OREANDA-NEWS. Fitch Ratings has affirmed Red Electrica Corporacion S.A.'s (REE) Long-term Issuer Default Rating (IDR) at 'A-' with a Positive Outlook. A full list of rating actions is provided at the end of this commentary.

Fitch intends to review REE's ratings after the publication of the remaining details of the regulatory determination. The parameters to be agreed upon are not likely to have a material impact on revenues; however, in our view political and regulatory risks still remain. Expected funds from operations (FFO) adjusted net leverage below 4.5x, as per our current expectations, would support a single-notch upgrade to 'A'.

REE's credit profile benefits from low business risk as the natural monopoly electricity transmission owner/operator in Spain and from predictable regulated earnings with minimal exposure to volume, price risks or inflation.

KEY RATING DRIVERS

Predictable Revenues
The Ministry of Industry, Energy and Tourism estimates REE's transmission revenues at approximately EUR1,675m for 2015. Annual growth of 3% thereafter reflects a solid proposed regulatory framework based on net asset value, a financial return benchmarked to the 10-year Spanish bond yield plus a 200bp spread, and reference costs for capex, maintenance and opex. The 6.5% pre-tax return on investment is fixed until 2019, and an annual adjustment of opex allowances offsets inflation.

Final Transmission Framework Pending
Fitch incorporates some regulatory and political risk into the ratings, pending the release of the final document, although these risks are small. The Ministry of Industry, Energy and Tourism is yet to publish the final details required for calculating the exact allowed remuneration. Agreement on the benchmark unit costs and residual asset lives for assets commissioned prior to 1998 remains outstanding. An interim methodology based on RDL 13/2012 is applied for 2015 instead.

Business Plan Increases Visibility
The publication of REE's 2015-2019 business strategy offers medium-term visibility particularly with regard to non-regulated activities. An increase in capex commitments (EUR1bn for international projects and storage on islands) and dividend growth commitment of 7% CAGR to 2019 are counterbalanced by a firm financial target of 3.5x net debt/EBITDA for the period. Fitch estimates that this target can be maintained, even under conservative assumptions where new unregulated projects do not contribute to revenue growth until 2019.

Infrastructure Plan Limits Capex
The first draft of the infrastructure plan estimates that investments in the transmission network will total EUR4.4bn by 2020. This is consistent with REE's strategy when taking into account capex already spent but not yet commissioned and also with the temporary methodology for transmission remuneration published in RD-I9/2013 which assumes assets put into operation of EUR600m/year. The plan gives us visibility into capex requirements until the end of the decade; however, by limiting the growth prospects in transmission (previously annual capex averaged EUR800m/year) it allows REE to seek non-regulated projects to maintain growth.

Contracts Support Cashflows
In 2014 REE won a 20-year concession on the Administrator of Railway Infrastructures' (ADIF) fibre optic telecommunication business. ADIF revenues are driven by long-term contracts with large telecommunications companies, and REE is seeking to achieve some efficiencies in operating the fibre optic network. Fitch estimates additional annual revenues of EUR65m and EBITDA of around EUR50m in 2015, which are reflected in our rating case. Overall we estimate non-regulated revenues to remain below 10% of total.

Credit Metrics Support Higher Rating
REE's FFO adjusted net leverage for FYE14 was 4.7x (FYE13: 3.9x), and FFO interest coverage was 7.3x (FYE13: 6.5x). The higher leverage reflects the ADIF transaction in 2014 and a negative change in net working capital due to payments that will be reversed in future months. We expect the implementation of the planned new regulation to result in leverage below 4.5x over the next four years, and interest coverage well above 5.5x, due to proactive liability management taking advantage of current low interest rates. We see limited downside from potential changes between the draft and the final regulatory framework, although regulatory risk still remains.

Senior Unsecured Debt Aligned
The senior unsecured debt rating is aligned with REE's IDR, rather than notched a level above the IDR that is typical for debt instruments of utilities with a large portion of regulated income, therefore resulting in higher expected recoveries in the event of default. This is because Fitch would not apply this notch-up if the uplift results in the debt rating being above the sovereign's ratings (BBB+/Stable), as per our criteria.

Holdco Debt Potentially Subordinated
We view potential creditors of REE as structurally subordinated to Red Electrica de Espana, S.A.U (REE S.A.U) creditors in the absence of a guarantee from REE S.A.U, the fully owned operating subsidiary. Currently, debt within the group is issued by REE S.A.U or guaranteed by both REE S.A.U and REE.

RATING SENSITIVITIES

Positive: Future developments that could lead to a positive rating action include:
- The final regulatory framework for electricity transmission in Spain for 2015 to 2019 being in line with Fitch's expectations on transmission revenues growth
-FFO adjusted net leverage remaining consistently below 4.5x

As the current Rating Outlook is Positive Fitch's sensitivities do not currently anticipate developments with a material likelihood, individually or collectively, of leading to a rating downgrade. However, future developments that could lead to negative rating action include:
- A downgrade of the sovereign rating, which would constrain REE's Outlook to Stable
- An increase in FFO adjusted net leverage to around 5.5x or above and/or FFO interest coverage of around 3.5x or below - both on a sustained basis - would lead to a downgrade to 'BBB+'

KEY RATING ASSUMPTIONS

- 2015-2019 transmission revenues are calculated based on the application of the interim methodology (RDL 13/2012) with revenue outcome in line with the path already published by the Spanish government;

- Fibre optic revenues that include the existing fibre optic contracts and the new ADIF concession ramping up to around EUR90m in 2019;

- Total capex for the period is EUR3.7bn, including EUR500m for international investments and EUR500 for pump-hydro storage in the Canary Islands. We prudently consider no material revenues coming from this non-transmission investment stream;

- No material efficiencies are included in the Fitch case with the EBITDA margin stable at 74%;

- Dividends per share growing at 7% CAGR from 2015.

LIQUIDITY AND DEBT STRUCTURE
REE's liquidity position is adequate. As of 31 December 2014, the group had EUR300m of cash and cash equivalents, and EUR1bn of undrawn committed medium-term credit facilities, of which EUR0.7bn is due beyond 2016. Fitch expects REE's free cash flow to be positive of around EUR200m, assuming capex of around EUR500m in 2015 and a pay-out ratio of around 70%. This liquidity position should cover debt maturities of EUR0.6bn and operational requirements over the next 24 months.

FULL LIST OF RATING ACTIONS

Red Electrica Corporacion, S.A.'s
Long-term IDR affirmed at 'A-'; Outlook Positive
Short-term IDR affirmed at 'F2'

Red Electrica de Espana, S.A.U.
Long-term IDR affirmed at 'A-'; Outlook Positive
Short-term IDR affirmed at 'F2'

Red Electrica de Espana Finance BV
Senior unsecured rating affirmed at 'A-'

Red Electrica Financiaciones, S.A.U.
Senior unsecured rating affirmed at 'A-'
Short term rating affirmed at 'F2'