Ratings On Six European Integrated Utilities Affirmed Amid Accelerated Energy Transition; One Outlook Now Negative

We affirmed our ratings after revising downward our funds from operations (FFO) to debt metric thresholds to reflect our view of the companies' improving business risk profiles (see table). The changes apply to entities we currently consider the energy transition leaders, namely Iberdrola, Enel, EDP, Orsted, and EnBW. We consider that these entities have built a solid asset base and are well positioned to fully benefit from recently reinforced energy transition policies in Europe, with robust and defensive investment pipelines. In contrast, while we also affirmed our ratings on Naturgy, we changed the outlook to negative from stable because of uncertainty on the group's long-term strategy and shareholder structure, as well as Naturgy's higher exposure to gas assets.PARIS (S&P Global Ratings)

Feb. 17, 2020--S&P Global Ratings has today affirmed its long- and short-term issuer credit ratings on six European integrated utility companies following a sector review (see "The Energy Transition And The Diverging Credit Path For European Utilities," published Feb. 16, 2021, on RatingsDirect).

Our ratings and related credit metrics thresholds for CEZ, Vattenfall, Verbund, Fortum, SSE, Engie, EDF, and ESB are unchanged following our sector review, since our ratios already reflect these companies' business risk positions.

 

Ratings List
Company	Rating affirmed	Change in FFO to debt thresholds (upside/downside)
Iberdrola S.A.	BBB+/Stable/A-2	Downside trigger lowered to 17% from 18%.
Enel SpA	BBB+/Stable/A-2	--Downside trigger lowered to 20% from 21% (consolidated). --Upside rating trigger lowered to 23% from 24% (consolidated).
EDP	BBB-/Stable/A-3	Upside rating trigger lowered to 19% from 20%. Upside trigger now also includes debt to EBITDA close to 4.0x.
Orsted A/S	BBB+/Stable/A-2	Downside trigger lowered to 23% from 25%.
EnBW	A-/Stable/A-2	--Downside trigger lowered to 19% from 20% previously (consolidated). --Upside rating trigger lowered to 23% from 25% (consolidated).
	Rating affirmed	Outlook action
Naturgy Energy Group S.A.	BBB/Negative/A-2	Outlook changed to negative from stable.

 

Iberdrola S.A.

Primary analyst: Massimo Schiavo

We revised downward our lower threshold for Iberdrola S.A.'s FFO to debt to 17% from 18%, leaving the upper threshold unchanged at 20%.

This is because Iberdrola is one of the most resilient large European integrated utilities, with about 50% of its earnings stemming from regulated power distribution activities, notably in Spain, the U.K., U.S., and Brazil. With its new strategic plan until 2025, Iberdrola will continue to strengthen its business risk profile, since it will allocate almost all its €75 billion investments to renewables (46%) and networks (45%, including the recently announced acquisition of PNM Resources) in highly rated countries, notably the U.S. and Spain. The former will become the group's second largest market by 2025. Iberdrola will reduce its exposure to Latin America, notably Mexico, which will represent 6% of EBITDA in 2025, compared with about 10% in 2020. Exposure to merchant and retail operations will remain at 25%-30% of total EBITDA, considering gradual renewables development without a subsidies scheme through 2025, although hedged for the following 12-18 months, thanks to retail activities.

Iberdrola's generation mix is already significantly skewed toward renewables, with 32 gigawatts (GW) of renewables capacity (including 13 GW of hydro) out of a total installed capacity of 52 GW in 2019.

Renewables is expected to represent about 60 GW of installed capacity in 2025 and about 95 GW in 2030, versus total installed capacity of about 80 GW and about 115 GW respectively. This translates into below-sector average carbon intensity at 110 grams of CO2 equivalent per kilowatt hour (gCO2eq/kWh) in 2019 declining to less than 70 gCO2eq/kWh in 2025 and about 50 gCO2eq/kWh in 2030.

Iberdrola will invest €10 billion on average over 2020-2022 and €13 billion over 2023-2025.

