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Rating action

Scope Ratings has today affirmed the A-/Stable issuer rating of Terna - Rete Elettrica Nazionale SpA (Terna). Long-term senior unsecured debt issued by Terna and its predecessor under the EMTN programme has been affirmed at A-; short-term debt has been affirmed at S-1.

Rating rationale

Terna’s issuer rating continues to reflect its limited business risks, with a monopolistic position in Italy under a robust regulatory framework that guarantees timely and full cost recovery as well as strong operating cash flow, depicted by an EBITDA margin sustained above 70%.

While Terna’s exposure to the Italian Republic (rated BBB+/Stable by Scope) remains a credit-negative, the company’s revenues and margins are deemed resilient, even during recessions and times of economic turmoil. According to Scope’s Public Finance analysts, Italy’s economy is on the cusp of technical recession, compounded by extra government spending and disruptions from the Covid-19 virus. However, Scope argues that a regulated grid operator like Terna would be less severely affected by such disruption. This view is based firstly on the robustness shown by Terna during the 2008/09 global financial crisis and the 2011/12 euro crisis, the latter of which affected Italy strongly. Since 2000, Terna’s EBITDA has reduced only once on a year-on-year basis (in 2008) and EBITDA margins have remained around or above 70%. Secondly, Italy’s framework for regulated grid activities, which generates more than 90% of Terna’s operating cash flows, is effective at limiting volume effects (only 10% of the transmission tariff relates to energy volume, while 90% relates to load, which is robust against withdrawn kWh from the transmission grid).

Terna’s very solid margins and cash flow provide strong credit support. Its EBITDA margin should remain high, also within the peer group of European regulated power grid operators, as the applicable WACC of Terna’s regulated asset base is fixed at 5.6% for the 2020 and 2021 tariffs. Further, the regulatory framework and applicable WACC are unlikely to see major changes for the remaining two years of the fifth regulatory period (until 2023). While it can be argued that transmission tariffs could be compromised by the regulator to appease politicians and the public, this is unlikely given the importance of Terna’s transmission infrastructure for Italy’s ongoing energy transition as well as the current developments regarding applicable risk premiums for investments in Italy.

Terna’s financial risk profile remains a major constraint to the rating. The updated capex programme, with raised net capex needs of EUR 7.3bn over 2020-24 (against net capex of EUR 6.2bn over a five-year period anticipated by Terna a year ago), is expected to result in neutral or negative free operating and discretionary cash flows. This will leave leverage, as measured by Scope-adjusted debt (SaD)/EBITDA, at around 5x. However, Scope does not anticipate the higher capex to inflate overall leverage as the resulting addition of both regulated and unregulated assets will be accompanied by steady growth in EBITDA and cash flow. Terna still has significant headroom to Scope’s negative rating trigger for debt (6x SaD/EBITDA), by around EUR 1.7bn on average based on Scope’s EBITDA forecasts for 2020-22E. Likewise, Terna could digest a 15% shortfall on average on the expected EBITDA before reaching the negative rating trigger.

Debt protection, as measured by EBITDA interest coverage, remains solid at above 10x. Such level is expected to be sustainable, strengthened by the refinancing of the EUR 600m bond (4.875% coupon) in October 2019 through new bond issues at much more favourable conditions, saving Terna around EUR 28m of interest every year. The same effect is expected for 2022 after the EUR 1,250m bond is refinanced in March 2021 (4.75% coupon).

Terna’s liquidity remains strong, with about EUR 2.7bn of debt to be refinanced over the next three years (EUR 0.2bn in 2020E, EUR 1.4bn in 2021E, and EUR 1.2bn in 2022E). This is likely to happen through external funding, given Scope’s expectations of neutral to slightly negative free operating cash flows over that period and the unrestricted cash cushion of more than EUR 1bn at YE 2019. Pointing to the company’s available credit facilities of more than EUR 2.5bn at the YE 2019, liquidity will be well above 200% at all times, which is sound for a low investment-grade financial risk profile.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s expectation that Terna’s indebtedness will remain high, with a Scope-adjusted leverage (SaD/EBITDA) sustained at around 5x in the next few years owing to rising capex needs over the medium term as indicated by the updated strategy and investment plan.

A positive rating action rating could be warranted by a stronger balance sheet, e.g. by reducing SaD/EBITDA towards 4x on a sustained basis. This is unlikely for the time being, however, given the large investment programme and associated low free operating and discretionary cash flows expected for the next few years.

A negative rating action could result from a deterioration in the financial risk profile following a prolonged period of negative free operating and discretionary cash flows, resulting in SaD/EBITDA rising towards 6x, or from drastic adverse changes in the Italian tariff regulation that jeopardise Terna’s high margin profile and timely recovery of costs.

Long-term and short-term debt ratings

All senior unsecured debt issued under Terna’s EMTN programme is affirmed A-, the level of the issuer.

Terna’s short-term debt rating has been affirmed at S-1. This is bolstered by Terna’s strong sustained liquidity as well as the well-diversified mix of capital market debt and loans (i.e. EIB and shareholder loans as well as ESG-linked credit facilities).

Stress testing & cash flow analysis
No stress testing was performed. Scope performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for this rating(s) and/or rating outlook(s) (Corporate Rating Methodology; Rating Methodology on European Utilities) are available on www.scoperatings.com.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rated entity participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity and Scope internal sources.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst Sebastian Zank, Executive Director
Person responsible for approval of the rating: Olaf Tölke, Managing Director
The ratings/outlooks were first released by Scope on 17 May 2019.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2020 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.

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