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Rating action

Scope Ratings GmbH (Scope) has upgraded the issuer rating of Norwegian utility company Sunnhordland Kraftlag AS (SKL) to BBB+/Stable from BBB/Stable. The rating on senior unsecured debt has also been upgraded to BBB+ from BBB, the same level as the issuer rating.

Rating rationale

The upgrade reflects the expectation that SKL will develop a more conservative financial risk profile, based on the significantly higher power prices already achieved and the current forward market prices. Despite higher dividend expectations and higher expected tax payments (following the 28 September proposal by the Norwegian government to raise taxes¹), Scope still sees the likelihood that SKL could operate with a net cash position in the short to medium term.

With regard to SKL’s business risk profile (assessed at BBB-), 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 with volatile prices and unhedged production output. Its low segment and geographical diversification, as well as its relatively high dependency on its largest power plants, are some business risk constraints.

Based on the company’s high volatility risk, Scope Ratings puts more weight on the business risk profile than the financial risk profile when assigning the overall issuer rating. The financial risk profile (assessed at BBB+; up from BBB) has been relatively conservative in the past, with the exception of FY 2020 when prices were historically low. This year, Scope expects the company to end up with a net cash position, given the strong cash flow from the significantly improved market prices. Although leverage is expected to be conservative in 2023 and 2024 as well, free operating cash flow is estimated to be negative, affected by much higher tax payments and unchanged investment plans. Further, we expect higher dividend levels as well, as already indicated by the extraordinary dividend payment announced in late October this year. Liquidity is adequate, with no significant maturing financial debt before 2025.

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 will adjust capex plans with that goal in mind. 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.

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 selected financial credit metrics will remain conservative, as exemplified by Scope-adjusted debt/EBITDA below 2x, given the prospect of achieving higher-than-normal power prices in the medium term. It also assumes that the company will maintain prudent investment and growth ambitions.

A positive rating action, though remote, could be warranted by an improved business risk profile, possibly by strengthened market position, increased vertical integration or increased horisontal diversification, while keeping credit metrics conservative.

A negative rating action could be warranted by a weakened financial risk profile, due to lower achieved wholesale prices for electricity or larger investment ambitions, with Scope-adjusted debt/EBITDA moving above 2x 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.

Rating driver references
1. Press release from Norweigian government on proposed tax changes for utilities

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, (General Corporate Rating Methodology, 15 July 2022; Government Related Entities Rating Methodology, 6 May 2022; European Utilities Rating Methodology, 17 March 2022), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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: Michael-Marco Simonsen, Associate Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing 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
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