Credit Opinion: PGE Polska Grupa Energetyczna S.A.

Transcription

1 Credit Opinion: PGE Polska Grupa Energetyczna S.A. Global Credit Research - 03 Jun 2014 Warsaw, Poland Ratings Category Outlook Issuer Rating PGE Sweden AB (publ) Outlook Bkd Sr Unsec MTN Moody's Rating Stable Baa1 Stable (P)Baa1 Contacts Analyst Phone Joanna Fic/London Andrew Blease/London Key Indicators PGE Polska Grupa Energetyczna S.A.[1] (CFO Pre-W/C + Interest) / Interest Expense 12/31/ /31/ /31/ x 91.9x 34.3x (CFO Pre-W/C) / Debt 275.2% 410.3% 269.6% (CFO Pre-W/C) / Net Debt % % % RCF / Debt 221.0% 255.8% 210.1% FCF / Debt 56.1% -47.9% 49.4% [1] All ratios are calculated using Moody's standard accounting adjustments. Source: Moody's Financial MetricsTM Note: For definitions of Moody's most common ratio terms please see the accompanying User's Guide. Opinion Rating Drivers - Leading Polish vertically integrated energy group with a long position in generation based mainly on lignite and coal - Low power prices and increasing costs of CO2 allowances affect profitability of the generation portfolio negatively - Modest contribution of lower risk regulated distribution activities - Large capex programme will result in a deterioration in the financial profile from the current strong position - One notch uplift for the government support

2 Corporate Profile PGE Polska Grupa Energetyczna S.A. (PGE) is a holding company for a vertically-integrated energy group, which is the largest utility in Poland. The group's businesses are (1) power generation, mainly in lignite and coal power plants, which have a total installed generation capacity of 12.8 gigawatts (GW); (2) electricity distribution, which accounts for around 28% of the group's EBITDA; and (3) supply of electricity to around 5.1 million customers. The company has about 38% market share of the generation segment in Poland and its activities are supported by the ownership of Poland's lignite mines, which provide 73% of PGE's fuel needs. PGE is currently approximately 62% owned by the Government of Poland (A2 stable). The remainder of shares are listed on the Warsaw stock exchange. SUMMARY RATING RATIONALE PGE's rating assessment reflects the company's strong position as a dominant generator of electricity in Poland, and as an integrated energy group. The company benefits from a low cost lignite-fueled generation fleet. However, these positives are offset by the exposure to power markets in the weak price environment and high exposure to carbon, albeit reduced due to the free carbon dioxide emission allowances. The assigned rating further takes into account an expected increase in leverage due to negative free cash flows arising from a significant capital expenditure programme. PGE's rating incorporates one notch of uplift for potential support from its owner, the Government of Poland (A2, stable outlook). DETAILED RATING CONSIDERATIONS LEADING POLISH VERTICALLY INTEGRATED ENERGY GROUP WITH A LONG POSITION IN GENERATION BASED MAINLY ON LIGNITE AND COAL PGE's is the largest energy group in Poland with installed capacity of some 12.8 GW as of end-2013, which accounts for some 34% of the installed capacity in the country. The share of electricity production is also very high. PGE's electricity generation amounted to 57 TWh in 2013, which accounts for about 38% of the market. PGE's generation capacity is based predominantly on lignite (sourced internally) and coal (sourced under longterm contracts). The group owns the two largest lignite mines in Poland, making it significantly independent from fuel suppliers. In 2013, around 73% of electricity generated by PGE group was fuelled by its own lignite resources with the remainder coming mainly from coal. Other generation is fairly limited. Although PGE's generation mix is in line with the average in the Polish market and large reserves of relatively cheap lignite and coal are readily available, such a high dependence on coal will require the purchase of additional CO2 permissions, exposing the company to a significant cost disadvantage. Whilst we consider that access to own fuel sources is beneficial and PGE's lignite plants are well positioned in Poland's merit order, the group lacks diversification of generation sources compared with large Western European utilities. As an integrated utility, PGE is able to capture value across the energy chain. However, the group lacks a balanced integrated position with sales of 37 TWh compared with 57 TWh of electricity generated. The group sells the energy in the exchange as well as under bilateral contracts. LOW POWER PRICES AND INCREASING COSTS OF CO2 ALLOWANCES AFFECT PROFITABILITY OF THE GENERATION PORTFOLIO NEGATIVELY Earnings in the conventional power generation segment have come under significant pressure as power prices collapsed. The key drivers have been falling coal and low CO2 prices, coupled with sluggish demand and expansion of renewable capacity. We do not expect any major recovery in the wholesale power prices in the near term, although we factor in some improvement in the level of power prices over the medium term. Base load forward contracts for 2015 are around PLN165/MWh, which is significantly below PLN200/MWh seen in 2012, but slightly above the levels of last year. In 2013, the negative impact of lower prices on PGE's generation segment EBITDA was PLN1.5 billion. Whilst some of this impact was mitigated by lower cost of fuel (PLN727 million), a further negative contributor to the decline in this segment EBITDA was an increase in the costs of CO2 (total of PLN1.3 billion, of which PLN549 million cash impact).

