Fitch Ratings has affirmed French water-network operator Holding d'infrastructures des Metiers de l'environnement (SAUR)'s Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB-'.

The Outlook on the IDR is Stable.

SAUR's IDR reflects its low business risk as an integrated water and wastewater network operator that is largely present in France and Iberia, with the majority of revenue supported by long-term contracts with municipalities, limiting volume and price risks. This is complemented by rising revenue contribution from the more profitable but less contracted global industrial water segment, which entails higher risk than traditional services to municipalities.

The ratings also reflect Fitch's expectation that SAUR's funds from operations (FFO) net leverage will be maintained at or below our 5.0x negative guideline for 2022 (pro-forma for M&A) to 2025, a level that is consistent with a 'BBB-' rating. This is supported by the strong commitment expressed by EQT Infrastructure, SAUR's controlling shareholder, to Saur's investment-grade rating as demonstrated by equity support to partially fund M&A activity.

Key Rating Drivers

Leverage within Guidelines: We forecast SAUR's FFO net leverage (pro-forma for M&A) to peak at around 5.0x in 2022 (from 4.8x in 2021) before deleveraging to 2.7x in 2025 in the absence of dividend payments and large bolt-on acquisitions and underpinned by organic investments and a highly cash-generative business. In addition, the expected end of its workforce-restructuring programme in 2023 would support its deleveraging capacity. However, we believe that SAUR will seek additional growth opportunities to exploit expected leverage headroom within its 'BBB-' rating in the medium term, and we therefore do not reflect in the rating the expected deleverage from 2023 to 2025.

Demonstrated Support from EQT: EQT infrastructure has supported SAUR's strategy in favor of growth over dividends. Moreover, its recent acquisitions have been conservatively funded through a mix of equity and internal cash flow to allow FFO net leverage to remain within our guidelines by end-2022. Shareholder's commitment is key to maintaining leverage that is consistent with the 'BBB-' rating.

Municipal Water Contracts Credit-Supportive: SAUR's low business risk profile is supported by its core activity as a water and wastewater network operator and long-term contracts with municipalities operated under local monopoly regimes. These are mainly delegated public-service (DSP)-type contracts in France of eight to 10 years and concessions in Iberia (15-20 years in Spain and 20-30 years in Portugal). The long-term contracted nature of this revenue stream (around 80% of 2022 forecast EBITDA), with seven years of average residual life and good counterparty diversification, including Aquapor's concessions in Portugal, support SAUR's medium-term earnings visibility.

Recent M&A Adds to Diversification: Following its acquisition of Portuguese municipal water company Aquapor in 2021 that enhanced its presence in Iberia, SAUR has completed the acquisition of the US-based Aqua-Chem and signed an agreement to acquire Veolia's European Mobile Water Services division. Both operations will strengthen its position outside the domestic French market, largely in the US and the UK. Sizable M&A in 2022 has also increased its exposure to industrial end-customers, largely in the more stable sectors of pharmaceutical, foods & beverage and military.

The sale of leisure activities (7% of consolidated EBITDA in 2021) in 2022 had no impact on diversification as we did not assign any related benefit in the past.

Growth in Higher-Risk Industrial Water: We expect EBITDA contribution from industrial water to rise to 32% by 2025 from 10% in 2021 (20% in 2022E) at the expense of traditional municipal water in France and Iberia. Industrial water's superior organic growth (CAGR 18.3% for 2021-2025) is supported by positive regulatory and business fundamentals, outsourcing trends and an ageing infrastructure. However, it results in higher counterparty risk and a less and shorter contracted revenue profile, slightly weakening the consolidated contracted profile.

Solid creditworthiness of counterparties and a balanced mix between contracted and uncontracted revenue profiles for the industrial water division will be important to preserving the stability of SAUR's business model and the related debt capacity.

Profitability to Improve: Fitch expects SAUR's Fitch-calculated consolidated EBITDA margin to increase at 12.2% in 2025 from 10.7% in 2021. as its business mix shifts towards higher-margin activities (services to municipalities and industrial water) and markets (Iberia, US and the UK). Margins will also benefit from operating improvement plans, with efficiencies achieved allowed by regulators to be fully retained by the operator in SAUR's main markets of operations. This should be further supported by gradual increases in average contract size and an improved value offer to end-customer, for instance, by adding technological value.

