Portuguese Power Utility EDP Affirmed At 'BBB-/A-3' With Limited Rating Headroom Through 2020; Outlook Stable

  • EDP - Energias de Portugal S.A.'s 2018 results were below our expectations, notably because of weaker-than-expected performance in renewable and conventional power generation.
  • We believe that EDP's recently announced strategic plan for 2019-2022 underlines its commitment to reducing leverage (net debt to EBITDA).
  • We are therefore affirming our 'BBB-/A-3' ratings on EDP, but note that there is limited headroom at the current rating level.
  • The stable outlook reflects our expectation that EDP will successfully execute its strategy, and improve adjusted funds from operations (FFO) to debt to about 16% in 2019, while reducing adjusted debt to EBITDA to about 4.5x.
PARIS (S&P Global Ratings) April 15, 2019--S&P Global Ratings today took the rating actions listed above.
We are affirming the ratings given our expectation that EDP will continue reducing leverage over 2019-2020, in line with its recently announced strategic plan for 2019-2022. This is despite weaker-than-expected performance in 2018, which results in headroom under the current ratings remaining limited.
EDP's strategic plan focuses on:
  • Accelerating the growth of long-term contracted renewables, which are likely to support cash flow visibility. EDP plans to increase its renewables production to more than 70% of power generated in 2022 and more than 90% in 2030, from 66% in 2018.
  • Increasing annual capital expenditure (capex) by 60% to €2.9 billion per year in 2019-2022 compared with €1.8 billion per year in its previous business plan (2016-2020).
  • Executing an ambitious asset rotation program: Over 2016-2018 EDP sold €1.9 billion of minority stakes. Over 2019-2022 EDP will focus on majority stake disposals, targeting more than €4 billion over the four-year time period. In addition, EDP plans to raise €2 billion from asset disposals in the next 12-18 months, which we understand prioritizes the disposal of merchant power generation assets in Iberia.
  • Significantly reducing reported net debt to EBITDA to below 3.2x (around 4.5x S&P Global Ratings' adjusted) in 2020, and below 3.0x (around 4.0x S&P Global Ratings' adjusted) in 2022, from 4.2x in 2018 (5.7x S&P Global Ratings' adjusted). We see this target as challenging, given the group's ambitious investment plan, which will be partly financed by the aforementioned asset rotation strategy, and the leverage level at which the group has operated historically (adjusted leverage was sustainably above 5.0x in the past five years). While debt-reduction efforts are paramount to the sustainability of the current ratings, notably in the context of currently weak credit ratios, EDP does not necessarily need to meet its ambitious 2020 leverage target of about 3.2x to maintain the 'BBB-' long-term rating. We consider 3.5x as adequate. Additionally, we note that most of the efforts to reduce financial leverage will be achieved in the early years of the plan (2019 and 2020).
  • Increasing shareholder payout: EDP increased the payout ratio to 75%-85% of net income (65%-75% in the previous plan), with a floor of €0.19 per share (dividends paid in 2018). We note EDP's payout ratio is higher than peers' Enel (70%) or Iberdrola (65%-75%), and that EDP's financial commitment to improve its credit metrics and ratings is somewhat hampered by this shareholder remuneration policy. However, we expect the company to increase dividends only if performance allows for it.
The new strategic plan, which dedicates €8 billion of investment to renewables, highlights EDP's ambition to accelerate growth in this division. EDP plans to finance part of this investment with asset rotation and disposals (cumulative amount of €6 billion over 2019-2022). We see this strategy as aggressive, but take into account EDP's strong track record in securing asset rotations in a timely manner.
Our assessment of EDP's business risk continues to be supported by the significant earnings' contribution from power network activities in Iberia and renewables operations in North America, Europe, and Latin America (about 71% in 2018, according to our estimates).
We expect regulated activities in Iberia will represent about 20% of group EBITDA over 2019-2022, while electricity distribution and transmission in Brazil should represent 10%. The contribution to total EBITDA of EDP's subsidiary EDP Renovaveis (EDPR) should remain broadly stable at about 41%, with exposure to merchant generation in Iberia declining to 20% of total EBITDA in 2022, from 23% in 2018. We consider EDP's power distribution assets as part of its core business, and should EDP partially exit from these assets, we would likely reassess its creditworthiness. We continue to see EDPR's portfolio as an additional strength to the business, with 90% of EDPR's revenue coming from regulated activities and power purchase agreements (PPA) versus 10% that are exposed to merchant power. The average remaining life of these PPA contracts is 15 years in the U.S. and 11-12 years in Europe, which provides significant cash flow visibility over a long period of time. As part of the 2019-2022 strategic update, EDP wants to increase the average remaining life of PPAs to 20 years.
At this stage, we see EDP's commitment to reduce its financial leverage as a key supporting factor to the rating. We currently consider EDP to be more leveraged than peers with a 'bbb-' stand-alone credit profile, notably Electricite de France and Fortum Oyj. We note that EDP's adjusted debt to EBITDA has been sustainably well above 5.0x (about 4.0x reported) over the past five years. As a result, our rating is underpinned by our understanding that EDP will prioritize efforts to reduce financial leverage as part of its strategic plan at least over the next two years, with adjusted debt to EBITDA expected to decline to about 4.5x by 2019 (3.5x reported).
The stable outlook on EDP reflects our expectation that our assessment of its financial risk will continue to improve over the next two years on the back of stronger operating performance and the disposal of merchant assets in Iberia in the next 12-18 months. This should lead to FFO to debt of close to 16% in 2019, and adjusted debt to EBITDA declining to about 4.5x over the same time period (3.5x reported), from 5.7x in 2018.
Management's perceived commitment to maintaining the investment-grade rating, and its policy to bring reported debt to EBITDA down further by 2020 underpin the outlook. We will continue to monitor the potential of a takeover of EDP by China Three Gorge Corporation CTG, and its potential impact on EDP's credit quality, although the likelihood of this event seems low in the near future (see "The China Three Gorges-EDP Deal: What Are The Potential Credit Implications?," published on May 18, 2018).
Should EDP sell part of its Iberian power distribution activities, we would likely reassess its creditworthiness.
We could downgrade EDP if FFO to debt does not improve as expected and stays materially below 16% in 2019. A downgrade would also be triggered by EDP's inability to materially decrease its leverage over 2019-2020, with adjusted debt to EBITDA materially above 4.5x in 2019.
This could be prompted, for example, by continuously challenging conditions in the Iberian power generation market; any deviation from the improvement in the leverage-reduction target presented in the 2019-2022 plan; a material heightening of Portuguese and secondarily Brazilian country risk (including adverse regulatory or fiscal effects); inability to effectively securitize tariff deficits or achieve its asset-rotation target in 2022; or debt-financed acquisitions of a significant amount.
We see ratings upside as remote over the next two years, since it would require EDP to achieve FFO to debt above 20% over the next two years, which we consider highly unlikely.
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