Fitch Affirms Infinis plc at 'BB-'; Outlook Stable
The affirmation reflects Fitch's expectations of positive free cash flow generation, supported by an increasing proportion of revenues qualifying for support under the renewable obligation (RO) scheme in place until 2027. However, the company's size and diversification are limited and average selling prices have been lowered by the recent cut to the Climate Change Levy (CCL) and lower UK wholesale power prices. These issues will affect the cash build and capacity to refinance the GBP350m bond due in 2019. Accordingly, Fitch would like to see faster deleveraging in future to reduce refinancing risk and maintain the existing credit rating.
KEY RATING DRIVERS
Largely Supportive UK Regulation
More than 90% of Infinis's revenues benefit from the RO incentive scheme. This figure is due to rise to 100% in FY19, raising average selling prices as lower fixed price NFFO contracts expire. RO certificate prices are supported by ensuring the minimum required number of RO certificates is higher than RO certificate generation. The UK government has confirmed its commitment to grandfathering existing incentive schemes and we assume will continue to receive the same level of support until 2027. However, the government announced in July 2015 its intention to discontinue the CCL exemption for renewable electricity from August 2015. Infinis expects a reduction in revenue and EBITDA of around GBP4.5m in FY16 and around GBP6.5m in FY17. This equates to 7% of FY15 EBITDA.
Power Price Exposure
Around 50% of Infinis's revenues are exposed to wholesale price risk under the RO scheme, which could lead to price volatility and have a substantial impact on cash flows and the rating. Weak gas prices, coal prices and demand have all meant continued weakness in UK wholesale baseload electricity prices. Latest forwards indicate GBP42/MWh through FY19, versus GBP52-55/MWh assumed previously. Although Infinis typically hedges ahead for 6-12 months, with the latest contracted position covering nearly 70% of 1H17 revenues, the longer-term impact is negative.
Fitch expects landfill gas (LFG) output to show a gradual continuous decline of 4%-6% per year. However, with a half-life of around 12 years, output can continue until around 2047. Although reliance on a single fuel source is a weakness, the portfolio is relatively well diversified by region, with the top 10 sites accounting for 38% of the total. Exported generation in the three months to June 2015 was 435 GWh versus 463GWh in 1Q15, a fall of 6% due to a combination of the natural decline in landfill gas, drier weather conditions and district network operator (DNO) instructed outages at Bletchley & Wapseys Wood, resulting in 11 days of lost output. Adjusting for the DNO outages, the output decline was 4.7%.
Fitch expects Infinis to refinance the GBP350m bond maturing in 2019 with a debt issuance sized at around 3.5x EBITDA. Repayment of the existing bond will depend on Infinis retaining adequate cash levels, as we estimate EBITDA be lower than previously expected due to the CCL cut and lower wholesale prices; however, this is offset by the dividend lock-up covenants. Our understanding is that the refinanced bond maybe amortising. Our estimate is that this should amount to around GBP275m. The forthcoming change in ownership structure of Infinis plc's ultimate parent, Infinis Energy plc (IEP), due to close by end 2015, may influence any potential early refinancing of the bond.
Fitch's view is that the bond indenture largely insulates Infinis from its parent, IEP and its investment in onshore wind projects. The bond indenture allows potentially substantial leakage of cash from Infinis in the form of dividends and other permitted payments, but the restricted payment provisions are standard and reflect the company's strong free cash (FCF) flow pre-dividends rather than weakness in the bond documentation. Infinis plc and its immediate parent Infinis Energy Holdings Limited (IEHL) are both 100% owned by IEP.
Terra Firma (TF), which owns 68.5% of IEFS, announced in October 2015 an offer to buy out the minorities. There is no short-term credit impact for Infinis plc, although longer term, this may lead to splitting off IEP's wind business from LFG, selling first wind, potentially in 2016, and later LFG. Because of political and regulatory changes affecting both wind and LFG, the offer to buy out the minorities is a change of strategy from last year when TF announced plans to sell its 68.5% stake.
Fitch's key assumptions within the rating case for Infinis PLC include:
For pricing, we assume sites remunerated by NFFO fall to 2% of revenues by 2018 and zero by FY19. All remaining NFFO contracts expire by November 2018. The proportion of LFG remunerated under the RO scheme therefore increases to 98% by 2018 and 100% by 2019, increasing Infinis's average selling price. For the NFFO, we assume an average GBP43.40 for FY16, based on the latest contracted position, rolled forward at RPI in line with regulation. For the RO scheme, we assume an average selling price of just over GBP90 per MWh, based on an average GBP48.90 for FY16 for RO certificates, rolled forward at an average 3% pa (in line with 2009-2015) plus the wholesale power price. We base estimates of uncontracted revenues beyond 1H17 on forward wholesale power prices of around GBP42/MWh through FY19.
A positive rating action is unlikely near term in view of the slow deleveraging and scope for increased dividends and permitted investments with affiliates. Future developments that could nevertheless lead to positive rating action include an increase in wholesale electricity prices or LFG recovery above Fitch's expectations, leading to FFO gross adjusted leverage sustainably below 3x and FFO interest cover sustainably above 4x.
Future developments that may, individually or collectively, lead to negative rating action include recoverable LFG depletion faster than we currently assume or wholesale electricity prices substantially lower than the forward curve, so that FFO net adjusted leverage is sustainably above 4x and FFO interest cover sustainably below 2.5x.
A slower pace of deleveraging, based on net adjusted leverage, as the refinancing deadline approaches could also lead to a negative rating action.
Based on solid FCF generation, we expect the company's liquidity position to be strong. Available liquidity consists only of cash on the balance sheet in view of the absence of a revolving credit facility in the restricted Group. As at June 2015, readily available cash stood at GBP61m, before the latest dividend payment of GBP17m. There is no uplift from the IDR for the senior notes, in view of average expected recoveries. Asset concentration and limited retail hedges are reflected in potentially greater than average volatility in LFG valuations.