OREANDA-NEWS. Fitch Ratings has affirmed Italian utilities company Compagnia Valdostana delle Acque Spa's (CVA) Long-term Issuer Default Rating (IDR) at 'A' with a Stable Outlook.

The affirmation primarily reflects the group's solid business profile and consistent net cash position, resulting from the conservative approach of the 100% ultimate parent Autonomous Region of Valle d'Aosta (VDA; A/Stable).

We believe that potential changes in CVA's shareholding structure following the upcoming reform of the public administration in Italy could result in a less conservative financial policy with regard to leverage and ultimately in a lower rating. However, until we have concrete evidence that such changes will materialise for CVA, the rating Outlook is not affected by this risk.

KEY RATING DRIVERS
Parent Linkage Considerations
Fitch sees limited-to-moderate legal and operational ties and moderate-to-strong strategic ties between the company and its shareholder. We believe that a downgrade of the region would not necessarily lead to a corresponding action on CVA, but we would limit the rating differential to one notch due to the possibility of cash upstream from the parent. On the other hand, where the region's rating would be higher than CVA's, Fitch would analyse the evolution of the legal ties and the evidence of financial support from the parent before applying any uplift.

Shareholding Structure
Based on the current draft of the legislative decree related to the management of publicly owned companies, VDA could be forced to sell or initiate a listing process for CVA. The draft decree, which does not apply to listed companies, foresees that public entities should own companies engaged in activities not realisable at the same conditions on a free market basis. The decree aims to significantly reduce the number of Italian publicly owned companies (currently around 8,000).

If the draft remains unchanged and is applied to CVA, leading to a sale or a flotation of the company, it would most likely imply the revision of the conservative financial policy consistently shown in the past, with a negative rating impact.

Solid Business Profile
CVA benefits from a 100% fuel cost-free asset base. The installed capacity of around 1 GW is represented by hydro at more than 90% (hydro production is partly incentivised), with the balance accounted for by quasi-regulated wind and, to a lesser extent, by PV solar. The group holds a favourable niche market position in supply activity and manages the electricity distribution network in Valle d'Aosta.

The regulated and quasi-regulated activities represented around 30% of CVA's EUR170m EBITDA in 2014 and we estimate their contribution will rise to more than 50% from 2017, due to expected declines of margins from hydro power plants. The average residual life of incentives stands at nine years for hydro plants and around 15 years for wind and PV plants.

Net Cash Position
VDA has historically pursued a conservative financial policy for CVA, allowing the company to accumulate a substantial amount of cash, and with a cautious approach to external growth. The company paid out extraordinary dividends distributions of around EUR100m per year (compared with an historical average of EUR30m) only in 2013-2014 before resuming in 2015 to dividends of EUR46.5m. As a consequence, CVA has consistently shown a net cash position, amounting to EUR22m at end-2015.

We understand from management that their target is to maintain a broadly neutral financial position, with readily available cash matching total debt. In our conservative rating case, which includes annual acquisitions of EUR50m in 2016-2018, CVA would reach a net debt of around EUR100m in 2018, with an funds from operations (FFO) adjusted net leverage of 1.1x in the same year, implying a limited breach of our leverage guideline of 1.0x.

Weakening Market Fundamentals
After a stable evolution of electricity prices in 2015, mainly due to low hydrology (with the positive exception of CVA), a summer heat wave and only slightly lower gas prices, 2016 started with a sharp pool price reduction to less than EUR40/MWh. Forward prices are weak, in line with recent evidence.

For CVA, which is focused on hydro power plants, electricity price reduction represents a direct hit to the EBITDA, without being compensated by lower commodity prices. However, the worsened prices have not yet been fully reflected in the company's margins, which are protected by hedging and a higher-than-average hydrology in 2014-15. The full impact will likely materialise only in 2017, as favourable hedges expire and hydrology returns to the average level. As a consequence, we expect an EBITDA of around EUR90m for 2017 (excluding contributions from annual acquisitions assumed in our rating case).

M&A Still on Agenda
In early 2015 CVA acquired a wind farm in southern Italy, for just under EUR50m, funded through cash on balance. The target company benefits from feed-in tariffs and contributed EUR5m to the group's EBITDA. Fitch believes that CVA will pursue further M&A opportunities, particularly in the wind sector, but we expect the size of potential acquisitions to be similar to the recent one and generally consistent with the target of preserving a neutral financial position.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for CVA include:
- Reduction of EBITDA (excluding contributions from annual acquisitions) to less than EUR90m in 2018, due to the worsening price environment (EUR38-40/MWh), the gradual roll-off of favourable hedging contracts and average hydro production
- No Robin Hood tax and corporate tax rate reducing by 3.5pp from 2017
- Average capital expenditure of EUR40m in 2016-2018, higher than 2013-2015 levels
- Dividends at EUR50m per year in 2016-2018, implying the distribution of reserves
- Acquisition of renewable assets for EUR50m per year in 2016-2018, with a contribution to EBITDA rising from EUR5m in 2016 to EUR15m in 2018

RATING SENSITIVITIES
Positive: Currently we see limited rating upside. However, future developments that may lead to a positive rating action include:
- An upgrade of VDA, coupled with strengthened legal ties between the two entities or evidence of the ability and willingness of the region to support the company

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Change in the shareholding structure, leading to a less conservative financial policy
- FFO adjusted net leverage above 1.0x (including adjusted financial assets in the cash computation), also as a result of material debt-funded acquisitions
- Should the region be downgraded, CVA will be allowed a maximum of one notch above the rating of the region to the extent that the standalone profile of the company remains unchanged

LIQUIDITY
CVA's liquidity is healthy. Its end-2015 readily available cash position was EUR297m, including EUR164m in cash and equivalents and EUR133m in liquid financial assets, against debt of EUR275m (of which EUR24.5m is due in 2016), resulting in a net cash position. We expect CVA to post structurally neutral-to-positive free cash flows. CVA does not rely on debt capital markets and is funded by bank loans.