This will lead to negative free operating cash flow (FOCF) after capital expenditure (capex) and dividends, and a 47% increase in net debt by end-2025 to €56.1 billion, compared with €38.2 billion in 2019. We expect Iberdrola to maintain some rating headroom, with adjusted FFO to debt staying above the 17% threshold for the current rating over 2020-2025. We forecast the ratio at about 17.5% in 2021 after Iberdrola acquires PNM, which it will have to integrate into its portfolio.

Outlook

The stable outlook reflects our expectation that, despite Iberdrola's aggressive investment plan, its credit metrics should remain within the 17%-20% range commensurate with the current rating. This will be due to Iberdrola's highly diversified and resilient business activities, with the majority of cash flows coming from regulated activities, which will be somewhat enhanced by the PNM acquisition. We expect adjusted FFO to debt will be higher than 18.0% in 2022 after 17.5% in 2021. In addition, we expect that Iberdrola will take adequate steps to manage any operational or financial setback. A key element is management's commitment to the current rating and to maintaining adjusted FFO to debt at 17%-20% over 2020-2025.

Downside scenario:

Rating pressure could arise if Iberdrola's cash flow and leverage metrics do not recover after the PNM acquisition, with adjusted FFO to debt remaining below 17% after 2021. In our view, this could occur if:

•	Iberdrola experiences any operational setback, such as, lower-than-expected profitability from installed assets or material delays in construction;
•	There are operational challenges in integrating new acquisitions, such as PNM;
•	COVID-19 has a worse effect 2021 than we anticipate, coupled with the company taking insufficient mitigation steps;
•	Regulation in one of Iberdrola's key markets is more adverse than we anticipate; or
•	There is a substantial increase in exposure to markets with higher country risk than its core regions Spain, the U.K., and U.S., than already announced.

Other risks, in our view, include execution risks related to large offshore wind projects and potential currency volatility. Although debt is adequately spread by currency, a material weakening of the U.S. dollar or pound sterling against the euro could somewhat reduce the group's financial flexibility within the 'BBB+' category. That said, we note the group's track record in installing wind offshore on time and on budget, and the natural hedge of foreign exchange risk.

Upside scenario:

Because Iberdrola's current strategic plan leaves little rating headroom, we see rating upside as unlikely over 2021-2025. Because of the group's particularly strong business profile among European integrated utilities, a one-notch upgrade could ultimately depend on a combination of:

•	An improved business risk profile continuously focusing on network activities under favorable regulatory frameworks and in highly rated countries;
•	More stable market conditions for liberalized power activities and Spain;
•	Timely delivery of the ambitious renewables pipeline; and
•	A more supportive financial policy, such that the group targets adjusted FFO to debt sustainably at 20% or higher.

 

Enel SpA

Primary analyst: Claire Mauduit-Le Clercq

We view Enel as one of the most resilient in the sector.

About 50% of Enel's earnings stem from regulated power distribution activities and there's an increasing contribution from long-term contracted renewables generation (expected to represent about 25% of earnings over 2021-2023). We expect that most of Enel's generation mix will shift away from conventional generation by 2030, thanks to accelerated dedicated investments. Renewables should represent more than 80% of total installed capacity by 2030 compared with about 55% at year-end 2020, facilitated by the faster phase-out of coal generation (8.9 GW installed capacity in 2020) now planned for 2027.

Hence we are widening the proportional (excluding the share related to minority shareholders) adjusted FFO-to-debt range for the 'BBB+' rating, and to compare Enel against peers, to 18%-21% from 19-22%.

At the same time, we are maintaining the 200 basis points (bps) difference between the consolidated and proportional adjusted FFO to debt stemming from the significant amount of minority shareholders' equity (about €16.6 billion as of year-end 2019) and because most of the consolidated debt is at Enel SpA. However, Enel's carbon footprint remains high, with carbon intensity expected to reach 218 gCO2eq/kWh in 2020, and is not among the best of the top 14 utilities. This compares with 110 gCO2eq/kWh in 2019 for its Spanish peer Iberdrola or 122 gCO2eq/kWh for Portugal's EDP. Enel's target is to further reduce its carbon intensity to 148g gCO2eq/kWh in 2023.

Enel's main credit weakness remains its geographic exposure to countries with high operating risks.

