A2A's 2021-2030 strategic plan focuses on renewable generation growth that will progressively dilute the regulated share of the business mix.
- As A2A unfolds its 2021-2030 business plan, we expect the acceleration of investments to progressively dilute the quality of its regulated earnings, with a larger share of generation and waste assets, which are less predictable by nature than fully regulated networks.
- We forecast funds from operations (FFO) to debt averaging 21% on 2022-2024 and debt increasing by €1.6 billion to fund high capital expenditure (capex) leading to €500 million of negative free cash flow annually.
- Although the company is committed to the rating and could implement credit remedy measures, its relatively high dividend distributions and acquisitive strategy might prevent the buildup of rating headroom.
- We revised our outlook on A2A to negative from stable and affirmed our 'BBB/A-2' long- and short-term issuer credit ratings, as well as our 'BBB' issue ratings on the company's senior unsecured notes.
- The negative outlook indicates that we could lower the ratings if, as A2A transitions to a more generation and merchant business model, it fails to implement sufficient measures to show FFO to debt above 23% over the next 18-24 months.
S&P Global Ratings today took the rating actions listed above
Throughout A2A's strategic plan, we observe a gradual transition of its business mix toward more contracted generation activities and a diminishing share of regulated activities, leading, in our view, to a less predictable cash flow generation profile. We expect A2A will invest around €5.7 billion in 2022-2024 with about:
- €1.5 billion in fully regulated activities;
- About €2.6 billion in contracted activities; and
- About €1.6 billion allocated to merchant activities.
The investment plan covers some bolt-on acquisitions to accelerate development of the renewable fleet. The company disposed of less-strategic parts of its gas distribution network in April 2022. Consequently, we expect the proportion of EBITDA from fully regulated gas, electricity, water network, and waste collection activities will gradually reduce to about 28% in 2024 from 37% in 2021. Under the revised strategic plan, the target for installed renewables capacity is 5.9 gigawatts (GW) by 2030. Most of the additional capacity will become functional only toward the end of the plan and relates mainly to solar and wind technologies. We still view the relatively high share of cash flow from contracted business as positive. We expect about 25% of EBITDA in 2022-2024 to come from contracted activities with stable and predictable cash flows, such as waste treatment, district heating, and subsidized renewable energy production.
We expect to raise our credit metric thresholds for the rating because we believe the group's strategic plan will reduce the share of purely regulated activities.
As A2A's strategic plan unfolds, we would increase our FFO-to-debt benchmark for the 'BBB' rating to well above 23%. This is because, in our view, the company is transitioning to a riskier business model with a lower share of regulated activities (less than 30% of EBITDA). We would then view A2A's business mix as more volatile, notably compared with its Italian peers Hera and Iren (with respectively 50% and 41% of strictly regulated EBITDA). Moreover, A2A's business mix would have a better proportion of regulated operations, but much smaller scale and no geographic diversification compared with peers like Orsted (no regulated activities, mainly focuses on renewable generation); French environment services leader Veolia; or renewable generation developer EDP (about 30% of regulated activities in EBITDA).
We expect A2A's ratios to fall short of the new threshold as the company generates negative free cash flow due to its large investment plan.
Although we view as positive that capex is mainly for the energy transition, this translates into higher leverage in the short term. We estimate A2A's adjusted debt will increase to €6.5 billion at year-end 2024 from €4.9 billion in 2021, with EBITDA rising less rapidly to about €1.7 billion in 2024. Absent any mitigating actions, our adjusted debt-to-EBITDA ratio will move toward 3.9x on average in 2022-2024 from 3.4x at year-end 2021; and adjusted FFO to debt to about 21% from 24.2%. This is because, although most of the capex (about €1.9 billion annually, including acquisitions) is slated for the early years of the new plan, with the acquisition of renewable developer Volta Green Energy and Ardian renewable plants signed in 2021 and beginning of 2022, the bulk of organic EBITDA growth will only be realized from 2023. We expect EBITDA to be relatively protected in 2022 from regulatory measures like windfall profit taxes on utilities in Italy to compensate for the surge in power prices, since it is mitigated by higher prices for merchant business and waste management. A2A also has an ambitious and relatively high dividend distributions, with a minimum dividend of 8.5 euro cents and 8.7 euro cents per share on the profit for 2022 and 2023, respectively (totaling €270 million-€290 million per year, including dividends to minority shareholders), and minimum growth of 3% per year expected thereafter. Because of the acceleration in capex, including for acquisitions, and the aggressive dividend policy, we expect A2A will generate negative discretionary cash flow--after capex and dividends--averaging about €500 million over 2022-2024, thereby eroding some of the financial headroom accumulated in 2021. Offsetting the increase in leverage somewhat, A2A sold part of its gas distribution networks, mainly less core assets, in April 2022 for about €125 million. In addition, A2A announced in January 2022 its intention to issue a €600 million hybrid bond to support its credit metrics.
The negative outlook reflects the expected weakening of A2A's business risk profile and the headroom under its credit metrics as the strategic plan is implemented. In this context, we forecast narrower rating headroom than previously anticipated combined with relatively higher volatility. Under our projections, we anticipate adjusted debt to EBITDA increasing to almost 3.9x or slightly higher, with FFO to debt close to 21% in 2022-2023.
We could lower our ratings on A2A over the next 18-24 months if we observed a faster dilution of regulated activities in the mix with no prospects for a rapid improvement of credit metrics, notably with adjusted FFO to debt failing to improve far beyond 23% as the company transitions to a more volatile business model. This could materialize if A2A:
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Speeds up investments significantly under its strategic plan or undertakes sizable acquisitions in nonregulated activities, putting more emphasis on generation or supply, without remedy measures.
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Earns lower investment returns while ramping up its strategic plan, or operating performance is weaker than anticipated, mainly owing to generation activities or underperformance of the waste treatment business, with adjusted FFO to debt declining below 21%.
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Struggles to renew its concession agreements in the gas distribution or hydropower generation segments, and this erodes the contribution from regulated operations or the quality of generation assets (even assuming that the corresponding financial indemnity would reduce debt).
Furthermore, we could downgrade A2A if we downgraded Italy by one notch, and we believed that A2A would not maintain its comfortable liquidity cushion to allow us to rate the company one notch above the sovereign. That said, a one-notch downgrade of Italy would not automatically trigger a one-notch downgrade of A2A.
We could revise the outlook to stable if A2A shows a clear path toward adjusted FFO to debt well above 23% by 2024 and demonstrates a supportive financial policy. This scenario could stem from mitigating measures and a financial policy supporting the current rating.
ESG credit indicators: E-3, S-2, G2
Environmental factors are a moderately negative consideration in our credit rating analysis of A2A, since its generation fleet compares unfavorably with that of the industry's leaders, given the relatively low contribution from renewables. This is partly mitigated by A2A's good positioning in regulated power networks, which represented about 11% of 2021 EBITDA. Out of approximately 18.7 terawatt hours (TWh) produced in 2021, about 14.1 TWh were from fossil fuel sources, mostly gas. We note that the company, as part of its 2021-2030 strategic update, is accelerating the modernization and greening of its generation fleet, targeting 5.9 GW of installed renewables capacity by 2030. Most of the additional capacity will become functional only toward the end of the plan and relates mainly to solar and wind technologies. Installed renewables capacity of about 2.2 GW as of year-end 2021 is expected to reach 2.6 GW by 2022 (representing 26% of the total 8.5 GW of installed capacity).