Italian Multi-Utility A2A SpA 'BBB/A-2' Ratings Affirmed; Outlook Stable

S&P Global Ratings today took the rating action listed above. We are affirming the rating as we expect A2A to retain substantial financial headroom compared with the 20% adjusted FFO-to-debt threshold for the current rating. This stems from better-than-expected results for 2018, coupled with a 2019-2023 strategic plan focused on improving the quality of A2A's earnings. A2A currently enjoys substantial financial headroom, with S&P Global Ratings-adjusted FFO to debt at about 25% expected over 2019-2021, compared with 26.2% in 2018. This leaves the group financial headroom for midsize acquisitions, which we expect will strengthen its generation portfolio by expanding its share of renewables, or will increase the company's customer base in the power and gas supply businesses. Should acquisitions be of a large amount in nonregulated businesses, we could reassess the rating. At the same time, we note A2A's strong track record in acquiring different businesses without harming its overall credit quality by implementing remedy measures, as evidenced in 2018 with the acquisition of a 41.34% stake in ACSM-AGAM.

A2A's business risk profile benefits from the substantial proportion of EBITDA generated from fully regulated gas, electricity, and water network activities (about 26% in 2018). In addition, 29% of 2018 EBITDA came from activities that have stable and predictable cash flow, such as waste collection and treatment and district heating. Under the 2019-2023 strategic plan, we expect A2A will invest about €2 billion of capex in fully regulated activities (compared with total capex of about €4 billion). This should support the growth of A2A's fully regulated activities and the stability of cash flow in coming years.

We note that for the more volatile generation and trading activities (about 30% of 2018 EBITDA), A2A should benefit from the implementation of the capacity payment system in 2019.

In our base-case scenario, we expect more than 80% of A2A's €4.0 billion capex for 2019-2023 will be invested in regulated or contracted activities. This translates in capex between €700 million and €750 million per year, with two main focuses: The re-tendering process for gas distribution licenses in the gas distribution sector; and in waste business, nine new waste treatment plants to be commissioned over 2019-2023.

We note A2A's aggressive dividend strategy, with dividend per share (DPS) expected to increase from 7.00 euro cents in 2018 to 7.75 in 2019 and to about 8.00 in 2020. Over 2021-2023, DPS should increase by at least 5% yearly. Despite the acceleration in capex and the aggressive dividend policy, we expect A2A will generate positive free cash flow--after capex and dividends--of about €25 million over 2019-2021.

The 'BBB' rating on A2A reflects primarily the group's stand-alone credit profile, which we assess at 'bbb'. As a domestic and government-related utility with a resilient liquidity position, the rating on A2A is currently capped one notch above our sovereign rating on Italy (unsolicited BBB/Negative/A-2). By contrast, the credit quality of Milan and Brescia does not represent a cap or provide uplift to the rating. This takes into account our view of a low likelihood of these two municipalities providing support for A2A, based on our assessment of:

• The limited importance of A2A to the municipalities, reflecting the fact that although A2A is a major provider of important public services, such activities could, in our opinion, also be undertaken by a private-sector or another public entity; and

• The limited link between A2A and its municipal shareholders, since the cities of Milan and Brescia each own 25% only, which could be sold in the coming years.

The stable outlook reflects our expectation that A2A will continue to strengthen its positions in regulated and more stable activities, while posting FFO to debt well above 20% over 2019-2021, which compares with 26.2% at end-2018.

Furthermore, given A2A's attention to cost reduction, with €170 million of savings already achieved over 2015-2018 and a €250 million target in 2023, and despite dividends increasing by a compound annual growth rate of about 7% over 2019-2020, we expect A2A will generate positive free cash flow after capex and dividends over the same time period.

We could downgrade A2A by one notch if, in our view, the company's business risk profile weakened. This could happen if A2A struggled to renew its concession agreements in the gas distribution or hydropower generation segments, and if this led to a material erosion of the contribution from regulated operations or a lower quality of generation assets (even when assuming that the corresponding financial indemnity would reduce debt). At the same time, sizable acquisitions in nonregulated activities, such as generation or supply, could also lead to a reassessment of the company's creditworthiness.

We could also lower the ratings if adjusted FFO to debt declined protractedly below 20%. This could happen if management shifted its focus away from deleveraging efforts or if operating performance was weaker than anticipated, mainly caused by its generation activities or underperformance in waste treatment. Large debt-financed acquisitions, not compensated by adequate remedy measures, could also lead to a downgrade.

Furthermore, we could downgrade A2A if we downgraded Italy by one notch and if we believed that A2A would not maintain its currently comfortable liquidity cushion to allow us to rate the company one notch above the sovereign rating.

Rating upside would require the combination of a continuous strengthening of the group's business risk profile, with growth primarily stemming from:

• Regulated and more contracted activities;

• A benign operating environment in the Italian market; and

• S&P Global Ratings-adjusted FFO to debt sustainably above 25% and debt to EBITDA at about 3.0x over 2019-2020.

In addition, as a government-related and domestic utility, A2A's long-term rating is currently constrained at one notch above the long-term foreign currency rating on Italy.

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