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Rating action

Scope Ratings GmbH (Scope) has today upgraded the issuer rating of Norwegian utility Hafslund AS to A- from BBB+. The Outlook remains Positive. Concurrently, the senior unsecured debt rating has been upgraded to A- from BBB+, whilst the short-term debt rating has been upgraded to S-1 from S-2.

Rating rationale

The upgrade is driven by Scope’s view on Hafslund’s significantly improved financial risk profile. Granted, the utility’s financials will remain volatile and strongly dependent on external factors such as achievable power prices. But Scope is comfortable assessing the financial risk profile at A-, backed by expectations of persistent elevated electricity market prices in the Nordics. Combined with an unchanged business risk profile assessment of BBB+ and a one-notch uplift due to the utility’s status as a government-related entity, Scope deems Hafslund’s issuer rating commensurate with a rating of A-. The Positive Outlook signals further rating upside should Hafslund sustain its leverage at a low level of around 2.0x beyond 2025E.

The rating continues to reflect a BBB+ business risk profile. The successful integration of Norway’s largest district heating and cooling company Celsio (formerly Fortum Oslo Varme) has put Hafslund’s business on a broader footing and will likely develop into a major growth driver for the company. This is paired with gradual growth in cash generation via an indirect exposure to regulated grid activities and associated dividend payments from equity stakes in associated companies, primarily Eidsiva Energi. Whilst Hafslund’s cash flow exposure will remain strongly geared towards its core business in unregulated power generation from hydropower plants, the growing cash flow exposure to power distribution and district heating provides the business with stability. This is particularly important in light of Hafslund’s large exposure to volatile electricity generation prices and its core exposure to spot market prices due to limited hedging activities. Whilst Scope assumes supportive electricity prices over the next few years in a range largely above the historical average, adverse price developments, e.g. due to heavy rainfall, cannot be ruled out.

Favourable market fundamentals and the company’s setup will likely translate into persistent strong profitability as measured by the Scope-adjusted EBITDA margin and Scope-adjusted ROCE. The consolidated group EBITDA margin (excluding income from associates) reliably stands above 60% given the low operating cost base of Hafslund’s core business in electricity generation. Operating costs for hydropower production, such as for pumping, energy purchases and transmission costs, are relatively low and vary with power prices and volume. As the cost base is comparatively low in absolute terms, margin fluctuation is also rather low. Granted, district heating and cooling is a business that is exposed to much higher operating costs pertaining to raw materials procurement and the operation of incineration plants, and the company’s exposure to this business is growing. But Scope does not foresee material risks that the group EBITDA margin and Scope-adjusted ROCE will fall significantly below 60% and 15% respectively.

As a producer of clean hydroelectric power, Hafslund and its business model revolve around sustainability (ESG factor), fulfilling the UN’s Sustainable Development Goal 7 (Affordable and clean energy). This is signalled by the company’s very low carbon intensity, with a specific carbon intensity of less than 20g CO2e/kWh. Such a position: i) rules out transition risks; and ii) ensures high utilisation of the hydropower generation portfolio, a high margin, robust cash flow generation and limited headwinds from regulation and political interference. Moreover, the exposure to hydropower generation guarantees a consistent GRE status. Moreover, Hafslund’s exposure to the generation of district heating and cooling is primarily based on waste incineration, which promotes a circular economy. Currently, the company builds the world’s first climate-positive waste incineration plant with carbon capture and storage capabilities.

Overall, the solid business risk profile remains supported by Hafslund’s position as a major electricity generator in Norway (right behind the leader, Statkraft). This is backed by its low-cost hydro production and flexibility from high reservoir capacity as well as direct and indirect exposures to monopolistic electricity grids and district heating and cooling. The assessment remains constrained by the industry-inherent volatility of power prices and limited business reach within and outside Norway.

Hafslund’s improved financial risk profile (assessed at A-) strongly supports its standalone credit assessment. Leverage, as measured by the Scope-adjusted debt/EBITDA has settled at a very low level of less than 1.0x over the past two years. This has been bolstered by a strong improvement in operating results (EBITDA) and consistent cash accrual, which brought down net debt and Scope-adjusted debt respectively. As a result, leverage is deemed to be very solid, particularly in light of the company’s significant exposure to subordinated shareholder loans (NOK 7.3bn at YE 2022 of which NOK 1.9bn have already been repaid in 2023), which make up more than 30% of its total interest-bearing debt.

Scope expects continued cash flow support from elevated – albeit decreasing – electricity prices of 100-60 ore/kWh in the relevant pricing zones (NO1/NO5) over the next few years. Moreover, recurring dividends from associates – primarily Eidsiva – are expected to settle at a level of more than NOK 600m per annum. This should support a sustained EBITDA level of NOK 14bn-10bn over the forecasted period. Scope believes Hafslund will partially deploy its current strong leverage for growth investments, primarily backed by operating cash flows and the solid cash buffer. Even under the assumption of large tax payouts, increasing capex for growth projects, significant dividend payouts and an overall increase in gross financial debt through new debt issuance, leverage is only expected to increase to about 2.0x, keeping the company’s financial risk profile in good shape. Scope highlights the company’s leverage excluding subordinated shareholder loans which is forecasted to remain below 1.5x over the medium term.

