OREANDA-NEWS. Fitch Ratings says Terna SpA's 'BBB+'/Stable rating is not affected by the company's acquisition of the high voltage grid owned by Ferrovie dello Stato Italiane S.p.A. (FS, BBB+/Stable) and the tariff determination for 2016-2023 for Italian electricity regulated activities.

Our updated rating case projections as a result of these two developments result in an average funds from operations (FFO) adjusted net leverage of 6.7x for 2016-2018, compared with the negative rating guideline of 6.75x. This is a slightly lower leverage compared with our projections in March 2015 when we affirmed Terna's ratings. At that time we had already included the potential acquisition of FS's grid at the beginning of 2016 and assumed reduction of weighted average cost of capital (WACC) from 2016. In March 2015 we had expected the net leverage ratio to be above the negative guideline for 2016-17, before trending lower to the guideline of 6.75x in 2018.

The acquisition of FS's grid, which closed in December 2015 for EUR757m, includes around 8,400 km of transmission lines and 350 primary stations. The acquired business is almost fully regulated and a regulatory asset base (RAB) of EUR674m was included in the national transmission grid as a consequence of the deal. The existing assets' residual life is equal to 29 years. A limited revenues stream of around EUR5.6m will come from a long-term contract for the housing of optical fibres.

No headcount and no debt were transferred with the business. The acquisition has been financed with available credit facilities and cash and was already factored in our rating case in March 2015 with a cash-out of EUR750m and capex outpacing EBITDA for around EUR20m annually from 2016. In 2016 Terna will only benefit from EUR42m allowed opex, while the full remuneration of the acquired regulated business will start in 2017.

In December 2015 Terna signed a EUR800m five years back-up revolving credit facility and a EUR153m 18-year loan with EIB and we continue to deem its liquidity profile as healthy.

Fitch believes that the price review published on 30 December 2015 by the Italian regulator Autorita per l'Energia Elettrica, il Gas ed il Sistema Idrico (AEEGSI) is overall well-balanced in light of a reduced need for investments in the Italian grid compared with the past. The review process has been transparent with consultation papers and the involvement of the industry players.

AEEGSI's determination introduces an eight-year regulatory period 2016-2023, divided in two sub-periods: the first one spanning across 2016-2019 is based on a methodological continuum with the current one, while in 2020-2023 a total expenditure (totex) mechanism will be introduced.

The real pre-tax WACC level defined for electricity transmission at 5.3% from 2016 compares negatively with the 6.3% applied in 2014-15, but is better than our conservative expectation included in the previous rating case (below 5%) and consistent with the current interest rate environment. The new framework for WACC definition provides more stability and visibility to the remuneration, while retaining some flexibility through the update of some key drivers after three years (see 'Fitch: Return on Capital Update is Credit Positive for Italian Networks', dated 4 December 2015).

The more selective approach to investments is confirmed by the reduction of the extra return on new investments (1% over base WACC versus previous 1.5% or 2%) and the introduction of some conditions, including authorisation of the projects at end-2015 and completion by 2019. The time lag for recognition of capex into the RAB has been reduced to one year, but the previous extra 1% on top of WACC to compensate for time lag has been eliminated for new investments. A gradual introduction of output-based incentives is also foreseen.

While these measures penalise Terna compared with the previous regulatory period, they are consistent with the current operational status of the network. The lower capex needs from 2016 and the improvement of the projected free cash flows were considerations for Fitch's rating affirmation in March 2015.

The AEEGSI has used 2014 as a reference year for operating cost allowances. The 50/50 profit sharing was confirmed, while the efficiency factor was reduced to 1% from 3%. The depreciation allowance will be mainly affected by the extension of the high voltage lines regulatory life to 45 years from 40. Terna management has indicated a negative impact of around EUR10m per year as a result of this change. Exposure of allowed revenues to electricity consumption volatility is negligible.

The price review refers also to companies operating in electricity distribution such as Enel SpA (BBB+/Stable) and Acea SpA (BBB+/Stable). Our rating case for these companies already include the WACC reduction, while the other changes have a limited impact on the consolidated figures, also in light of the share of electricity distribution in total EBITDA (2014: around 25% for Enel and 30% for Acea).