Italy contributes about 40% of the group's EBITDA and Latin America about 30%. The latter share will remain stable until 2023 since planned capex over 2021-2023 is still higher than peers', entailing potential earnings volatility through currency fluctuations; the impact on EBITDA was about €800 million in 2020.

Enel is continuing to simplify the group.

As of Dec. 31, 2020, Enel Americas' annual general meeting validated the merger of Enel Green Power in all Latin American countries (except Chile) and Enel Americas; and the elimination of the 65% bylaws threshold. We view Enel's robust governance as an important protection against uncontrolled expansion as the group increases capital deployment. Over 2021-2023, Enel intends to:

•	Increase its owned installed renewables capacity base by 15.4 GW from 45 GW expected at year-end 2020, and the renewables capacity under the stewardship model by 4.1 GW from around 4 GW expected in 2020;
•	Increase the share of power generation from renewable sources to 70% of the group's 100 GW of capacity in 2023 from an estimated 55% in 2020, and to more than 80% in 2030; and
•	Accelerate investments in global networks to enhance the resilience of the grid and digitalization, thereby expanding the regulated asset base (RAB) by 10%-15% in 2023 compared with that in 2020.

Outlook

The stable outlook reflects our expectation that Enel's credit metrics will remain relatively stable over 2020-2023, despite increased investments. In particular, we consider that adjusted FFO to debt will continue to comfortably exceed 20% on a consolidated basis, corresponding to about 18% on a proportional basis, in line with the current 'BBB+' rating. Earnings growth from the group's large investment pipeline in networks and long-term contracted renewables should support credit ratios, despite negative free cash flow after capex and dividends. We believe Enel can maintain a solid liquidity profile that enables us to rate the company higher than Italy (unsolicited; BBB/Stable/A-2).

Downside scenario:

At this stage, we see limited risk of a downgrade. We could, however, lower the rating if Enel's credit metrics were to deteriorate over 2021-2023, especially if consolidated adjusted FFO to debt fails to stay above 20%, which corresponds to proportional adjusted FFO to debt of 18%. This could occur if the group's increased investments were not as profitable as expected, shareholder remuneration exceeded Enel's updated guidance, or Enel undertook large mergers or acquisitions without significant remedy measures. Operating underperformance, notably on liberalized activities or the execution of the renewables pipeline, could also weigh on the rating. A significant deterioration of economic prospects in key countries where the group operates, especially Italy or Brazil, could also have negative rating implications.

Upside scenario:

An upgrade would depend on Enel's successful execution of its ambitious capex program. We expect Enel to use any additional flexibility to either expand its investment pipeline, continue its minority buyout program, or increase shareholder remuneration. A one-notch upgrade could ultimately depend on a combination of:

•	Business risk profile improvement with successful "greening" of the generation portfolio, smooth execution of the planned coal phase-out, and continued focus on network activities in favorable regulatory frameworks;
•	Further simplification of the group and stable contribution from operations in countries with higher country risks; and
•	A supportive financial policy targeting adjusted FFO to debt sustainably above 23%, corresponding to above 21% on a proportional basis.

 

EDP - Energias de Portugal S.A.

Primary analyst: Renata Gottliebova

EDP's power network activities (26% of 2019 earnings) in Iberia and Brazil, and its renewables operations (61% of earnings) in North America, Europe, and Latin America support its resilient business position among large integrated utilities in Europe.

EDP is the largest generator, distributor, and supplier of electricity in Portugal, and the third largest electricity generation company on the Iberian Peninsula. We expect regulated activities in Iberia will represent about 20% of the company's EBITDA over 2020-2022, while electricity distribution and transmission in Brazil should represent less than 10%. The contribution to total EBITDA of EDP's renewables subsidiary EDPR should increase to about 45% in 2022, with exposure to merchant generation in Iberia declining to less than 20% of total EBITDA in 2022 from 22% in 2019. We are therefore lowering the upper boundary for EDP's FFO to debt for the rating to 19% from 20%, while keeping the lower boundary at 16%.

