OREANDA-NEWS. Fitch Ratings has affirmed Spanish utility group Redexis Gas S.A.'s (RG) Long term Issuer Default Rating (IDR) at 'BBB-' with a Stable Outlook and its senior unsecured rating at 'BBB'. Fitch has also affirmed Redexis Gas Finance BV's senior unsecured rating at 'BBB'.

The ratings reflect greater stability and sustainability of new gas distribution and transmission regulation in Spain. Although RG has ambitious plans for organic growth, it has flexibility over capex and dividends to preserve its credit metrics, which Fitch expects to continue. The Stable Outlook reflects an improvement in interest cover after a successful bond issue in April 2015, while the liquidity profile is sufficient to cover operational and financial requirements until 2019 when its current loan facilities expire.

KEY RATING DRIVERS
Greater Stability and Sustainability
Regulation of gas transmission and distribution is now more stable and sustainable following recent reforms. Established by law, the regulation can only be changed at end-2020 by parliamentary approval and requires a report from the Spanish regulator National Commission for Markets and Competition (CNMC). With national elections due, we believe that there is political consensus supporting the development of the gas system, particularly as a means of reducing unemployment.

Limited Volume Risk
Long term regulatory weaknesses remain in the form of volume risk and lack of indexation to inflation. However, RG is more diversified and its distribution business has lower sensitivity to residential gas demand than immediate peer Madrilena Red de Gas, S.A.U. (BBB-/Stable). Also, inflation is currently not a risk. Fitch Sovereigns team has recently lowered its estimates of Spanish inflation to 0.8% from 1% in 2016 and to 1.5% from 2% in 2017.

Gas Tariff Deficit Resolved
As a result of Reform Law 8/2014, the gas system has generated a surplus for the first time since 2007-08. This implies a more sustainable regulation with reduced risk of further reform and allows RG to start recovering regulatory receivables of around EUR22m from 2015. Fitch recently revised the sector Outlook in Spain to Stable from Negative for 2016.

Acquisition of LPG Supply Business
RG acquired 71,500 regulated LPG supply points along with a medium-term supply contract from Repsol, S.A. (BBB/ Stable) in September 2015. The transaction, which is due to close by 2Q16, reinforces RG's presence in existing coverage areas and raises its total supply points above 600,000, with scope for greater efficiency on a larger customer base. RG funded the acquisition, which Fitch expects to add nearly EUR14m to 2017 EBITDA, solely with cash of EUR136m.

Dividend and Capex Flexibility
RG has plans for ambitious organic growth in distribution and transmission, requiring total capex of EUR480m between 2016 and 2020. This is slightly higher than the previous business plan and RG has not ruled out further acquisitions. According to our projections, RG has no headroom for additional debt-funded acquisitions in 2016 within our rating guideline of funds from operations (FFO) adjusted net leverage of up to 6.5x. However, with maintenance capex averaging EUR2m a year, RG has considerable discretion over capex. RG has also indicated that dividend policy is flexible to preserve its investment grade rating. The 2014 dividend payout of EUR19m was consistent with maintaining FFO adjusted net leverage below 6.5x, which Fitch expects to continue.

Capital Structure Changes
RG in April 2015 issued a fixed-rate bond of EUR250m with a 1.87% coupon, lowering the cost of debt and lengthening its maturity profile. This bond proceeds refinanced the debt used to acquire EDP Gas Networks in 2014 and covered capex needs and are slightly higher than previous expectations of an issue of around EUR200m.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for RG include:
-Growth in distribution supply points of 4.5% pa, based partly on conversion from LPG to natural gas, and residential demand growth of 2% pa.
-Growth of industrial demand of 3% pa.
-In gas transmission, we assume no uplift factor (akin to CPI) for the first regulatory period. Gas demand growth for the continuity of supply component of remuneration is in line with government's expectations of around 2.5% on average for (2015-2020).
-For LPG distribution, we assume around 60,000 LPG connections points by end-2020 (from around 12,000 in 2014), including conversions to natural gas. Decreasing average consumption per LPG connection point is due to new additions located in warmer areas. EBITDA contribution is forecasted slightly above EUR7m in 2020 (from around EUR1m in 2014).

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, result in positive rating action include:
-Stronger cash flow generation due to lower cash dividends leading to FFO adjusted net leverage below 5.5x and FFO interest cover above 3.5x on a sustained basis.

Negative: Future developments that may, individually or collectively, result in negative rating action include:
-Further major debt-funded acquisitions, as part of an ambitious growth strategy.
-Weaker cash flow generation due to further regulatory change leading to FFO adjusted net leverage above 6.5x and FFO interest cover below 2.5x on a sustained basis.

LIQUIDITY
As of 30 June 2015, RG had cash and cash equivalents of EUR75.6m plus an available capex and revolving credit facility of EUR300m. Fitch expects negative free cash flow of around EUR40m in 2015. None of the facilities have an amortising profile and the cash balance for operational needs is low. Fitch expects RG's liquidity profile to be sufficient to meet operational and financial needs until 2019 when current loan facilities expire.