3 PGE's generation portfolio has a high exposure to carbon with emissions of some 1 tonne per MWh, which is a high ratio compared with the large Western European utilities. The current prices of CO2 are low and we do not expect any significant increase over the medium term due to oversupply of emission rights on the market and decreased demand from the industry sector due to the economic slowdown. Whilst the exposure to carbon is high and will continue to affect PGE's profitability in the generation segment, the negative impact will be somewhat reduced due to the free CO2 emission allowances. These amounts will decrease over time until 2020 when they will be eliminated. MODEST CONTRIBUTION OF LOWER RISK REGULATED DISTRIBUTION ACTIVITIES PGE's share of lower risk regulated distribution activities has increased as the earnings in the conventional generation segment were pressured, but remains below that of its Polish peers. We expect these activities to account for some 30% of the group's EBITDA in the medium term. We view the Polish regulatory framework as supportive in that it provides good earning predictability. Electricity distribution tariffs in Poland are set by the Energy Regulatory Office (ERO) using a price cap model. As a general rule, the distribution companies' revenues are determined in order to cover the so-called justified costs: operating costs, capital depreciation charges, tax charges, cost of purchase of electricity to cover balancing differences, in addition to providing a return based on weighted average cost of capital (WACC) on the companies' RAB. WACC is adjusted on an annual basis. The pre-tax WACC was set at 7.283% in Poland is considered to have developed a relatively transparent regulatory regime for its electricity networks, although it still needs to gain a proven track record compared to more established regulatory regimes. Regulation in the electricity network segment appears to be generally spared from political interference. Overall, we believe that the regulatory framework and its transparency are improving. In this regard, the presence of regulated cash flows is supportive of PGE's profile, although we note that it is fairly modest in comparison with other Polish energy groups, such as for example Energa S.A. (Baa1 stable). LARGE CAPEX PROGRAMME WILL RESULT IN A DETERIORATION IN THE FINANCIAL PROFILE FROM THE CURRENT STRONG POSITION In May 2014, PGE announced an updated strategy for the period until The update was long awaited and is positive to the extent that it reduces the uncertainty around the future investment plans of the group. We positively assess a revision of the investment plans, although we consider that they are sizeable in absolute terms and compared with the historical amounts. In addition, we consider that planned investments of PLN50 billion pose an execution and financing risk in the context of the weak power market and uncertainty around the evolution of the energy market in Poland. Investments will be targeted mainly in the conventional generation segment with approximately PLN34 billion to be spent on expansion and modernization of the capacity. In particular, PGE plans to spend some PLN16 million on existing plants and PLN15 billion on new capacity. New capacity projects include Opole power plants based on hard coal. The two units with 900 MW of installed capacity each are expected to be commissioned in 2018 and Total investments are PLN11.6 billion. Other projects include Turow power plant based on lignite and with an installed capacity of 496 MW (gross). We note the cautious approach to investments in nuclear plant, which would be Poland's first. This is positive considering the risks involved in development of new nuclear plants given the long construction lead times, possible budget overruns and substantial upfront capital costs. The current plans assume continuation of preparatory works on this project with some PLN700 million to be spent until Whilst PGE's low leverage and strong liquidity mitigate some of the risks associated with the implementation of such a sizeable investment programme, the financial profile of the group will deteriorate. We expect financial metrics to be well positioned against the guidance set for the current ratings, namely funds from operations (FFO)/net debt in thirties in percentage terms and FFO interest cover above 5.0x. We note that these levels are commensurate with management stated leverage of a maximum net debt/ebitda of 2.5x. ONE NOTCH UPLIFT FOR GOVERNMENT SUPPORT PGE is currently 62% owned by the Government of Poland (A2 stable) and the remaining shares are publicly held. Despite a gradual reduction in the state's share in PGE, we believe that the Polish government expects to retain its controlling stake in the company over the long term.

