Fitch Ratings has affirmed Italian renewables generation company ERG S.p.A.'s Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB-'.

The Outlook on the Long-Term IDR is Stable.

The affirmation reflects ERG's visible cash flow generation from its largely long-term incentivised and contracted clean onshore energy production, the disposal of its thermal assets, and progressive diversification in mature European, UK and US markets as well as solar and battery technologies.

Fitch expects ERG to maintain material net leverage headroom in 2024 (3.6x funds from operation (FFO) net leverage vs negative sensitivity of 4.4x), before likely reducing in 2025-2026, as ERG continues to invest to increase its installed capacity.

Key Rating Drivers

Fully Clean Business Profile: ERG has successfully disposed of its 480MW combined cycle gas turbine (CCGT) assets, after material delays and uncertainties since the initial sale agreement in 2022.This completes its green transition towards onshore renewables generation.

The divestment leaves ERG with no position in dispatchable energy sources, which was a stabilising factor for the group's performance in the past. However, the exit and investment of the proceeds will support ERG in pursuing its targeted 85%-90% exposure to incentivised and long contracted business. We estimate that only 40-45% of CCGT EBITDA was derived from visible incentives, capacity market mechanism, purchase price agreements and grid remuneration.

Diversification into US: We view ERG's entry into the US market as prudent, through a mid-size deal and without incurring development, energy price or operation & maintenance risks. The move will add a fully operational 317MW to the group's perimeter in 2024. The recently commissioned onshore solar and wind assets are fully commercially contracted for more than 10 years.

Material 2024 Net Leverage Headroom: FFO net leverage was around 3.0x in 2023, with significant headroom over the 4.4x negative sensitivity. We expect this financial flexibility to only moderately reduce in 2024 (FFO net leverage expected at 3.6x) when accounting for current investment deployments and the full effect of the US acquisition.

We believe that the upcoming update of the business plan will provide guidance on medium-term investment and capacity developments. The Stable Outlook considers management's credible commitment to the current rating, the cash-generative nature of its current asset base and the modular nature of its investment plan.

Limited Exposure to Price Reduction: ERG is among the Fitch-rated generation companies retaining lower direct exposure to merchant prices (0.6TWh in 2024 and 1.5TWh in 2025, considering green certificates as incentivised). Consequently, we expect it to be less affected by the progressive price reduction envisaged in current forward trends, also due to its diversification and proactive hedging strategy. The preferred routes to market for new or repowered projects remain incentivised auctions or purchase price agreements with a long tenor.

Both mechanisms have recently seen implicit repricing or explicit recognition of inflation pressure. Project permitting and authorisation continue to take a long time to be obtained, but the political commitment to renewables developments to foster energy transition is at an all-time high. This is clearly visible in the latest Italian governmental draft decree targeting almost 12GW of renewables additions annually until 2028.

Derivation Summary

ERG is rated at the same level as Corporacion Acciona Energias Renovables, S.A. (CAER; BBB-/Stable), which we view as its closest peer. Following the disposal of its CCGT assets, ERG is a pure renewables company, with quasi-regulated production representing around 85-90% of EBITDA compared with CAER's 70%. However, apart from its much larger size, CAER is slightly better-diversified by geography and generation mix.

ERG is rated two notches below the global offshore wind leader Orsted A/S (BBB+/Stable) due to the latter's much larger size, diversification and leadership on the offshore sector, with long-term incentivised/contracted businesses representing the 80% of EBITDA. Moreover, we expect Orsted to reach FFO net leverage of 3.0x, more than one turn lower than ERG and CAER in the medium term.

ERG has a lower rating than Italian peer Alperia SpA. (BBB/Negative), but this is largely due to Alperia's effective value-chain integration and more conservative targeted financial structure (net debt/EBITDA of 2.5x). It also has a lower rating than C.V.A S.p.A. a. s.u. (BBB+/Stable), mostly due to different leverage. However, Alperia and C.V.A. have 0.4x lower debt capacity than ERG, mostly due to the latter's larger quasi-regulated share of EBITDA more than offsetting the lack of integration.

Key Assumptions

Volumes for 2024-2026 based on historical averages and P50 energy production analysis

Energy prices around EUR100/MWh in Italy, albeit with a decreasing trend in 2025-2026

Cash tax rate at around 22% of pre-tax income

Maintenance capex on current assets at around EUR10 million per year for 2024-2026

Investments for growth (development, M&A and repowering & re-blading) of around EUR1.9 billion in the coming years

Dividends near EUR150 million per year

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

An upgrade is unlikely, as we expect FFO net leverage to converge at our negative sensitivity in the later stage of the rating horizon. However, FFO net leverage below 3.6x on a sustained basis, assuming a broadly unchanged business mix (i.e. about 90% of EBITDA from incentivised or contracted production), may lead to positive rating action.

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Medium-term FFO net leverage trending above 4.4x and FFO interest cover below 4x, for instance, as a result of a lack of mitigating actions from management amid high capex or M&A and rising leverage.

Failure to maintain a business mix with quasi-regulated activities across the investment horizon representing at least 80% of EBITDA could lead to a tightening of rating sensitivities.

Liquidity and Debt Structure

Solid Liquidity: At end-2023, ERG had cash and equivalents of about EUR703 million and an undrawn ESG long-term committed revolving credit facility of EUR600 million. This compares with short-term debt of about EUR165 million maturing in 2024 and negative free cash flow expectation of EUR350 million, after accounting for acquisitions.

Issuer Profile

ERG is an independent producer of clean energy from renewable sources, operating in nine countries at European level as well as in US. It is the leading onshore wind power operator in Italy and among the top 10 in Europe. The group is also active in solar energy production where it ranks in the top five in Italy.

Criteria Variation

Fitch views the provisions of the shareholder agreement related to the veto right of IFM for transactions potentially resulting in sub-investment grade rating at ERG as equivalent to an effective ring-fencing documentation in key long-dated financing documents for its Parent and Subsidiary Rating Criteria assessment.

We believe that the interests of long-term minority equity investor are aligned with that of bondholders in maintaining ERG's rating at investment-grade level. Therefore, we deem the company as insulated from its ultimate parent San Quirico and rate it on a standalone basis.

Sources of Information

The principal sources of information used in the analysis are described in the Applicable Criteria.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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