Key relative weaknesses include EDP's exposure to uncertain and volatile power prices in Iberia, partly mitigated by its hedging policy, and above-average country risk exposure to Brazil, which represents close to 20% of total EBITDA.

We note that EDP's merchant exposure has been gradually decreasing as EDP reduces its business risk, notably due to asset disposals that have significantly reshaped the company's business. By the end of 2020, EDP had received €2.7 billion in proceeds from disposals, surpassing its €2 billion target of disposal proceeds for 2019-2022.

EDP stands out positively in terms of its carbon footprint.

Its carbon intensity was 122 gCO2eq/kWh in third-quarter 2020 versus Iberdrola's 110 gCO2eq/kWh and Enel's 218g CO2eq/kWh in 2020. This relatively low carbon intensity stems from the large proportion of renewables in EDP's generation mix and the reduced operations of the coal-fired power plants in Iberia. As of Sept. 30, 2020, EDP benefits from a modern, low-carbon generation fleet, with about 74% of installed capacity and 75% of power production coming from renewables (includes hydro, wind, and solar). We note that EDP, through its renewables subsidiary EDPR, is the fourth largest renewables operator in the world, with a geographic footprint in Europe--notably Iberia--North America, and Brazil. At year-end 2020, EDP had 2.3 GW of wind and solar capacity under construction.

Over 2021-2022, we expect EDP will continue to focus on its large capex program, notably in renewables.

This program will lead to negative free cash flow after capex and dividends of about €300 million. EBITDA will increase, more so than adjusted debt, on the back of capacity additions. Rating headroom should improve over 2021-2022, underpinned by sound performance in 2020. We expect an increase of adjusted FFO to debt to 18%-19% in 2022 compared with an estimated 16%-17% in 2020.

Outlook

The stable outlook reflects our expectation that our adjusted FFO to debt ratio for EDP will surpass 16% in 2020, and adjusted debt to EBITDA will strengthen to about 4.7x from 5.0x in 2019. We believe the company's financial risk profile will improve over the next two years on stronger operating performance and the sale of merchant assets and retail B2C clients on the Iberian Peninsula for more than €2.7 billion.

Downside scenario:

We could lower the ratings if, over 2021-2022, EDP's FFO to debt drops materially below 16% or the company were unable to deleverage, with adjusted debt to EBITDA remaining materially above 4.5x. One or more of the following scenarios could prompt a negative rating action:

•	Continuously challenging conditions in the Iberian power generation market;
•	Underperformance of the leverage-reduction target in the company's 2019-2022 plan;
•	A material heightening of country risk in Portugal and (secondarily) Brazil, including adverse regulatory or fiscal effects);
•	Larger-than-expected foreign exchange effects; or
•	The company's inability to achieve its asset-rotation target over 2020-2022.

Upside scenario:

Ratings upside over the next two years would require EDP to achieve FFO to debt above 19% and debt to EBITDA close to 4.0x under its expected improved business risk profile, coupled with EDP's commitment to the higher rating level.

 

Orsted A/S

Primary analyst: Per Karlsson

Orsted, a global leader in offshore wind, has a market share of approximately 30%.

The group has a strong track record of project delivery, on time and on budget, spanning more than a decade. As of Dec. 30, 2020, total installed renewables capacity was 11.3 GW, up from 9.9 GW in 2019, with offshore wind representing about 7.6 GW compared with 6.8 GW. The company intends to increase installed renewables capacity to more than 30 GW by 2030. From a European focused group, Denmark-based Orsted has transformed itself into a global renewables operator, diversifying in the U.S. and Taiwan, as well as into onshore wind and solar technologies. By 2025, we expect EBITDA generated outside Europe (including the U.K.) to represent about 30% of the group's total EBITDA, compared with about 5% in 2020. From an environmental standpoint, Orsted has one of the lowest carbon intensity rates at 58 gCO2eq/kWh at end-2020, and it aims to become carbon neutral by 2025 with carbon intensity below 10 gCO2eq/kWh.

Owing to Orsted's strengthening business risk profile, we are revising our FFO to debt thresholds for the 'BBB+' to 23%-40% from 25%-40%.

