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Rating action

Scope Ratings GmbH (Scope) has affirmed the BBB+/Stable issuer rating on Norwegian power grid operator Arva AS. Concurrently, Scope has also affirmed Arva’s senior unsecured debt rating at BBB+ and its short-term debt rating at S-2.

Rating rationale

The BBB+ issuer rating reflects Arva’s standalone credit assessment of BBB plus a one-notch uplift based on Scope’s view of the company’s government-related entity (GRE) status. The standalone credit assessment continues to reflect a strong business risk profile and a moderate financial risk profile.

Arva’s business risk profile of ‘A+’ continues to be driven by its sole exposure to fully regulated power distribution. The company’s holds a natural monopoly within its service territory in northern Norway where it serves more than 120,000 residential and commercial customers. Arva’s market position is also strengthened by Scope’s view on Norway’s robust economy and the supportive regulatory framework applicable to the country’s regional power grid operators that allows for a timely pass-through of an increased cost base. Due to the monopolistic and fully regulated operations, the company’s lack of horisontal and geographical diversification is not seen as a major rating constraint.

The company achieved regulatory efficiency scores in 2022 and 2023 of 100% and 102%, respectively, indicating cost efficiency close to an average Norwegian power grid operator. The company is actively working towards its goal of achieving a level of 105% by 2027 through realisation of synergies after being established in late 2020 by a merger of Troms Kraft Nett and Nordlandsnett. Profitability is also supported by the higher interest rate environment which positively impacts the income cap calculation and leads to higher margins.

In terms of adjustments, the company reports under Norwegian accounting principles (NGAAP). Reported EBITDA does therefore not reflect the revenue surplus/deficit resulting from deviations between the actual revenues collected from customers through tariffs and the allowed revenue granted by the regulator. In order to stay consistent across Scope’s rating spectrum, Scope-adjusted EBITDA is adjusted to consider the revenue surplus/deficit, which is the treatment under IFRS and makes EBITDA more reflective of cash flows. However, this is just a periodisation effect as Norway’s power grid operators are required to take their revenue balance towards zero over time.

The financial risk profile of ‘BB-’ remains constrained by high leverage with Scope-adjusted debt/EBITDA expected to average around 6.0x over the next years. Scope does not put too much emphasis on the high Scope-adjusted debt/EBITDA of 6.8x recorded in 2022, as this was largely due to a revenue deficit of NOK 164m, with the ratio expected to improve to below 5.5x already in 2023. Scope continues to expect that free operating cash flow will stay negative for a prolonged period based on the company’s 10-year investment programme of about NOK 8.5bn. About half of the planned capex is maintenance capex while the remainder mostly covers expected new capacity requirements. Combined with continued dividend payments, the planned capex is expected to result in a high dependency on additional external financing in the coming years. Over time, such high capex will feed into increasing regulatory asset base and a larger cost base, supporting a sustained growth in EBITDA and operating cash flow. Lastly, higher interest rates and more debt is likely to pressure Scope-adjusted EBITDA interest cover in the near term, and the ratio is forecasted to decline from 6.1x in 2022 to 3.4x in 2024, before gradually improving to around 4.0x.

Liquidity remains adequate, with debt maturities in 2024 being refinanced via new debt raised in Q1 2024, comprising a NOK 500m loan signed with the Nordic Investment Bank and issuance of two bonds totaling NOK 600m. Scope also expects that the company will extend its NOK 750m undrawn committed credit facility which matures in June 2024. Liquidity ratios are expected to remain pressured by negative free operating cash flow and upcoming debt maturities of NOK 700m in 2025 and NOK 1,400m in 2026. However, the company has good access to external funding and Scope therefore believes it can raise new debt as needed.

The issuer rating incorporates a one-notch uplift for parent support to the standalone credit assessment of BBB based on Scope’s view of Arva’s government-related entity status, leading to an issuer rating of BBB+. This is based on the indirect public majority ownership by municipalities in northern Norway and the essential public services provided by the company as the sole distribution grid operator for electricity within its service territory. Scope has applied the bottom-up approach using the framework outlined in its Government-Related Entities Methodology. The one-notch uplift reflects the anticipated capacity and willingness of Arva’s indirect Norwegian municipality owners to provide financial support if needed.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s view that Arva will continue to generate solid operating cash flows from its monopolistic and fully regulated power grid operations. It further reflects Scope’s forecasts that negative free operating cash flow due to high capital expenditures plans will result in Scope-adjusted debt/EBITDA of around 6.0x. Lastly, the Outlook assumes continued indirect majority-ownership by Norwegian municipalities.

A positive rating action could be warranted if Scope-adjusted debt/EBITDA fell to around 5.0x on a sustained basis, resulting in an improved financial risk profile.

A negative rating action could be motivated by an increase in Scope-adjusted debt/EBITDA to well above 6.5x and interest cover falling below 4.0x, both on a sustained basis. Alternatively, a reduction in indirect municipal ownership to below 50% and the loss of GRE status could also trigger a downgrade.

Long-term and short-term debt ratings

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

Scope has also affirmed the S-2 short-term debt rating, driven by the underlying BBB+/Stable issuer rating and good access to external financing.

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, 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 these 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 and/or Outlook 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: Per Haakestad, Senior Specialist
Person responsible for approval of the Credit Ratings: Sebastian Zank, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 29 March 2023.

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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