OREANDA-NEWS. Fitch Ratings has today, affirmed Australia-based Ergon Energy Corporation Limited's (Ergon) Long-Term Foreign Currency Issuer Default Rating (IDR) and foreign currency senior unsecured rating at 'AA'. The Outlook on the IDR is Stable. The agency has also affirmed Ergon Energy Queensland Pty Ltd's (EEQ) Long-Term Foreign Currency IDR and foreign currency senior unsecured rating at 'AA'. The Outlook on the IDR is Stable.

EEQ is a 100% owned subsidiary of Ergon, which is a Queensland state-owned electricity distribution company.

KEY RATING DRIVERS
Very Strong Strategic Linkages: The ratings of both Ergon and EEQ are aligned with those of the state of Queensland (Queensland, AA/Stable), as viewed under Fitch's parent-subsidiary rating methodology. The state government is committed to retaining ownership of both entities. The state does not explicitly guarantee Ergon and EEQ's obligations, but Fitch believes the links are sufficiently strong to warrant equalisation of their ratings with those of the state.

Potential for Consolidation: The government is looking at options to merge all three of its state-owned electricity network companies into one, however, no final decision has been made on a preferred option. The government is also considering options to merge its energy retailing business with a state-owned electricity business or retain it as a standalone business. Any such move, may further strengthen the strategic linkages of the state-owned company with that of the state. Fitch, however, notes that the state-owned networks will be required to increase dividend pay-outs to the state government, resulting in increased financial leverage for these businesses.

Integrated with the State: The state borrowing authority - Queensland Treasury Corporation (QTC, AA/Stable), currently arranges all of Ergon's and EEQ's debt. The virtually assured availability of perpetual senior debt funding from QTC indicates a high degree of financial integration with the state, which effectively controls the appointment of Ergon's board, as well as its capex and cash distribution policies.

Strong Standalone Credit Profile: Ergon's strong standalone credit profile reflects the regulated nature of its largely network business and the transparent and stable regulatory environment. Fitch expects the regulator's upcoming final decision on 30 October 2015, will provide further clarity and guidance of the regulatory approach on Ergon's forecast expenditure and expected total invested capital returns over the next regulatory determination period from 1 July 2015 to 30 June 2020 - the first time under the new electricity rules.

Government Payments Supports Profile: EEQ's unsupported credit profile will reflect that of a pure retailer. In Fitch's view, a pure or standalone retailer generally bears very high business risks. Its credit profile, however, benefits from the community service obligation (CSO) payments from the state government, compensating for the shortfall in recovery of its costs as a result of the government's uniform tariff policy across Queensland.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
-Revenue and pricing outcomes for the regulatory determination period from 1 July 2015 to 30 June 2020 is based-on AER's preliminary determination on 30 April 2015
-Dividend pay-out ratio of 100%
-Special dividend payment of AUD1.2bn in the financial year ending 30 June 2016
-Continuation of CSO payments for the retail business

RATING SENSITIVITIES
The issuer's rating is currently equalised with that of Queensland.

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-Upgrade in the Queensland state's ratings, provided the rating linkages remain intact.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-Downgrade in the Queensland state's ratings; or
-Evidence of weakening linkages with the state.

For the sub-sovereign rating of Queensland and QTC, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 2 September 2015:

Negative rating action could occur if a significant, unexpected increase in Queensland's debt levels occurs along with a large deterioration in its operating performance. Forecast operating margins do not allow much room for unexpected shocks.

An upgrade in the short term is unlikely as Queensland's operating and current margins would need to improve unless it reduces its debt more significantly.

QTC's ratings will move in line with any rating action on Queensland.
The ratings of the Australia-backed securities are linked to the ratings of the sovereign. A downgrade of the sovereign's IDR would result in a downgrade of QTC's guaranteed senior unsecured debt rating.