Moreover, we now regard the company's tax equity credits as a true sale, rather than debt in our previous assessment. This is likely to improve our historical adjusted FFO to debt figures by almost 100 bps and our forecasts by about 130 bps. This revision was not triggered by any change in Orsted's tax equity contracts.

Orsted has successfully self-funded its growth over the past few years through asset rotation.

This has resulted in its balance sheet increasing by more than 40% since 2016 to over Danish krone (DKK) 196 billion (about €27 billion). Now the company has a larger portfolio of relatively new cash flow yielding assets, making the group less dependent upon asset rotations to finance its significant growth pipeline. Orsted plans to make DKK200 billion of investments over 2019-2025, with 2021 capex expected at DKK32 billion-DKK34 billion.

In 2020, Orsted's operations showed resilience to difficult conditions related to the COVID-19 pandemic.

The company not only exceeded its EBITDA guidance of DKK16 billion-DKK17 billion, but also delivered key projects on time and budget. There were also some pandemic-related capex delays in 2020, with total capex at DKK27.0 billion versus our forecast of DKK33.5 billion. Given the higher-than-expected EBITDA and lower investments, we forecast adjusted FFO to debt at 45% in 2020, well above our initial estimate of about 31%. This ample rating headroom will give Orsted flexibility to continue its ambitious capex plan, with investments set to exceed DKK30 billion in 2021. In our rating assessment, we consider that the Danish government has proven to be a supportive shareholder, requiring no dividend from Orsted at the time of its transformation from an oil and gas company into a pure renewables player. This translates into one notch of uplift from the stand-alone credit profile of 'bbb'.

Outlook

The stable outlook on Orsted reflects our assumption that the wind power segment's operating performance will remain credit supportive over the next two years, thanks to the stable and predictable nature of the segment's operations. We expect that the company's relationship with the Danish government will be stable following the sale of the local power distribution assets, and there will be no significant changes to Orsted's strategy or financial policies, which support FFO to debt of about 30%. We expect the company will have some headroom over 2021-2023, with adjusted FFO to debt above 30%.

Downside scenario:

We could lower the rating if Orsted's operating performance were to deteriorate significantly over the next two years, which we see as unlikely. This could occur due to pandemic-related delays in commissioning new projects, sizable acquisitions, higher-than-expected dividends, or greater-than-forecast capex. We could also lower the rating by one notch if credit metrics weakened, with FFO to debt below 23% over the next two years. In addition, we could lower the rating by one notch if we believed that the likelihood of government support had weakened. This could happen, for example, if the government showed less willingness or ability to support its investment in Orsted, or it no longer held a majority stake in the company, which we see as unlikely over the next two years.

Upside scenario:

We see rating upside as constrained by Orsted's existing financial policy targeting FFO to debt of about 30%. However, we could upgrade the company if it revised its financial policy, leading to stronger, durable credit measures, such as FFO to debt sustainably at 35%-40%. We see this as a remote possibility during the outlook period.

 

EnBW Energie Baden-Wuerttemberg AG

Primary analyst: Renata Gottliebova

EnBW is one of Europe's strongest integrated utilities.

More than 50% of EnBW's EBITDA stems from regulated activities (power and gas transmission and distribution) in Germany, under a regulatory framework we believe to be very credit supportive. As part of its "EnBW 2020 Strategy," the group has successfully shifted its focus from conventional generation and trading toward low risk activities including regulated (50% EBITDA) and contracted renewables generation (30%). 2019 was the first year that the contribution from renewables was higher than conventional generation (mainly nuclear and coal).

With the "EnBW 2025 Strategy," the group aims to strengthen its business risk profile and become a sustainable and innovative infrastructure utility by expanding its RAB and renewable fleets, as well as providing smart infrastructure solutions.

We expect low risk activities will represent about 70%-80% of EnBW's EBITDA by 2025, and the remainder from digital activities and supply. However, EnBW's investments, expected to be €2.0 billion-€2.5 billion over 2021-2025, are much lower than the sector average of €18 billion per year. We expect about 50% of EnBW's investments will go toward networks and 35% toward renewables expansion. As of 2019, about 60% of EnBW's generation portfolio still uses conventional sources, with carbon intensity at 235 gCO2eq/kWh, far above the sector average. EnBW aims to decommission its entire conventional generation portfolio by 2035, including the last nuclear plant by 2022 and coal by 2035. This will help it reduce its carbon intensity toward the sector average.

