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Rating action

Scope Ratings GmbH (Scope) has today upgraded the issuer rating of Norwegian utility Haugaland Kraft AS to A- from BBB+ and revised the Outlook from Positive to Stable. Concurrently, Scope has upgraded the senior unsecured debt rating to A- from BBB+ and the short-term debt rating to S-1 from S-2.

Rating rationale

The upgrade is driven by Scope’s view on Haugaland’s significantly improved financial risk profile at end-2022 which is believed to persist in the medium term. Scope expects that Haugaland’s financial flexibility and continued high power prices in its region of operation (NO2) will allow for higher-than-historical investments and continued dividends with moderate need for external funding, thereby maintaining a conservative financial profile. The utility’s financials will remain dependent on external factors such as achievable power prices, but as prices are expected to remain comfortably above historical averages the agency feel confident in upgrading the financial risk profile to A. Scope has recently added Scope-adjusted return on capital employed in the European Utilities Rating Methodology to assess profitability for integrated utilities. With an average Sa-ROCE of 16% the last 5 years, this metric supports the assessment of Haugaland’s profitability as strong. Further, it’s EBITDA-margins remain among the highest for the Nordic utilities. The business risk profile remains at BBB. The utility’s status as a government-related entity results in a one-notch uplift from its standalone credit assessment of BBB+, leading to an issuer rating of A-.

The rating continues to reflect a BBB business risk profile, supported by its monopolistic market position as the regulated distributor for Haugaland County. Distribution contributes less than historically to aggregated performance as surging prices increase the contribution from Haugaland’s hydropower generation, but Scope still considers the regulated operation as a stabilising force for cash flow and a strong component of its aggregate market position. Another highlight of Haugaland’s business risk assessment is its adept, efficient and environmentally friendly generation capabilities (positive ESG factor). Although Scope does not have emissions figures for Haugaland’s generation, Norsus estimates that the average Norwegian hydropower plant has an average carbon footprint of less than 5g CO2e/kWh¹. Scope therefore considers it highly likely that even when including Haugaland’s other business areas, its carbon intensity will be much lower than the European average of more than 250g CO2e/kWh. Such a strong position should support future cash flow and access to funding through high utilisation of its hydro assets and should lower the risk of headwinds from regulation and political interference. Haugaland does not hedge its production and was therefore able to fully capitalise on the surging energy prices observed in 2022 and some of 2023. This led to a record-high 2022 EBITDA margin of 76.2%, up from 62.9% in 2021. This is among the strongest profitability of all Scope-rated Nordic utilities. However, the unhedged nature of Haugaland’s generation also exposes the company to pricing risk, as exemplified by an EBITDA margin of 39% in 2020, when prices were record low.

Haugaland’s business risk profile continues to be hampered by low geographical diversification, with all operations located in the Haugaland County of Norway, which has a relatively small population of around 150,000 inhabitants and moderate prospects of economic growth compared to other Norwegian regions. Another limiting factor is the concentration risk in its generation portfolio, as its three largest plants contribute around 60% of its aggregated generation capacity. Hence, the effect of a standstill in one of these plants could have a material impact on cash flow. However, it is not a likely scenario.

Scope expects energy prices to go down in Haugaland’s region, which would reduce the margin-accretive effect on aggregated EBITDA margins from unregulated generation. Scope also believes that profitability in the company’s retail operation will remain below historical averages due to increased competition and more cost-conscious end-consumers. Margins in regulated distribution should increase as 2022’s cost base, rising interest rates and rising inflation will be reflected in an increased state-set revenue cap. This leads to projected consolidated EBITDA margins averaging 65% in the medium term, which is still above historical averages and strong.

Haugaland’s improved financial risk profile (assessed at A) strongly supports its standalone credit assessment. The company ended 2022 in a net cash position, from a Scope-adjusted debt/EBITDA of 1.0x in 2021. Although very strong, Scope notes that a large reason for this deleveraging was an increase in cash reserves to NOK 3.1bn from NOK 461m in 2021, in preparation for when 2022’s high tax payments were due in 2023. Scope therefore expects an increase in leverage in 2023, once said tax payments are paid and cash reserves normalise, with a Scope-adjusted debt/EBITDA of 0.8x in 2023. For 2024-2025, Haugaland’s highly efficient generation portfolio and the projected NO2 prices should enable it to comfortably manage high tax payments, upcoming debt maturities, high investment in power grids and dividends to its municipal owners, with minimal need for additional interest-bearing debt. In fact, Scope expects a moderate increase in leverage to about 1.5x in 2025, keeping the company’s financial risk profile in good shape. While Scope expects leverage to normalise from the exceptional levels seen at end-2022, it has no major concerns about a significant erosion of credit metrics.

