OREANDA-NEWS. Fitch Ratings has affirmed Compagnia Valdostana delle Acque Spa's (CVA) Long-term Issuer Default Rating (IDR) at 'A' with Stable Outlook.

The affirmation reflects CVA's sustained financial flexibility and solid credit metrics and the high quality of the generation portfolio, focused on hydro. An unfavourable market environment in Italy and the risk of further acquisitions are compensated by the expected reduction of dividends paid to Autonomous Region of Valle D'Aosta (VDA; A/Stable), CVA's 100% shareholder, after two years of extraordinarily high distributions.

Fitch rates the company on a standalone basis since March 2013, when Fitch removed the one-notch uplift for parental support, after the region's rating was downgraded to 'A', as a result of the Italian sovereign downgrade. However, given the relevant links with the parent, Fitch would likely allow a maximum one-notch positive differential between CVA's and the region's ratings.

KEY RATING DRIVERS

Parent Linkage Considerations
Fitch views the existing links between the company and its shareholder VDA as moderate, in accordance with Fitch's Parent and Subsidiary Rating Linkage methodology. This linkage has evolved during the past few years, as the region has materially benefitted from CVA's dividend payments (around EUR65m in 2013 and EUR135m in 2014, partly compensated by the payment of a receivable by the parent for EUR30m) and stable tax income. This is in contrast with the past when the region had supported CVA, particularly through a modest dividend extraction policy.

Therefore, should the region have a lower rating than CVA, we would likely allow a maximum of one-notch positive rating differential to consider the possibility of cash upstream to VDA. On the other hand, where CVA's rating would be lower than the region's, the group's rating would not automatically benefit from an uplift, as Fitch would analyse the evolution of the legal ties and the evidence of financial support from the parent.

Solid Business and Financial Profile
CVA benefits from strong asset quality, with over 90% of the installed capacity of around 1 GW relating to hydro and the balance being represented by incentivised wind and, with a limited contribution, PV solar (100% fuel cost-free power sources). The group holds a favourable niche market position in supply activity (leader in supplying to banks and large retailers in Italy) and manages the electricity distribution network in Valle d'Aosta (regulated activity). Regulated and quasi-regulated earnings contribute almost 50% of expected EBITDA in a low power price environment.

In 2013 and partly in 2014 favourable hydrology and effective hedging largely offset the decline of wholesale prices in Italy (to EUR52/MWh in 2014 from EUR75/MWh in 2012). Fitch believes that the operating cash flows of CVA will decrease in the medium term as hydro production returns to long-term average levels (-10% compared with 2014) and hedging transactions are renewed in a lower price environment.

Nevertheless credit ratios are expected to remain sound, considering the sizeable liquidity buffer available at end-2014 (EUR328m, net cash of EUR51m) and expected lower dividends after the peak of the last two years.

Weakening Market Fundamentals
Fitch believes that the price reduction experienced in the last couple of years in Italy is largely structural and due to a new market equilibrium deriving from significantly higher installed capacity, but also cyclically lower demand. Marginal plants setting the price for the system for a substantial part of the day are still the most efficient combined cycle gas turbines (CCGTs), but in case of low demand and favourable weather conditions prices can decrease dramatically and potentially go down to zero when photovoltaic and wind plants are sufficient to cover demand. This is a significant hit to conventional power generators and hydro players, which are price takers in the system. In light of the worsening market environment, we are revising our funds from operations (FFO) net adjusted leverage guideline for downgrade to 1.0x from 1.5x.

M&A Still on the Agenda
CVA completed in early 2015 the acquisition of a wind farm in southern Italy, for cash payment of slightly less than EUR50m, funded through available cash. The target company benefits from feed-in tariffs and should contribute around EUR4m-EUR5m to the group's EBITDA. Fitch believes that CVA will pursue further M&A opportunities, particularly in the wind sector, but we do not expect that the size of potential acquisitions would be dramatically larger than the recent one, particularly considering that they would likely be funded by new debt or available cash since the region is unlikely to inject equity in CVA to fund external growth outside of the reference geographic area.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Reduction of EBITDA over the rating horizon to around EUR100m due to long term average hydro production and the worsening price environment
- Decrease of the income tax rate due to the recent cancellation of the "Robin Tax" in Italy
- Capital expenditure in line with the 2013 level for the whole period to 2017, assuming that the mechanism of recognition of investments in residual asset value payable to the hydro concessionaires upon expiry and loss of concessions will be clarified
- Acquisition of renewable assets in 2016 and 2017 with a similar value and contribution to EBITDA of the recently closed transaction
- Dividends higher than net income and average historical levels, but substantially lower than the exceptionally high levels reported in 2013 and 2014

RATING SENSITIVITIES

Positive: Currently we see limited rating upside. However, future developments that may lead to a positive rating action include:
- An upgrade of VDA, coupled with strengthened legal ties between the two entities or evidence of the ability and willingness of the region to support the company

Negative: Future developments that could, individually or collectively, lead to negative rating action include:
- Should the region be downgraded, CVA will be allowed a maximum of one notch above the rating of the region to the extent that the standalone profile of the company remains unchanged
- Deterioration of FFO net adjusted leverage above 1.0x (including adjusted financial assets in the cash computation), also as a result of material debt-funded acquisitions
- A relevant shift in the business profile towards higher-risk activities

LIQUIDITY

CVA's liquidity is healthy. Its FYE14 readily available cash position was EUR328m, including EUR173m in cash and equivalents and EUR155m in a diversified investment portfolio against debt of EUR277m, resulting in a positive net financial position. CVA is structurally free cash flow positive.