Annual investments of €2.0 billion-€2.5 billion and dividends of €500 million-€600 million over 2021-2025 translates into negative discretionary cash flow.

We also anticipate a 20% increase in S&P Global Ratings-adjusted net debt to about €13 billion by end 2025 from €10.7 billion in 2019. We therefore expect EnBW to maintain some rating headroom, with adjusted FFO to debt at 20.5%-22.0%. We are therefore revising downward our lower and upper rating threshold of adjusted FFO to debt to 19%-23% from 20%-25%. The new range reflects EnBW's track record over previous years, our expectation of further transformation toward greener activities, and a material amount of minority shareholders at subsidiaries.

Outlook

The stable outlook reflects our view that a robust regulated business, accounting for more than 50% of EBITDA, and low-risk renewables operations will continue to provide steady cash flow, boosting EnBW's resilience to the difficult economic conditions. We expect EnBW will continue its decarbonization efforts through implementing its renewable project pipeline and phasing out legacy nuclear and coal assets. Consequently, we anticipate FFO to debt will remain at 19%-23% over the next two years.

Downside scenario:

We could lower our rating if we believe that EnBW will post FFO to debt consistently below 19%. This could occur, for example, due to a change in the company's financial policy, underperformance of the supply business, or a sharp and continued decline in financial assets covering pension and nuclear liabilities. We could also lower the rating if we no longer assume EnBW would receive support from the state of Baden-Wuerttemberg.

Upside scenario:

Rating upside is currently limited, since we believe it would require substantial improvement of EnBW's credit metrics compared with current base-case scenario. This implies FFO to debt sustainably above 23% and gradual strengthening of the business risk profile as the company increases the share of EBITDA from regulated or long-term contracted activities to 80%-90% by 2025.

 

Naturgy Energy Group S.A.

Primary analyst: Gerardo Leal

We revised our outlook to negative because we lack clarity on Naturgy's medium-to-long-term strategic plan, which is being delayed by the IFM tender offer.

On Jan. 26, 2021, Australian infrastructure fund IFM Investors launched an offer to acquire 22.7% of Naturgy's share capital at €23 per share. Because IFM would have two seats on the board if its bid is successful, the offer is delaying the release of Naturgy's strategic plan, which was set for February after being postponed from November 2020. We understand the Spanish government has up to six months from the offer date to approve or reject it, since it entails the purchase of more than 10% of an entity operating critical infrastructure. Rioja Acquisition S. à. r. l. and Global Infrastructure Partners, which own 20.7% and 20.6%, respectively, of Naturgy have stated that they will not sell their shares; Criteria Caixa, S.A.U., Naturgy's largest shareholder with 24.8%, will not declare its stance until after the government releases its decision. We believe the alignment of shareholders is key to executing a strategic plan; however, if this transaction goes through, a realignment of the remaining shareholders could further delay implementation of the plan. In addition, it's unclear what the transaction would mean for the group's governance and financial policy.

Moreover, so far, Naturgy's business evolution doesn't appear well aligned with the energy transition.

In our opinion, Naturgy's investments in renewables lag those of peers such as Iberdrola, Engie, and Enel. We consider that Naturgy's above-average exposure to gas assets, below-average investments in recent years, and aggressive financial policy have increased pressure for the group to speed up investments in areas more aligned with the energy transition. However, the deferral of the strategic plan adds uncertainty to the group's medium-to-long-term strategic direction and could widen the gap between the group and its peers.

The credit implications of increased financial headroom following recent disposals will depend on capital allocation.

