ENGIE Rating Placed On CreditWatch Negative Amid COVID-19 Outbreak Due To Tight Financial Headroom And Governance Change

  • Given a likely European economic slowdown in the context of the COVID-19 pandemic, we believe that ENGIE S.A.'s earnings could be pressured by lower contributions from its more cyclical Clients Solution business, and by lower power prices on unhedged positions growing from 2021.
  • ENGIE's financial headroom has tightened following an acquisitive 2019 and upward revisions of its nuclear provisions. We believe that the group's current rating cannot withstand any operational underperformance without credit-protective measures.
  • This is in the context of uncertainty around the group's strategic direction and organization, as the search for ENGIE's CEO's replacement started in February 2020.
  • We are placing the 'A-/A-1' long- and short-term issuer credit ratings on CreditWatch with negative implications to reflect growing operating pressures at a time when the company's governance is more vulnerable.
  • We plan to resolve the CreditWatch placement after we assess the extent of the downside risks and the group's action plan to counterbalance lower earnings prospects, and once we have evidence of its commitment to support credit metrics including FFO to net debt above 20%.
PARIS (S&P Global Ratings) March 25, 2020—S&P Global Ratings today took the rating actions listed above.
ENGIE had lower rating headroom before the start of the COVID-19 outbreak.
ENGIE's 2019 results already reflected tight financial headroom following significant investments and capital deployed (€10 billion in 2019, including €1.5 billion to acquire 49.3% in Brazilian gas pipeline TAG). This translated in funds from operations (FFO) to net debt of about 19%, already below our 20% requirement for the current rating. In the context of possible lower earnings, and without credit protective measures, we believe it will be difficult for ENGIE to restore metrics above 20%, bearing in mind delayed investments will be mitigated by a potential halt in the disposal process (initially planned for a total of €4 billion from 2020-2022).
This comes on top of a change in governance that occurred on Feb. 6, 2020. In an extraordinary meeting, ENGIE's board of directors did not renew Isabelle Kocher's board mandate (which was due to expire in May), effectively ousting her as CEO. The move exposed, in our view, dissension and a lack of alignment between Ms. Kocher, the board, and its president, Jean-Pierre Clamadieu. It also cast uncertainty around the group's strategic direction and organization as the search for a replacement begins.
We expect ENGIE's earnings to be negatively affected by the looming global recession in its more cyclical Client Solutions business.
We now forecast Europe to enter into a recession for the first half of 2020 (see "COVID-19 Macroeconomic Update: The Global Recession Is Here And Now," published March 17, 2020) and see economic risks rising for the following quarters, notably with a potential rapid appreciation of the euro and further economic slowdowns in other regions.
As a result, we forecast that ENGIE's Client Solutions business--still mostly exposed to Europe--may suffer from a significant reduction of its contracting base, especially in its asset-light services. We assess that both types of ENGIE's clients--industrial (about 27% of its portfolio) and public municipalities--will likely reduce discretionary nonprioritized spending, including on ENGIE's energy services. While we think the asset-based solutions are more resilient (longer-term contracts between 10 and 15 years, e.g. district heating and cooling infrastructures) ENGIE's growth over 2020-2022 will be driven primarily by asset-light energy services. While the economic situation is still evolving amid an undefined lockdown period, asset-light services, in the form of projects and recurring services, are more likely to suffer in our view from a prolonged economic slowdown because they are more cyclical. We are thus uncertain about the pace of a growth recovery after 2021 given the lack of clarity on the magnitude and length of the current outbreak.
ENGIE's generation and supply earnings will also be at risk for 2020 and 2021.
We also expect ENGIE's generation and supply earnings to be negatively affected by lower electricity consumption in Europe (negative 5%-7% down in 2020 year over year), as well as weaker commodity prices driving lower power prices (negative 20% next year compared to our previous assumptions) will affect earnings on its unhedged outright production, hydro and nuclear, in France and Belgium.
EBITDA contribution of its supply business was already weak in 2019 (about €640 million, or 6% of the total group's EBITDA), primarily due to lower margins on gas and power retail for B2C clients as well as some one-offs in different geographies. We forecast a limited recovery from this low point due to weaker demand prospects.
In light of our revised power price forecasts in France and Belgium of €40 per megawatt hour for 2020 and 2021, and based on the current level of hedged of its outright production (about 58 terawatt hours) of 80% in 2020 and 54% in 2021, we assess a lower EBITDA of about €300 million, with a greater impact in 2021.
