The latest information on the rating, including rating reports and related methodologies, is available on this LINK.

Rating action

Scope Ratings GmbH (Scope) has today affirmed its A-/Stable issuer rating on Terna - Rete Elettrica Nazionale SpA. At the same time, Scope has affirmed the A- rating on senior unsecured debt, the BBB rating on subordinated (hybrid) debt and the S-1 short-term debt rating.

Rating rationale

Terna’s A-/Stable issuer rating continues to reflect the low business risk from its monopolistic position in Italy, where it operates under a robust regulatory framework. This ensures timely and full cost recovery as well as an investment return on the company’s regulated asset base, even in times of challenging macro-economic conditions. The company is sustainably delivering its conservative business plan.

Terna’s operating margin (EBITDA margin) and operating cash flow are being hampered by the reduction of the applicable weighted average cost of capital (WACC) on its regulated asset base, implying an annual EBITDA burden of about EUR 90-100m (rate reduction to 5.0% for 2022-24 from 5.6% over the past three years). The company is nonetheless expected to deliver robust operating results over the coming few years. Scope anticipates that the negative effect of the rate reduction on EBITDA and operating cash flow will be largely offset by a growing asset base and higher income from output-based incentives (mainly related to efficiency measures and debottlenecking). As such, Scope expects only marginal pressure on Terna’s achievable EBITDA margin, anticipated to settle at around 70%. This assumption should hold in the medium term beyond the end of the fifth regulatory period, with the likely and credit-supportive introduction of a tariff-setting concept incorporating total expenditure and a forward-looking approach on investment remuneration that could also involve an increase of the applicable WACC in the medium term. Dramatic adverse changes to Terna’s applicable regulatory framework and cash flow generation are also deemed unlikely. This is in light of the grid operator’s importance within Italy regarding the seamless integration of a growing share of electricity generation from renewables, particularly in the south, as well as its central role in the security of energy supply and in the reduction of congestion (ESG factor: credit-positive environmental and social factors), to which the operator dedicates the largest share of its medium- and long-term investment budget.

Terna’s heavy 10-year development plan of EUR 18.1bn (covering the years 2021-2030) and more specifically the EUR 9.5bn domestic regulated capex (up from EUR 9.0bn) scheduled for 2021-2025 under its strategic investment plan¹ , continue to provide constant pressure on its financial risk profile, namely its leverage. While Terna’s operating cash flow has been historically broadly sufficient to cover annual capex needs, the accelerated investments until 2025 will likely require more external funding. Negative free operating and discretionary cash flow will therefore persistently weigh on leverage and cash flow cover and will trigger additional measures aimed at keeping leverage commensurate with the current rating. Moreover, capex needs over the medium to long term could remain high if Italy put more emphasis on the ramp-up and integration of renewables in its electricity mix beyond the targeted 55% by 2030 in an attempt to reduce its dependency on gas- and coal-fired electricity generation.

Scope expects a smaller headroom against a negative rating action in relation to leverage, measured by Scope-adjusted debt (SaD)/EBITDA, by YE 2024. While SaD/EBITDA is expected to remain within 5x and 6x until 2024 (against an estimated 5.3x in 2021 or 5.0x average over the past three years), which would still be commensurate with the A- issuer rating, further capital measures would be required to keep leverage within that corridor. Scope understands Terna’s strong commitment to preventing a sustained deterioration of its indebtedness if a weaker financial risk profile and a potential negative rating action become too likely. This was evident in early 2022 when Terna launched its inaugural EUR 1.0bn subordinated hybrid bond, benefiting from a 50% equity credit on the debt exposure. Scope believes that similar hybrid debt placements might be executed over the next few years after Terna has witnessed the appetite for such funding instruments, judging by the strong oversubscription of more than 4 times from the test balloon in 2022. Furthermore, Scope sees the possibility that Terna would conduct asset disposals on non-core assets outside of the Italian market, something that has already been envisioned within the reporting of the 2021 preliminary figures through the classification of South American subsidiaries as assets held for sale. While Terna has just confirmed its medium-term dividend policy with a CAGR of 8% from 2020-2023 and a payout floor for 2024/25, Scope does not rule it out that the company would revisit its dividend strategy if this would be required.

Based on Scope’s EBITDA forecasts for 2022-2024, Terna’s debt headroom against a potential negative rating action (triggered if SaD/EBITDA nears 6.0x) is expected to shrink from EUR 1.6bn in 2022 to EUR 0.8bn in 2023 and to EUR 0m in 2024.

Despite the rising pressure on leverage from prolonged negative discretionary cash flow, interest coverage and liquidity are expected to remain very solid. The EBITDA interest coverage ratio is expected to be retained well above 10x. Scope expects liquidity over the next few years to stand consistently above 200%, backed by the solid unrestricted cash buffer of over EUR 2.5bn at YE 2021, available committed revolving credit facilities of EUR 3.15bn and operating cash flow expected at more than EUR 1bn annually.

The issuer rating on Terna is one notch higher than the sovereign rating on the Italian Republic (rated BBB+/Stable by Scope) as Scope does not apply mechanistic sovereign rating caps. While Terna is certainly exposed to regulations and subject to significant public scrutiny, Scope believes regulated grid operators are only affected to a limited extent by the country’s investment grade-rated state finances and macroeconomic conditions.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s expectation that Terna’s indebtedness will remain high, with SaD/EBITDA in the 5x-6x range in the next few years, gradually increasing to the upper end of this range owing to rising capex needs over the medium term.

A positive rating action could be warranted if the company strengthened its balance sheet, e.g. by reducing SaD/EBITDA of close to 4x on a sustained basis. Given the large investment programme and low free operating and discretionary cash flow over the next few years, such a rating upgrade is currently unlikely.

A negative rating action could result from a sustained deterioration in the company’s financial risk profile as displayed by a SaD/EBITDA of close to 6x. This could happen if measures to contain leverage are not sufficient over the medium term. Alternatively, drastic adverse changes in Italian tariff regulation would jeopardise Terna’s high margin profile and timely recovery of costs and put the current rating under pressure.

Long-term and short-term debt ratings

All senior unsecured debt issued by Terna has been affirmed at A-, the level of the issuer rating. Subordinated (hybrid) debt issued by the company has been affirmed at BBB, two notches below the issuer rating.

Terna’s short-term debt rating has been affirmed at S-1, bolstered by sound and sustained liquidity measures as well as well-diversified funding channels consisting of capital market debt and loan financing (i.e. European Investment Bank and shareholder loans as well as ESG credit facilities).

Rating driver references
1.Terna’s updated 2021-25 Industrial Plan

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, 17 March 2022), are available onhttps://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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 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: Sebastian Zank, Executive Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 17 May 2019. The Credit Ratings/Outlook were last updated on 23 November 2020.
The Subordinated Debt Credit Rating was first released by Scope Ratings on 1 February 2022.

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
© 2022 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.