4 We view PGE as having a strategic role for the Polish government as a provider of essential services and a key player in the implementation of the state energy policies. PGE generates around 38% of total domestic electricity production. It is the largest vertically integrated electric utility, its strategic importance to the overall Polish economy and the fact that it represents one of the largest employers and contributors to the state budget. Although no direct state guarantees are currently provided, we believe that the Polish government recognises the strategic importance of PGE, which is reflected by the nomination of the company as a main partner for building nuclearbased generation capacity in Poland. In light of the above considerations, PGE's Baa1 rating factors in one notch of uplift to the company's standalone credit quality expressed by us as a baseline credit assessment (BCA) of baa2. Liquidity Profile As of end-march 2014, PGE had cash of PLN5.1 billion and availability under bank facilities of PLN1.7 billion. PGE does not face any material debt maturities in the near term. The current biggest single debt maturity is a domestic bond in the amount of PLN1 billion due in We note, however, that the group's sizeable capex programme will result in negative free cash flow and will result in increased funding needs over the medium term. Rating Outlook The stable outlook assumes that PGE will manage its capital structure such as to ensure a financial profile aligned with our guidance for the Baa1 rating which includes funds from operations (FFO) interest coverage of at least 5.0x and FFO/net debt above 30%. What Could Change the Rating - Up Upward rating pressure is unlikely in the short to medium term given the challenges that PGE faces in terms of carrying out its capital investment programme and the anticipated decline in its credit metrics. Over the medium to long term, we would consider an upgrade in the event of improved clarity around the future shape of the energy market in Poland coupled with a successful implementation of the investment projects and strong financial profile of the group. What Could Change the Rating - Down Negative pressure on PGE's rating would develop if (1) power prices and spreads declined further so that rating guidance was not met; (2) the group's FFO interest coverage ratio were to fall below 5.0x, FFO/net debt were to decline below 30% on a sustainable basis; (3) there was a material adverse change in the regulatory framework in Poland; or (4) the group were to embark on the nuclear investment without adequate financial and contractual risk protections. In addition, a deterioration in the credit quality of the Government of Poland and/or reduction in the support assumptions currently incorporated into our assessment would likely put a negative pressure on PGE's ratings. Other Considerations METHODOLOGY GRID: PGE's rating reflects our assessment of the company's business profile and financial performance in line with our rating methodology for Global Unregulated Utilities and Power Companies, published in August We expect the rating to be more aligned with the grid indicated rating as the group implements its capex programme and leverage increases. Rating Factors PGE Polska Grupa Energetyczna S.A. Unregulated Utilities [1][2] Factor 1: Market Assessment, Scale & Competitive Position (25%) Current FY [3]Moody's Months Forward 12/31/2013 View As of 06/03/2014 Measure Score Measure Score

5 a) Size and Scale Baa Baa b) Competitive Position and Market A A Structure Factor 2: Cash Flow Predictability of Business Model (25%) a) Fuel Strategy and Mix Baa Baa b) Degree of Integration and Hedging Strategy A A c) Capital Requirements and Operational B B Performance d) Contribution from Low/High Risk Baa Baa Businesses Factor 3: Financial Policy (10%) a) Financial Policy Baa Baa Factor 4: Financial Strength Metrics (40%) [1][2] a) (CFO Pre-W/C + Interest) / Interest Expense (3 year Avg) 62.7x Aaa 12-15x Aa b) (CFO Pre-W/C) / Debt (3 year Avg) 313.7% Aaa 45-55% Aa c) RCF / Debt (3 year Avg) 228.0% Aaa 30-40% Aa d) FCF / Debt (3 year Avg) 23.0% Aa (-45)-(-55)% Caa Rating: a) Indicated BCA from Grid a2 a3 b) Actual BCA Assigned baa2 baa2 Government-Related Issuer Factor a) Baseline Credit Assessment baa2 b) Government Local Currency Rating A2 c) Default Dependence Very high d) Support Strong [1] All ratios are calculated using Moody's standard accounting adjustments. [2] As of 12/31/2013. [3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY'S ("MOODY'S PUBLICATION") MAY INCLUDE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY'S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE

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