At this stage we forecast a power price recovery in 2022 driven by tight supply in neighboring countries and a drawdown of coal and nuclear capacities in Germany. If commodity prices remain depressed for longer, we would expect further EBITDA deterioration related to ENGIE's merchant-exposed generation.
We see some upward pressure on economic debt, with potential higher nuclear provisions delayed to next the triennial revision.
Increasing pension and asset retirement obligation deficits may also affect ENGIES's economic debt as actuarial assumptions may increase liabilities. Given the existing Belgian regulation, we forecast that the group could face another material increase in its nuclear provisions in 2022, when next the triennial revision is due by the Belgian Nuclear Provisions Commission. ENGIE already faces an increase of €2.5 billion in its nuclear provisions in 2019 to €14 billion (see "Credit FAQ: Higher Nuclear Provisions And Lower Regulatory Returns: What Do They Mean For Engie S.A.?" published Dec. 20, 2019).
At the same time, we see additional risks any underperformance of planned assets (because of the significant decline in the stock markets over the past few weeks) offsets pension liabilities and, to limited extent dedicated assets offsetting nuclear liabilities, which could increase the deficit. More precisely, we see the current deficits widening for 2020 on increased pension liabilities and reduced fund performance, resulting in an increase of about €1 billion for 2020, with potential higher nuclear provisions delayed to 2022 (when the next triennial regulatory revision is due). These deficits, combined with lower earnings, could pressure further ENGIE's adjusted credit metrics.
Some mitigating factors will support ENGIE's cash flow.
Engie's regulated infrastructure business provides some resilience to the group's earnings (39% of EBITDA in 2019) thanks to the essential service of transporting and distributing gas in France, and the regulated nature of its activities (network business).
On supply, in ENGIE's French market, we foresee working capital increasing as a result of extraordinary supportive measures announced by the government, including the postponement of gas and electricity bill payments. We recognize that working capital needs generally peak during the winter season and start to decrease as spring comes and payments are made. It is therefore likely that we will not see a major increase in debt over the coming months, but we also may not see the typical decrease at that time of the year. While temporary, this would be a negative for credit metrics and the recovery of the working capital outflows could take time. If the extent of this outflow becomes material, some governments may also provide some kind of support, including government-backed liquidity lines. Such measures have not been announced at this stage.
Supply chain disruptions could hurt the commissioning of renewable capacities and cause delays. While difficult to quantify at this time, we assess that it's currently marginal and thus manageable for ENGIE's earnings.
Growth capex cut could also provide some short-term relief.
Lower investments will likely support credit metrics in the short term. Less activity from suppliers and reduced availability of staff and contractors due to forced containment will force utilities to focus on the most essential projects in Europe and postpone many of their discretionary projects. We believe this applies to ENGIE and that a complete revision of its growth capital expenditure (capex) plan is most likely as the group assesses the full impact of the outbreak on its different businesses. We also believe the lockdown will materially delay maintenance capex, most likely into 2021.
ENGIE continues to maintain an excellent liquidity position.
ENGIE had a very comfortable liquidity position, with €10.9 billion of cash and equivalents at the end of December 2019, as well as €12.4 billion of committed undrawn credit lines, maturing beyond 12 months, that cover debt maturities beyond 2020. Amid volatile financial markets, ENGIE successfully issued a €2.5 billion multitranche bond with maturities up to 2032, with almost no impact on the average cost of debt to approximately 2.7%.
The CreditWatch negative placement indicates that we could downgrade ENGIE if the group cannot provide clear remedy measures to address weaker credit metrics arising from lower earnings prospects amid the COVID-19 outbreak. We anticipate ENGIE will continue assessing the magnitude of the crisis on its business in the coming weeks. We will be monitoring the effectiveness of ENGIE's board to manage the current situation. Without proactive measures to support the balance sheet, including dividend reduction and hybrid debt issuance, we would consider lowering the rating.
Lower earnings prospects could materialize on the back of:
  • Further evidence of Client Solutions contraction for a prolonged period.
  • Reduced availability of its nuclear fleet due to unplanned outages.
  • Greater-than-expected disruptions of its supply chain, lowering the group's renewables contribution.
  • Higher working capital requirements resulting from the government's constraints on its supply activity.
We could affirm the rating if we gain comfort that the group will be able to restore adjusted FFO to net debt above 20% amid lower earnings prospects on the back of strong counterbalancing measures.
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