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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 Scope’s credit-positive view of the limited risk in the company’s business. Terna’s monopolistic position in Italy under a robust regulatory framework guarantees timely and full cost recovery as well as robust operating cash flow, as depicted by the grid operator’s sustained EBITDA margin of above 70%. The company’s strong operating performance amid the Covid-19 pandemic as well as depressed electricity consumption and transmission volumes impressively underpins its robustness under the regulated framework for electricity transmission.

While Terna’s exposure to the Italian Republic (rated BBB+/Negative by Scope) remains a credit-negative, this is not reflected through a mechanistic rating cap. Scope keeps its view that, despite being subject to regulations and significant public scrutiny, Terna is affected only to a limited extent by the finances and macroeconomy of Italy (a feature shared with other regulated grid operators operating in mature and investment-grade-rated countries). Firstly, Terna’s remuneration for its crucial infrastructure assets and services, in the form of regulated tariffs (more than 90% of recurring income), is largely independent of macroeconomic developments. Secondly, deteriorating sovereign refinancing rates are expected to have only a limited effect on regulated grid operators’ refinancing rates and are partially offset by adjusted tariffs (through an adjusted WACC). Lastly, Scope deems it unlikely that a significant negative adjustment of electricity transmission tariffs would become politically sensitive, given the low single-digit percentage earmarked for transmission infrastructure in the electricity bills of industrial, commercial and household customers.

Terna’s credit quality remains strongly supported by its very solid margin and cash flow profile, with a recurring EBITDA margin of above 70%. This is set to continue, with the applicable WACC to Terna’s regulated asset base fixed at 5.6% for 2020 and 2021 tariffs. Although WACC may reduce for the remaining two years in the fifth regulatory period (until 2023), the effect on EBITDA and operating cash flow is expected to be balanced by the growing asset base and, potentially, a growing cash inflow related to output-based incentives. Overall, Scope does not expect drastic changes for the credit-supportive regulatory framework. This view is supported by the importance of transmission infrastructure for Italy’s ongoing energy transition. Overall, Scope regards Terna’s business to benefit from political and regulatory tailwinds that reduce the likelihood of unexpected adverse changes in regulation (ESG-factor: credit-positive environmental and social factor).

Terna’s financial risk profile, however, remains a major rating constraint. This is particularly in light of the company’s updated Strategic Investment Plan, which schedules accelerated net capex of around EUR 8.9bn over 2021-251, against EUR 7.3bn over five years under the previous plan. The resulting negative free operating and discretionary cash flow will leave little room for Terna to keep its leverage – as measured by Scope-adjusted debt/EBITDA – below 5.0x, as it has over the last four years. While Scope forecasts leverage to increase gradually to around 5.5x over the next two years, Terna’s headroom to a 6x Scope-adjusted debt/EBITDA, which is the trigger for a potential negative rating action, remains significant. However, with capex increasing in the latter stage of the new plan, such headroom would shrink materially after 2022 if Terna does not offset the effects. However, Scope understands that if the debt headroom were to become too narrow, the company would commit to measures such as (re)financing through hybrid debt and other measures that would strengthen the company’s balance sheet. Based on Scope’s EBITDA forecasts for the next three years Scope assumes that Terna’s debt headroom against a potential negative rating action would shrink from EUR 1.7bn in 2021 to around EUR 500m in 2023.

Despite rising pressure on leverage from prolonged negative discretionary cash flows, debt protection and liquidity remain very solid. Debt protection – measured by the EBITDA interest coverage ratio – remains well above 10x, despite the increased debt burden. Amid the still favourable interest level, Scope expects significant interest savings following the refinancing in March 2021 of the EUR 1.25m bond with a 4.75% coupon. Terna’s favourable interest rate level was impressively evidenced in 2020 by two debt placements: a 12-year green bond with a 0.75% coupon issued in July and a 10-year bond with a 0.375% coupon in September.

Terna’s liquidity position is expected to stand strong despite the accelerated capex plan and the more than EUR 4.0bn of debt to be refinanced over the next three years (EUR 1.4bn in 2021E, EUR 1.1bn in 2022E and EUR 1.6bn in 2023E). While Terna is likely to refinance maturing bonds via capital markets, its annual refinancing needs are consistently covered twice over, by the unrestricted cash buffer, expected to remain above EUR 1.5bn (EUR 3bn as of September 2020), and available credit facilities, expected at more than EUR 2.5bn at YE 2020. As such, Terna’s strong liquidity somewhat offsets Scope’s slightly deteriorated view on leverage and free cash flows.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s expectation that Terna’s indebtedness will remain high, with a Scope-adjusted debt/EBITDA in the 5.0-5.5x range in the next few years, owing to rising capex needs over the medium term, as indicated by the updated strategic plan.

A positive rating action rating could be warranted if the company strengthened its balance sheet, e.g. by reducing Scope-adjusted debt/EBITDA towards 4x on a sustained basis. Given the large investment programme and low free operating and discretionary cash flows over the next few years, such a rating upgrade is unlikely for the time being.

A negative rating action could result from a deterioration in the company’s financial risk profile. This could follow a prolonged period of negative free operating and discretionary cash flows that results in Scope-adjusted debt/EBITDA rising towards 6x, or drastic adverse changes in Italian tariff regulation that jeopardises 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 has been affirmed at A-, the level of the issuer rating.
Terna’s S-1 short-term debt rating has been affirmed, bolstered by sound and sustained liquidity measures as well as well-diversified funding channels consisting of capital market debt and loan financing (i.e. EIB and shareholder loans as well as ESG credit facilities).

One or more key drivers for the credit rating action are considered ESG factors.

Rating driver references
1 19 November 2020 TERNA press release: 2021-2025 INDUSTRIAL PLAN APPROVED

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 as of 26 February 2020; Rating Methodology on European Utilities as of 18 March 2020) 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. The ratings/outlooks were last updated on 13 March 2020.

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. Scope Ratings GmbH, Lennéstraße 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Director: Guillaume Jolivet.