Fitch Ratings has affirmed Italgas SpA's Long-Term Issuer Default Rating (IDR) at 'BBB+' with Stable Outlook.
The rating affirmation factors in Italgas's regulated business, a transparent and fair regulatory environment in Italy, and a strong record of delivery of business plans through the pandemic. It also reflects rising leverage driven by a large investment plan and regulatory reset risk over the business-plan horizon.
The Stable Outlook reflects that despite higher capex and lower expected weighted average cost of capital (WACC), funds from operations (FFO) net leverage will only slightly breach our sensitivities in 2024-2025. Although headroom across the business-plan horizon is limited, management remains committed to a financial policy that is commensurate with the current ratings.
KEY RATING DRIVERS
Slight Investment Increase: Italgas's 2021-2027 business plan includes cumulative capex for EUR7.9 billion, up 5% from 2020-2026 and 23% from 2019-2025. The plan mainly includes EUR5.5 billion capex for core operations and EUR2.2 billion for tenders until 2027, which should expand its regulatory asset base (RAB) to almost EUR12 billion by end-2027 (from EUR7.7 billion in 2020). The remaining EUR0.2 billion investment would be used to diversify into the Italian energy efficiency and water distribution system operator (DSO) businesses. Italgas will use EUR1.4 billion of capex for digitalisation, which it expects to yield cumulative benefits of around EUR250 million.
Significant WACC Downward Revision Risk: The allowed return on RAB will be updated from 2022. The first consultation paper is proposing a large reduction of the allowed cost of debt. In our view, the WACC in the new formula could lead to a decrease of around 100bp from 6.3% currently, which we assume in our rating case. This implies a potential annual EBITDA hit of EUR30 million-EUR50 million across the business plan versus Fitch's prior expectations of 5.7% WACC and even higher at EUR70 million-EUR90 million versus Italgas's 6.1% assumption.
Other Regulation Challenges and Opportunities: The current (fifth) regulatory period started in 2020 and will last until end-2025, giving good visibility on earnings. Digitalisation initiatives should prepare Italgas for delivery on a challenging real efficiency factor of 3.5%, while we see some opportunities from potential new regulation on innovation and the potential introduction of standard capex. The latter would provide earnings upside given Italgas's market leadership and focus on digitalisation.
Limited Rating Headroom: We expect average capex to reach more than EUR1.2 billion per year in 2023-2026, and project FFO net leverage to broadly stand at 6.5x, in line with our negative sensitivity, up from 5.8x in 2020. The large capex plan, coupled with rising dividends, will result in consistently negative free cash flows (FCF) and net debt rising to EUR7.5 billion in 2027, from EUR4.7 billion in 2020. Net debt/RAB is also expected to reach our 63% negative sensitivity from 2024 onwards.
Potential Acquisition in Greece: Our rating case does not include the potential business expansion into the Greek DSOs market through the acquisition of DEPA infrastructure assets in the regions of Thessaloniki, Thessaly, Attica, and throughout the remaining part of the Greece territory. Italgas is competing with the Czech EP Investment Advisors for the acquisition and we have no details over Italgas's potential funding strategy.
If the acquisition materialises, Fitch would update its rating case and reassess Italgas's debt capacity, by considering the EBITDA contribution of the Greek assets, diversification benefits and the lower predictability of the Greek regulatory framework. Overall, full debt funding of the transaction is likely to be credit-negative if not accompanied by adequate remedial actions.
Uncertainty on Tenders: Only few tenders out of the total 177 districts have taken place so far, following delays persist since 2017. Italgas has included in its business plan capex of EUR2.2billion as net cash outflow related to tenders, comprising EUR1.4 billion net capital deployed and EUR0.8 billion capex for improving the awarded district network. This assumes that Italgas will be awarded 75 districts, increasing their market share to 45% in 2026. Notwithstanding the main roadblocks identified by the Italian government to tenders, we continue to see a risk that the timetable assumed by Italgas will not be respected, but this would be neutral to positive for its credit ratios and not affect it debt capacity.
DERIVATION SUMMARY
Italgas has a solid business profile that is largely comparable with that of Italian gas transmission system operator Snam S.p.A. (BBB+/Stable). Italgas is smaller and subject to higher cash flow volatility related to tenders, leading to slightly tighter downgrade guidelines (6.5x vs. 6.7x) for leverage for the same rating.
Nevertheless, it has the same rating as the large and diversified Germany-based company E.ON SE (BBB+/Stable), due to more predictable and transparent Italian regulations and almost no exposure to unregulated businesses (20% of EBITDA in the case of E.ON), and can thus accommodate around 0.7x higher leverage (6.5x vs. 5.8x).
Italgas's business risk is also lower than that of the Czech DSO Czech Gas Networks Investments S.a r.l (BBB/Stable) due to better regulatory features and a longer record of fully independent regulation. CGNI's leverage is similar to that forecast for Italgas, and the rating differential is mostly explained by our view of lower business risk at the Italian operator.
KEY ASSUMPTIONS
WACC at 5.3% for 2022-2027
Distribution real efficiency factor set at 1.5% in the sixth regulatory period
Capex in line with management's guidance of EUR7.9 billion cumulatively, including tenders
RAB to expand to almost EUR12 billion by end-2027 from EUR7.7 billion in 2020
EBITDA gradually rising to around EUR1.5 billion in 2027, of which around EUR1.1 billion is represented by the current scope of operations
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
FFO net leverage below 5.7x on a sustained basis, net debt/(RAB+associates) approaching 55%, with structurally positive FCF before dividends and financial investments, assuming an unchanged business risk profile
Increased visibility in relation to the evolution of tenders and Italgas's ability to successfully integrate acquired activities
Factors that could, individually or collectively, lead to negative rating action/downgrade:
FFO net leverage above 6.5x, FFO interest coverage below 4.5x, net debt/(RAB+associates) above 63% over a sustained period, for instance as a result of structurally higher-than-expected investments or lower-than-expected contributions from gas distribution tenders, or upward revision to dividend policy
Weakening business risk profile, as a consequence of a less predictable regulatory framework or adverse policy measures
Significant deterioration of the operating environment
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
LIQUIDITY AND DEBT STRUCTURE
Adequate Liquidity: As at end-June 2021, Italgas had more thanEUR680 million of cash available and zero balance in its committed back-up revolving credit facility (RCF), following the early cancellation of its EUR500 million RCF in March 2021. However, proactive liability management means liquidity is adequate to cover its less than EUR200 million debt maturities in the next 18 months and an estimated EUR475 million negative FCF.
ISSUER PROFILE
Italgas is the leading gas distribution operator in Italy. The Italian distributors operate on a licensing basis, with local public authorities appointing service providers through concessions. Italgas's revenues are regulated, based on a mature and transparent regulatory framework with no volume risk.
CRITERIA VARIATION
Fitch mostly views the contractor business of Italian utilities in the context of the approved eco-bonus on the energy requalification of buildings as a pass-through item. This is mainly due to the clear recovery framework through tax credits in the following years.
In light of its prolongation of most of these bonuses and their presence in Italgas's business plan, we reverse the impact on leverage metrics caused by related investments/working-capital drains.
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
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This 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. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
RATING ACTIONSENTITY/DEBT RATING PRIOR
Italgas S.p.A. LT IDR BBB+ Affirmed BBB+
senior unsecured
LT BBB+ Affirmed BBB+
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ITALGAS S.P.A. 