Moderate Execution Risks: Fitch expects SAUR to progress on its long-term strategic plan, with an EBITDA CAGR of 10.6% for 2021-2025, compared with the company's forecast of 11.7%. This reflects fewer global contract wins and a slightly lower EBITDA margin than the company's forecasts, as we expect a slowdown in the tendering process and some pressure from cost inflation. However, the company has around 80% of its revenue indexed to inflation, largely in France and Portugal, providing good margin protection against rising costs.

Derivation Summary

SAUR is France's third-largest water and wastewater management company in France, behind Veolia Environnement S.A. (BBB/Stable), and the 'New Suez'. After the completion of Veolia's tender offer on Suez, Veolia became the bigger operator on water and wastewater management worldwide. The 'New Suez' post-acquisition will retain its second position in the French water distribution market and will continue to run, to a lesser extent, wastewater and hazardous waste management. Both companies benefit from larger scale and higher presence outside the domestic market.

In the water sector, these peers also benefit from larger and more profitable contracts, which explains their higher profitability even though they operate under the same contractual framework as SAUR. This drives a higher debt capacity of 5.0x at 'BBB' for Veolia against 5.0x at 'BBB-' for SAUR.

FCC Aqualia, S.A. (BBB-/Stable), the Spanish water concessions operator, is SAUR's closest peer in business mix and scale. Aqualia's municipal concessions and operation & maintenance activity accounts for about 90% of EBITDA, compared with around 80% for SAUR in 2021, which we expect to fall as contributions from the industrial water segment increase.

Overall, we see Aqualia's business risk as slightly better than that of SAUR, with longer average concession residual life, higher renewal rates, better profitability due to higher capex intensity and a contractual framework that includes financial-equilibrium mechanisms. This allows for a slightly higher debt capacity at the same rating; 5.3x for FFO net leverage at Aqualia compared with 5.0x for SAUR.

Key Assumptions

Renewal rate of water concessions for 2022-2025 in line with historical trends

Consolidated revenue CAGR 2021 (including the acquisition of Aqua-Chem and MWS) to 2025 of about 6.6%, supported by external growth, stable renewal rates and tariffs indexed to inflation

Average capex of about EUR156 million a year over 2022-2025, with EUR318 million net M&A-related cash flows recorded in 2022

Fitch-calculated consolidated EBITDA margin to improve from 10.7% in 2021 to 12.2% in 2025; this is pre-IFRS 16 and after exceptional costs and Fitch's adjustments. The improvement will be driven by growth in industrial water and efficiency gains coupled with a gradual fall in exceptional costs linked to restructuring programmes

No dividends

RATING SENSITIVITIES

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

FFO net leverage below 4.2x on a sustained basis, coupled with a gradual EBITDA margin improvement in line with Fitch's expectations

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

FFO net leverage above 5.0x on a sustained basis, for instance, due to delays in implementing the business plan or large M&A without offsetting measures

Increased earnings volatility due to changes in public contract agreements or regulatory frameworks, a less contracted business mix or contracted with higher-risk counterparties, for example with industrial water rising above 25% of total EBITDA (20% by 2022E), could lead us to review SAUR's debt capacity for the current rating

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: SAUR's liquidity position is supported by the medium-to-long term structure of its main debt facilities, including a bullet EUR250 million revolving credit facility (RCF) maturing in 2026 and its EUR950 million two-tranche sustainability-linked notes maturing in 2025 and 2028.

Fitch-calculated readily available cash was EUR251 million at end-2021.. SAUR has no material debt maturities in the short term..

SAUR is a highly cash-generative business that benefits from a negative net working-capital position. This is due to the structural features of the water business in France, including end-user taxes collected by SAUR on behalf of municipalities.

Centralised Debt Structure: SAUR's bond and RCF, which represent more than 90% of its total debt, are placed at the non-operating holding company and are on-lent to its operating subsidiaries. None of its subsidiaries are defined as guarantors for the instruments, but negligible prior-ranking debt and no dividend upstream restrictions at the subsidiary level eliminate the possibility of structural subordination.

Issuer Profile

SAUR is an integrated water and wastewater treatment and distribution operator. It also provides engineering and procurement and other water-related works. It serves more than 20 million residents and 7,000 municipalities and industrial companies.

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.

Public Ratings with Credit Linkage to other ratings

N/A

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

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