Fitch Affirms Infrax at 'A'; Outlook Stable
The affirmation reflects our view of the group's standalone profile of 'A-' and a one-notch uplift reflecting moderate links with its parents, municipalities within the Flemish Community (AA/Negative). The standalone credit profile reflects Infrax's solid business profile of a network-focused multi-utility covering a large part of Belgium's Flemish region as well as positive regulatory changes that should help Infrax reduce its leverage largely incurred due to tariff under recovery during 2010-2014.
KEY RATING DRIVERS
Strong Business Profile
Infrax's strong business profile benefits from its operations as an electricity and gas distribution system operator (DSO, 75% of 2014 EBITDA), complemented by sewerage operations (14%) as well as long-term media cable rental income (7%) from Telenet NV (B+/Stable). Fitch views the company's core regulated networks operations as supportive to its ratings.
Evolving Regulatory Framework
Infrax's tariffs for electricity and gas for 2015 were for the first time set by VREG, the Flemish regional regulator, which ended the period of competencies transfer from the federal regulator (CREG). In addition to the change of regulatory body, a shift from the cost plus to a price cap tariff methodology has been introduced. Under the new methodology, DSOs' costs will be split into exogenous and endogenous with the latter determined by a trend analysis in comparison with sector peers. Volume differences will be treated as exogenous and as such any deficits between the actual and budgeted amounts will be recovered in the next tariff period.
From Fitch's perspective, the concentration of supervisory powers in electricity and gas distribution (VREG) eliminates the risk of policy inconsistencies and is positive for the ratings. The new tariff methodology is in general more demanding for DSOs, although its impact on Infrax's credit profile will depend largely on the scale of required efficiency improvements.
Accumulated Regulatory Differences
At end-2014, Infrax had close to EUR0.5bn of accumulated regulatory differences due to non-balancing costs in 2010-2014 tariffs attributable to the approaching transition of regulatory duties from CREG to VREG (tariffs were effectively frozen), as well as the accumulated stock of green power (GPC) and cogeneration (CHP) certificates. Both issues peaked in 2014. The tariff for 2015 allows a timely pass-through of new regulatory differences and certificates from now on. VREG has also approved a five-year recuperation of the regulatory differences from non-balancing costs in 2010-2014, which is positive for the ratings and should help the company improve its leverage and liquidity metrics.
Steady Sewerage and Cable TV Contribution
Infrax's sewerage tariffs are linked to the Flemish supra-municipal tariff (can be up to 40% higher) and are passed through to end-customers with their bills for drinking water. Cable TV activities comprise inflows from a long-term (2008-2046) lease of the network to Telenet, which has exclusive rights on the cable. Both segments provide stable EBITDA contribution.
Imposition of Corporate Income Tax
Until 2014, the Belgian associations of local authorities were excluded from corporate income tax (CIT). This exclusion was removed by a new law in December 2014. In response, VREG made an interim change in electricity and gas tariffs to include equivalent CIT from 1 August 2015, with the tax for the first seven months of 2015 to be recuperated in 2016. With respect to the sewerage business, Infrax expects that the Belgian Ruling Commission will exempt sewerage operators from CIT (a decision is expected in the next few weeks). The only segment that will be affected by CIT is cable TV. Fitch views introduction of CIT as negative for the company's credit profile, although tax obligations will most likely be limited only to cable TV (with those in electricity and gas passed through to end-customers and probable exemption from CIT in sewerage).
Group Structure Limitations
Infrax's group structure is quite complex due to a number of affiliated companies, its legal status as a cooperative as well as existence of several boards of directors (at Infrax and each DSO) and shareholders. Moreover, Belgian accounting principles do not require preparation of consolidated statements for the group or cash flow statements for the individual DSOs. These factors represent a credit constraint of one notch compared with the standing of Infrax group within our sector navigator for network utilities.
Links with Shareholders
Infrax's links with its parents stem from the Belgian utility sector's legal and institutional framework, which supports public ownership of distribution networks. The eight DSOs and asset owners within Infrax group are fully municipality-owned public legal entities (inter-municipalities or IMs) active solely in 126 municipalities in Belgium (AA/Negative), of which 122 are in the Flemish Region and four in the Walloon Region. In our view, their legal nature, high strategic importance to the regions, control over key decision making and tangible support in the sewerage segment warrant a one-notch rating uplift.
The DSOs guarantee Infrax's obligations severally, according to their respective share of its capital. The lack of a joint guarantee by all DSOs represents a credit constraint. This is mitigated by the overall comparable business and financial profiles of the individual DSOs as well as by the tight integration within the Infrax group, which acts externally as a single entity in terms of its operations, financials and treasury management. We therefore base the ratings on the group's overall profile.
Fitch's key assumptions within the rating case for Infrax include:
- Stable income in all business areas.
- Full recuperation of the regulatory differences arisen from non-balancing costs in 2010-2014 within the next five years.
- Income tax largely passed through to end-customers.
- Capex of EUR1bn within the five year projection period.
- Dividend pay-outs at current level.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Funds from operations (FFO) net adjusted leverage sustainably below 3.5x.
- Greater regulatory clarity with full and timely resolution of the regulatory differences, GPC and CHP carry.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO net adjusted leverage sustainably above 4.5x.
- Worsening in the regulatory environment with uncompensated or increasing regulatory differences, GPC and CHP carry or tax burden.
As of 30 September 2015, Infrax's liquidity position included EUR14m of cash and undrawn short-term committed credit lines of EUR177m versus debt due in the next 12 months of EUR105m (out of this EUR81m by end-2015) and negative free cash flow forecasted by Fitch for 2015 and 2016. Overall we assess Infrax's liquidity as adequate, although it depends on the timely renewal of available short-term credit lines.