Rating action

Scope Ratings GmbH (Scope) has today affirmed the issuer rating of Norwegian utility Sunnhordland Kraftlag AS (SKL) at BBB+ and changed the rating Outlook to Positive from Stable. Scope has also affirmed the BBB+ senior unsecured debt rating.

Rating rationale

The Outlook change to Positive from Stable reflects the likelihood that SKL’s financial profile will remain very strong credit metrics until 2025, as power prices in the NO2 price region of Norway remain higher than historical levels. Historically, the volatility of SKL’s performance has been a constraint on its financial risk profile. Increased interconnectedness with the UK and Europe through two subsea cables from NO2 could reduce this going forward, as price impact from domestic supply/demand and hydrology changes becomes less relevant. Scope expects prices to remain above EUR 70/MWh in NO2 in 2023-2025, albeit down from 2022 levels. This will drive continued solid profitability from SKL’s efficient hydro power assets with reservoir capacity (positive ESG factor), leading to EBITDA margins of 82%-84% over the next few years. Scope now considers SKL more likely to sustain a net cash position in the medium term than previously anticipated, assuming the company follows its financial policy and there are no extraordinary dividends or other expenditure.

The business risk profile, assessed at BBB-, continues to benefit from the company’s environmentally friendly and low-cost hydropower production, favourably located in the NO2 price region on the south-western coast of Norway. Much like other European price regions, NO2 reported record-high power prices in 2022, as Russia’s invasion of Ukraine and the subsequent reduction of gas deliveries to the EU led to a substantial energy deficit and surging prices across the continent. For SKL, this led to a record-high EBITDA margin of 88% in 2022, even after NOK 159m in windfall taxes were recognised as other operating expenses. This is below Scope’s projections from last year, but still stronger than all rated peers. SKL’s strong profitability assesment is further highlighted by the recently introduced Scope-adjusted return on capital employed calculation, with a 2019-2022 average return on capital employed of 54%.

SKL does not hedge any production and its historical performance has been volatile. This perceived volatility has been a constraining factor on its overall rating. However, as NO2 is directly linked with the UK and Germany through two subsea cables, prices in the region have been higher and more stable in 2023 than for other Norwegian price regions. High prices have been driven by sustained foreign demand, which seemingly dampens the effects of domestic supply/demand changes and/or changes in domestic hydrological balances. Scope cautiously acknowledges this pattern and considers it more likely that performance will remain very strong in the medium term compared to its expectations in the last review.

SKL’s improved financial risk profile at A is helped by the stronger-than-expected 2022 financial results and the prospect of more supportive power prices than anticipated in the previous rating review. Based on a power price assumption of EUR 70-80/MWh in 2023-2025 for the NO2 price region and the added benefit from SKL’s substantial reservoir capacity (50% of mean production), Scope-adjusted EBITDA will likely remain high at around NOK 1.7bn-2bn. Further, Scope expects investments of around NOK 150m with a ramp up to NOK 700m in 2025 and continued dividends in accordance with the company’s stated dividend policy. Lastly, given its NOK 297m bond repurchase in March 2022, SKL does not have any refinancing needs before 2025. This results in a projected net cash position over the next years, assuming the company follows its financial policy and there are no extraordinary dividends or other expenditures.

Liquidity remains adequate, with substantial liquidity reserves, an unused NOK 300m committed credit facility and no current interest-bearing liabilities at end-2022. SKL’s end-2022 liquidity consisted of NOK 627m in cash reserves; NOK 1.7bn deposited in a group cash pool (at the Haugaland Kraft AS level); and NOK 1.8bn in short-term financial assets. Scope considers it likely that this buffer will be used to service 2022’s high tax payments, estimated at around NOK 3.1bn, which are due in 2023. Scope expects SKL to maintain this high internal financing capacity, supported by high operational profitability and limited investment opportunities in the medium term.

SKL’s financial policy has no impact on its rating. Nevertheless, Scope highlights the relatively high payout in 2022, consisting of 80% of the preceeding year’s net income, based on a solid performance in 2022. This deviates from the established dividend policy of 60% of the preceeding year’s net income. Scope’s base case incorporates a 60% payout ratio over the next few years, but acknowledges the possibility of extraordinary payments reoccurring based on the very strong projected financial profile.

The issuer rating continues to incorporate a one-notch uplift to the standalone credit assessment of BBB for parent support, leading to a final issuer rating of BBB+. Scope has applied a bottom-up approach using the framework outlined in Scope’s Government Related Entities Rating Methodology. The one-notch uplift reflects the public sponsor’s capacity and willingness to provide support and is in line with the assessment of other Scope-rated Norwegian regional utilities that are majority-owned by at least one municipality.

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

Outlook and rating-change drivers

The Positive Outlook reflects further rating upside, driven by the possibility of prolonged higher-than-historical power prices in NO2. This will likely lead to a strong performance in SKL’s efficient and adept hydropower assets and a sustained net cash position in the medium term, given no unexpected acquisitions and/or extraordinary shareholder remuneration.

A rating upgrade could be warranted if credit metrics remained at their strong end-2022 levels, exemplified by a sustained net cash position. Albeit remote, an upgrade could also be warranted by an improvement in market position or diversification with still strong credit metrics.

A negative rating action, such as a revision of the Outlook to Stable, could be triggered if a net cash position became less likely. This could be driven by significantly lower-than-expected power prices, higher-than-expected capex, extraordinary dividends, or structural transactions that weigh on the company’s financial risk profile.

Further rating downside could occur through a significant deterioration in credit metrics and/or loss of the company’s status as a government-related entity.

Long-term debt rating

Scope has affirmed the senior unsecured debt rating at BBB+, the level of the issuer rating.

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, (European Utilities Rating Methodology, 17 March 2023; General Corporate Rating Methodology, 16 October 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 Outlook 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 13 December 2021. The Credit Ratings/Outlook were last updated on 28 November 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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