Like Haugaland’s leverage, its debt protection metrics have settled at a very solid level following the strong operating results in 2021 and 2022. 50% of Haugaland’s bonds are fixed-rate, which mitigates some of the effects from the rising interbank interest rate. Further, since the state-set revenue cap for regulated distribution includes an interest rate element, this also acts as a hedge against rising interest rates. The expected rise in interbank rates and gross debt will increase net interest paid from NOK 38m in 2022 to NOK 70m in 2023 and 2024 before declining to NOK 54m in 2025. However, Scope forecasts that the company will comfortably sustain EBITDA interest coverage of more than 10x over the next few years.

Scope expects Haugaland’s liquidity profile to remain strong despite forecasted pressure from large tax payments and higher-than-historical capex. Between 2023 and 2025, Haugaland faces refinancing needs of only about NOK 300m. These refinancing needs are comfortably covered by Haugaland’s projected cash reserves and its committed credit facilities of NOK 1.5bn at H1 2023.

Haugaland’s financial policy remains prudent. It focuses on retaining an investment-grade rating and active monitoring of quantitative and qualitative factors that affect creditworthiness to maintain high financial flexibility. Given the company’s status as a municipality-owned entity, Scope sees negligible risk that Haugaland 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 Government Related Entities Rating Methodology with a bottom-up approach, reflecting a conservative assessment of the capacity of the public sponsor (12 local municipalities in the Haugaland County area hold 86% of the shares) to provide a credit uplift and its willingness to provide financial support if needed (a situation deemed highly remote). The public sponsor’s creditworthiness is significantly higher than Haugaland’s standalone credit assessment, signalling a high capacity for a credit uplift. Scope assesses the public sponsor’s willingness as significant, given Haugaland’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 has revised the Outlook to Stable from Positive following the upgrade, reflecting the belief that power prices will remain high for some years, leading to substantial contribution from unregulated generation (through Sunnhordland Kraftlag AS). In addition, Scope expects a steadily increasing contribution from regulated distribution, which will see favourable tailwinds once 2022’s cost levels, rising interest rates and inflation roll into the government-set revenue cap. Scope believes that higher-than-historical investments and continued dividend payouts in line with Haugaland’s stated dividend policy will necessitate external funding but that its financial flexibility will remain strong, as exemplified by a Scope-adjusted debt/EBITDA normalising above 1.0x. Scope also assumes that the company will remain majority-owned by Norwegian municipalities.

A positive rating action could be warranted if Haugland Kraft maintained Scope-adjusted debt/EBITDA below 1.0x and positive free operating cash flow, sustained.

A negative rating action could be warranted if Haugaland Kraft’s financial risk profile weakened due to lower wholesale prices or debt-financed transactions and/or investments, exemplified by Scope-adjusted debt/EBITDA sustained close to 2.5x. A reduction in municipal ownership to below 50% and the loss of government-related entity status could also trigger a downgrade.

Long-term and short-term debt ratings

The upgraded A- senior unsecured debt rating is in line with the issuer rating.

Scope has also upgraded the short-term debt rating to S-1, reflecting the underlying issuer rating of A-/Stable, sufficient short-term debt coverage and adequate access to both bank and bond financing.

1. https://norsus.no/wp-content/uploads/AR-01.19-The-inventory-and-life-cycle-data-for-Norwegian-hydroelectricity.pdf

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 Outlook, (General Corporate Rating Methodology, 16 October 2023; European Utilities Rating Methodology, 17 March 2023; Government Related Entities Rating Methodology, 13 July 2023), 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 Outlook 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 Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlook are UK-endorsed.
Lead analyst: Michael-Marco Simonsen, Associate Director
Person responsible for approval of the Credit Ratings: Thomas Faeh, Executive Director
The Credit Ratings/Outlook were first released by Scope Ratings on 24 November 2021. The Credit Ratings/Outlook were last updated on 21 October 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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