Hafslund continues to have ample internal funding capacity for capital expenditures. Historically, capex has been covered comfortably by operating cash flow. Going forward, Hafslund is likely to deploy its large leverage headroom for increased capex and opportunistic growth opportunities, which will put some pressure on the generation of positive free operating cash flow. Nonetheless, the largest part of expected capex payouts remains covered by operating cash flow. As annual free operating cash flow and the resulting cash flow cover (FOCF/Scope-adjusted debt) remain volatile due to tax payments, working capital swings and opportunistic capex, Scope bases its judgement about the utility’s internal funding capacity on average cash flow cover of about 14% for the years 2020-25E. While Scope expects credit metrics to normalise from the very strong levels seen at YE 2022, it has no major concerns about a significant erosion of credit metrics.

Similar to Hafslund’s leverage development, its debt protection metrics have settled at a very solid level following the strong operating results in 2021 and 2022. Scope flags a significant exposure to floating-rate debt, which amounts to around 20% of total interest-bearing debt, and assumes a rising interest burden over next few years, driven by rising interest rates (effective interest rate is assumed to rise from 3.7% in 2022 to 4.3% in 2025E), along with increasing gross debt exposure. However, the agency is still forecasting that the company will comfortably sustain EBITDA interest coverage of more than 10x over the next few years.

The liquidity profile remains very strong despite forecasted pressure from potential capex and large tax payments. Between 2023 and 2025, Hafslund faces refinancing needs of about NOK 5.5bn (including NOK 1.7bn of commercial paper). Such positions and FOCF that is expected to be slightly negative are comfortably covered by the company’s unrestricted cash buffer of roughly NOK 13bn at YE 2022 and available credit facilities. As of YE 2022, Hafslund had access to a NOK 2,500m committed unused credit facility with expiry in November 2027 (plus the option of a one-year extension). Whilst Scope believes Hafslund is likely to refinance maturing debt pertaining to bonds and private placements through the issuance of similar debt positions, such positions can comfortably be covered by available cash sources. Moreover, Scope highlights the company’s wide access to different funding sources, including bonds, bank debt, private placement debt and shareholder loans.

Hafslund’s financial policy is deemed prudent. It focuses on retaining an investment-grade rating and active monitoring of quantitative and qualitative factors that affect creditworthiness in order to maintain high financial flexibility. Given the company’s status as a municipality-owned entity, Scope sees little risk that Hafslund will prioritise shareholder remuneration over creditor protection. While the company does not publicly stick to specific minimum/maximum financial thresholds, Scope believes it steers its capex and shareholder remuneration in a way that will not jeopardise the rating.

The rating continues to incorporate a one-notch uplift to the standalone credit assessment of BBB+, resulting in a final issuer rating of A-. This follows the framework set out in Scope’s rating methodology for government-related entities with a bottom-up rating approach, reflecting a conservative assessment of the capacity of the public sponsor (the City of Oslo, which is the 100% shareholder) to provide a credit uplift and its willingness to provide financial support if needed (something that is deemed highly remote). The public sponsor’s creditworthiness is deemed to be significantly higher than Hafslund’s standalone credit assessment, signalling a high capacity for a credit uplift. Scope assesses the public sponsor’s willingness to be significant, given Hafslund’s primary exposure to hydropower generation assets, which need to be in the hands of public authorities. Overall, the rating uplift is restricted to just one notch, in line with other Scope-rated Norwegian utilities with majority or full public ownership but no explicit guarantees on their debt or financial support.

One or more key drivers of the credit rating action are considered an ESG factor.

Outlook and rating-change drivers

Scope maintains the Positive Outlook on the rating given further potential rating upside. The Positive Outlook reflects the possibility that Hafslund will retain a stronger financial risk profile over a prolonged period should achievable power prices remain at elevated levels for several more years. In addition, a stronger financial risk profile could be retained if Hafslund did not use the large headroom on its leverage for massive capex expansion. Overall, Scope sees a good chance that Hafslund will keep its leverage, as measured by the Scope-adjusted debt/EBITDA ratio, at around 2.0x.

A rating upgrade could be warranted if credit metrics, as exemplified by a Scope-adjusted debt/EBITDA ratio of around or below 2.0x, were sustained. This implies that EBITDA would stay higher than NOK 10bn even under more normal power generation prices, whilst the company seeks significant external funding for growth projects over the next few years.

A negative rating action, such as a revision to a Stable Outlook, could be triggered if Scope’s expectation of leverage remaining at or below 2.0x (Scope-adjusted debt/EBITDA) became less likely. This could be driven by significantly lower-than-expected power prices, higher-than-expected capex, or structural transactions that weigh on the company’s financial risk profile. Further rating downside could evolve if Hafslund’s credit metrics were expected to deteriorate strongly, e.g. through an increase in leverage to around 4.0x. Alternatively, rating pressure would arise if the company lost its status as a government-related entity, a change that is deemed to be remote.

Long-term and short-term debt ratings

Following the upgrade of Hafslund’s issuer rating to A-, Scope has also upgraded the rating of long-term senior unsecured debt to A-. Hafslund’s senior unsecured bonds display standard bond documentation, including pari passu and negative pledge.

The upgrade of the short-term debt rating to S-1 reflects the underlying issuer rating of A-/Positive and robust short-term debt coverage, as well as good access to external funding from banks and debt capital markets.

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 Outlooks, (General Corporate Rating Methodology, 15 July 2022; European Utilities Rating Methodology, 17 March 2023; Government Related Entities Rating Methodology, 6 May 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 Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Sebastian Zank, Managing Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 9 July 2021. The Credit Ratings/Outlooks were last updated on 7 June 2022.

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

Conditions of use/exclusion of liability
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