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Rating action

Scope Ratings GmbH (Scope) has assigned a BBB/Stable issuer rating on Norwegian utility company Sunnhordland Kraftlag AS (“SKL”) along with a BBB senior unsecured debt rating.

Rating rationale

The issuer rating reflects a stand-alone credit quality of BBB- and a one-notch uplift based on our assessment of parent support. The uplift is driven by the anticipated capacity and willingness of the indirect municipality owners to provide support, assessed in accordance with Scope’s Government Related Entities methodology.

With regard to SKL’s business risk profile, Scope notes positively its low-cost, environmentally friendly hydropower production (positive ESG factor). The company also has significant reservoir capacity (about 50% of annual production) that provides its power generation segment with more flexibility, which is advantageous when operating in a market that has volatile prices. Limiting factors for SKL’s business risk profile include the electricity price exposure to its unhedged production output, and the volatile nature of the power generation industry, coupled with low diversification by segment and geographical pricing market. Its high dependency on its largest power plants, which account for a significant share of its annual production, is also a business risk constraint.

When assessing SKL’s financial risk profile, Scope notes volatility in selected credit metrics during the last two to three years due to market conditions and its high exposure to power price volatility, as the company does not engage in any power price hedging. Although fiscal year 2020 showed negative operating cash flow and weak financial credit ratios, Scope Ratings expects 2021 to be the opposite, resulting in unusually conservative credit ratios. With Scope’s power price assumption and the expectation that the company will have higher investments going forward and maintain its dividend policy, Scope Ratings expect the company to operate with leverage of 2x-3x in the medium term.

Based on the company’s high volatility risk, Scope Ratings put more weight on the business risk profile than the financial risk profile when assigning the overall issuer rating, as long as liquidity is adequate. This is also reflected in Scope’s positive and negative rating triggers described in the Outlook section.

Scope has made no adjustments for financial policy, as this is already reflected in our financial risk profile assessment. Scope notes that the company aims to keep an investment-grade profile, and thus capex plans should always be analysed against this goal before any commitment is made. Should the company make a large investment that increases its financial risk, Scope understands that SKL’s policy could be to secure part of its power pricing risk via a hedging arrangement in the future.

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

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s expectation that SKL will continue to be a cost-efficient and profitable hydropower generation company that maintains a prudent and conservative financial risk profile that can withstand the expected volatility in power prices. It also assumes the indirect municipality owners will continue to be long-term owners with both the capacity and willingness to support the company if needed.

A positive action is remote unless business risk is reduced through measures that reduce the company’s high volatility. In this scenario, it could be warranted if discretionary cash flow remained positive over time, resulting in a sustainable improvement in credit metrics. This would be exemplified by a Scope-adjusted debt/EBITDA of around (or below) 2x on a sustained basis.

A negative rating action could be triggered by lower achieved wholesale prices for electricity and larger investment ambitions. This would create a weaker financial risk profile, exemplified by a Scope-adjusted debt/EBITDA of above 3.5x on a sustained basis

Long-term and short-term debt ratings

The BBB senior unsecured debt rating, which is in line with the issuer rating, is based on the company’s standard bond documentation, which includes a pari passu clause and a negative pledge. Senior unsecured bonds are issued at the level of Sunnhordland Kraftlag AS.

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

Methodology
The methodologies used for these Credit Ratings and/or Outlook, (Corporate Rating Methodology, 6 July 2021; Rating Methodology: European Utilities, 18 March 2021; Rating Methodology: Government Related Entities, 5 May 2021), are available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity, the Rated Entities' Related Third Parties and Scope Ratings' internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed.
Lead analyst: Henrik Blymke, Managing Director
Person responsible for approval of the Credit Ratings: Tommy Träsk, Director
The Credit Ratings/Outlook were first released by Scope Ratings on 13 December 2021.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
© 2021 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis 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.