opportunities. The ratings reflect the target leverage of 2.5x net debt/EBITDA, which we expect the company to reach within the next two to three years, potentially through a capital return to the shareholders.
Weaker Business Profile
Depending on the areas and businesses in which Fortum intends to invest, the business mix may change over time which may lead to a change in our rating guidelines. Our current guidelines reflect the existing business mix with 55%-60% of cash flows generated by the Nordic power division, 25% Russia and 15%-20% heat. Fortum will provide further details of its strategy during its 2015 results presentation on 3 February 2016.
Nordic Prices Continue to Weaken
Nordic forward prices remain low at between EUR20-25/MWh, reflecting extraordinarily high hydro reservoirs, warmer-than-usual weather and an increasing share of non-hydro renewables in the generation mix. Fortum has been able to achieve higher-than-system prices historically, due to differences in area prices, production management and a successful hedging strategy and we assume an achieved price in the Nordic division of about EUR30/MWh. However, this still represents a 27% decline from last year, which will be directly reflected in Fortum's earnings and cash flow.
Risks in Russia
Fortum's new gas-fired combined heat and power plants (CHPs) in Russia are contracted under capacity supply agreements, which allow for recovery of capital costs, including a target return of 12%. The division's profitability has increased due to new units being commissioned and receipt of capacity payments despite a weakening rouble. However, weak demand fundamentals, a lower-than-expected increase in domestic gas prices and potential changes to the capacity agreements have led to delays in recovering returns from Russia.
Cash Flow Generative Business
Fortum generation and heat assets have historically been cash flow-positive. The group has 17.7GW of electricity and heat capacity in Russia and is finalising its EUR2.5bn investment programme. Fortum's power (9.85GW capacity) and heat (3.9GW capacity) in the Nordic region, the Baltics and Poland include 7.4GW of low-cost nuclear and hydropower (excluding Oskarshamn 1 and 2). Other activities include district heating and sales activities in the Nordic region and the Baltics, which have a stronger business risk profile than pure power generation.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Achieved power prices in the Nordic region of approximately EUR 30/MWh (2016-17);
- CSA payments in Russia spread over 15 year, with a negative annual impact of up to EUR70m initially, offset by the longer payback period;
- Capex of EUR 600m/year, in line with Fortum's guidelines;
- Proportional consolidation of Fortum's share in TVO Oy;
- Tax rate of 21%, at the upper end of management's guidance;
- If Fortum fails to find sufficient investment targets we assume a substantial return of capital to shareholders to achieve the target capital structure (net debt to EBITDA of 2.5x)
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- FFO adjusted net leverage below 2.5x on a sustained basis and in the foreseeable future, also reflected in the company's targets
- FFO fixed charge cover above 6.0x on a sustained basis (2014: 5.95x)
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Fortum's credit metrics are commensurate with a higher rating until the strategy is executed and we do not currently anticipate developments with a material likelihood, individually or collectively, of leading to a rating downgrade. However future developments that may lead to a downgrade are:
- FFO adjusted net leverage above 3.5x on a sustainable basis
- A further deterioration of the political, economic or regulatory environment in Russia
- Further structural decline in Nordpool power prices
LIQUIDITY
As of 30 September 2015, the group had available EUR8,032m of cash and equivalents. Additionally, EUR2bn of committed and undrawn revolving credit facilities with maturity in July 2017 and EUR0.2bn short-term overdraft facilities were in place. This funding position will provide sufficient liquidity for scheduled debt maturities, operating requirements, capex and dividends until end-2019.
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