Naturgy's disposal of the Chilean electricity network business, Compania General de Electricidad, will provide about €2.3 billion in proceeds after tax, while resulting in the deconsolidation of about €1.3 billion in debt. The agreement reached between Naturgy, ENI, and the Egyptian government to resolve disputes affecting Union Fenosa Gas will provide an additional €489 million. We assume the proceeds will boost FFO to debt to 20%-21% this year, but only temporarily, since we assume investments will increase once the new strategy is released, and the group has historically had an aggressive financial policy. How the disposal proceeds may affect Naturgy's credit quality will depend on their use. A move that preserves the share of regulated assets, while reducing exposure to volatile gas markets and increasing stable renewables generation, could support a sustainable path toward energy transition. That said, increasing the share of renewables at the expense of regulated assets could hurt the group's business risk profile. In addition, we see a risk that, by the time a strategy is agreed, investing in renewables assets or networks could be more expensive, due to increased competition as peers move toward the energy transition.

Muted performance in 2020 highlights the relative weaknesses of Naturgy's business.

On a like-for-like basis (excluding CGE and including restructuring costs), Naturgy's EBITDA dropped by 19% in 2020 compared with 2019, which we expect to be one of the steepest declines for rated peers in Europe. This was mostly due to low gas demand during the first lockdown, which coupled with sluggish prices resulted in negative margins at the LNG business (close to 11% of EBITDA). Overall, EBITDA from power and gas sales and energy management, which include International LNG, markets and procurement, pipelines EMPL, and thermal generation, dropped by 46% in 2020. In our view, this reflects these businesses' high exposure to commodity price and demand fluctuations, which represents a key weakness for the group. In addition, last year Naturgy created impairments of about €1.3 billion on long-term assets, of which €1.1 billion relates to its CCGT plants in Spain. This supports our view of an asset portfolio that is misaligned with the energy transition. Another material impact comes from foreign exchange effects, resulting in a 13% drop in EBITDA from the Latin American operations (which contribute about 20% of EBITDA). Although these are regulated activities, the drop in EBITDA in 2020 shows that they are riskier than European grids. What's more, the contribution from the Spanish gas network activities is decreasing due to limited investment opportunities. These effects translated into S&P Global Ratings-adjusted FFO to debt of 17.2% for 2020, which is below our expectations and the current 18% trigger for the 'BBB' rating.

Outlook

Our negative outlook reflects increased uncertainties stemming from the delay in presenting Naturgy's long-term strategic plan, which we believe is increasing risks for the group as the energy transition accelerates. We believe generous shareholder remuneration and relatively lower investments have put the company at a disadvantage in the context of the energy transition. A long delay in executing a strategic plan could widen this gap, and costly investments in the energy transition could lead to weaker credit metrics. Moreover, potential shareholder misalignment if IFM's offer is successful would complicate the execution of strategy.

Downside scenario:

We could downgrade Naturgy if the company adopts a strategy that, in our view, does not support long-term business sustainability or erodes its financial risk profile, with FFO to debt staying below 18%. We see important milestones during the next six months because the Spanish government has to approve or reject IFM's offer in that period. We assume Naturgy would reveal its strategic plan as intended in February 2021 if the offer is unsuccessful. If the offer goes through, we foresee higher risks since it could take time to align strategic goals between IFM and the other shareholders.

Upside scenario:

We could revise our outlook to stable once the group's strategy becomes clearer and Naturgy executes a plan that enhances the stability and quality of its earnings base over the long term. In our view, this also means recalibrating shareholder remuneration to required investments, and keeping FFO to debt sustainably above 18%.

Related Criteria

•	General Criteria: Group Rating Methodology, July 1, 2019
•	General Criteria: Hybrid Capital: Methodology And Assumptions, July 1, 2019
•	Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
•	Criteria | Corporates | General: Reflecting Subordination Risk In Corporate Issue Ratings, March 28, 2018
•	General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
•	General Criteria: Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015
•	Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
•	Criteria | Corporates | Industrials: Key Credit Factors For The Unregulated Power And Gas Industry, March 28, 2014
•	General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions, Nov. 20, 2013
•	General Criteria: Methodology: Industry Risk, Nov. 19, 2013
•	Criteria | Corporates | Utilities: Key Credit Factors For The Regulated Utilities Industry, Nov. 19, 2013
•	General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
•	Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
•	General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
•	General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
•	General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010

Related Research

•	The Energy Transition And The Diverging Credit Path For European Utilities, Feb. 16, 2021

 

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