Fitch Ratings has affirmed EDP - Energias de Portugal, S.A.'s Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB', Short-Term IDR at 'F2' and hybrid securities at 'BB+'.

The Outlook is Stable.

The affirmation reflects EDP's steady credit profile under its recently updated strategic plan as well as our expectation that leverage will remain consistent with the 'BBB' rating in the medium term. The new strategic plan entails higher execution risk, including more ambitious renewable capacity deployment targets, but we believe this is balanced by credit-protection measures, a reduced exposure to emerging markets, and a lower contribution from thermal generation.

The Stable Outlook reflects Fitch's forecast that funds from operations (FFO) net leverage will average at 4.4x through to 2026, leaving moderate headroom under our negative rating sensitivity of 4.7x.

Key Rating Drivers

Updated Strategic Plan: EDP presented its 2023-2026 strategic plan in March 2023. The plan entails a step up in capex, with cumulated expansion investments of EUR23 billion and targeted renewable capacity additions of 4.5 gigawatts (GW) a year (gross) over the period. EDP also anticipates that it will meet the financial targets in its prior plan more than a year earlier, helped by strong market tailwinds. EDP's strategy continues to revolve around an asset rotation model, with EUR8 billion of disposal and asset rotation proceeds, excluding capital gains, and EUR4 billion of tax equity partnerships assumed in the plan.

High Capex Cycle in Renewables: The strategic plan includes the deployment of 17GW until 2026, and the disposal of 5GW compared with the current capacity of 15GW under EDP Renovaveis (EDPR). The execution risk embedded in the investment plan is partially offset by visibility on capex and the procurement of supplies. Around half of total capex is secured, with 90% of solar panels and 50% of wind turbines to be deployed until 2024 also contracted.

Visibility on the capex plan comes from around 40% of it being already secured by power purchasing agreement or price-support mechanisms, including contracts for difference and feed-in tariffs. The remaining 60% is backed by a renewables pipeline of around 74GW as at end-2022. Delays to project authorisations and persistent supply-chain challenges remain as the key execution risks.

Balanced Funding Mix: The strategic plan is funded by a combination of organic cash flow, new debt, fresh capital, disposals and tax equity partnerships. EDP has a record of tapping into various funding sources across the cycle; for example, the recent hybrid refinancing and capital increases at EDP and EDPR totaling EUR2 billion. We forecast the effective cost of debt to remain at around 4.0%-4.5%, despite the higher interest-rate environment, due to EUR2 billion in pre-hedged maturities in 2023 and 2024 and large share of fixed-rate debt.

Unchanged Credit Profile: We expect EDP's share of regulated earnings to remain close to 30% over 2023-2026, reflecting a credit profile that is less regulated than that of most integrated utility peers in Europe. In addition, the share of regulated plus quasi-regulated activities should remain close to 80% of EBITDA over the period, based on the progressive investments in renewables that will strengthen EDP's business profile. We expect the contribution from the merchant business to represent about 20% of EBITDA.

EDP aims to reduce its presence in Brazil and focus on developed markets and stable jurisdictions across Europe and North America. It is also decreasing its exposure to thermal generation under its strategic plan.

Rating a Key Target: The strategic plan lists the maintenance of a 'BBB' rating as a key element. EDP expects to maintain a solid balance sheet during the upcoming high capex cycle, targeting a stable adjusted net debt/EBITDA ratio of 3.3x and FFO/net debt of above 20%. It plans to limit the rise in net debt to EUR4 billion over 2023-2026, despite EUR23 billion in growth investments and the EUR3 billion in dividend distributions included in its plan. EDP's strategy incorporates credit-protection measures, comprising EUR8 billion of asset rotation and disposal proceeds and EUR2 billion of equity injections already executed.

Manageable Regulatory Uncertainty: Regulatory uncertainty in the European energy market continues to impact companies with windfall taxes. Similar mechanisms are also being implemented differently across jurisdictions. We forecast a flat amount of windfall tax and clawbacks, despite decreasing energy prices, to capture this regulatory risk.

Positive Financial Performance: Financial performance for 2022 was much better than guidance communicated in 3Q22, due to an exceptional fourth quarter for hydro generation in Iberia and still-healthy yet decreasing price environment. The lower generation in hydro was partially compensated by higher thermal generation. EDP closed the 2022 year with FFO net leverage of 4.1x, against Fitch's positive sensitivity of 4.0x.

Asset Rotation Model: The proceeds from the asset-rotation plan primarily relate to the sale of around 5GW of wind and solar capacity for about EUR6 billion, as well as divestments of transmission assets in Brazil totaling EUR0.5 billion and generation assets, such as the Pecem coal power plant. We expect EDP to maintain an adequate balance between capex deployment and asset rotation. While a potential mismatch could induce some variability in credit metrics, this is mitigated by the sufficient leverage headroom in our rating case.

Derivation Summary

EDP is a vertically integrated utility and the incumbent in Portugal. EDP, along with Iberdrola S.A. (BBB+/Stable) and Enel S.p.A. (BBB+/Stable), anticipated the energy transition ahead of most other European utilities, although EDP has a smaller scale and its business risk profile is not fully comparable due to a lower share of fully regulated businesses.

EDP benefits from a higher share of long-term contracted and incentivised renewables business, which results in a regulated plus long-term contracted share, excluding asset-rotation capital gains, of about 80% of total EBITDA in the medium term.

EDP's higher business risk justifies the one-notch rating differential with Iberdrola and Enel, with both peers having a larger scale, greater diversification and a higher share of regulated EBITDA. We view Naturgy Energy Group, S.A.'s (BBB/Stable) business risk profile as similar to EDP's, due to Naturgy's larger share in regulated business (networks) being offset by a bias towards more volatile gas activities, subdued growth and a shareholder-friendly strategy.

We do not apply the one-notch uplift to EDP's senior unsecured rating, as the company's fully regulated EBITDA share is below 50% (or below 40% regulated plus 10% of contribution from renewables).

Key Assumptions

Our Key Assumptions within our Rating Case for the Issuer:

12GW of net renewable capacity additions, in line with the strategic plan, including 5GW of asset rotation

Wind and solar generation increasing to 65 terawatt hours (TWh) in 2026, from 33TWh in 2022, with the selling price averaging at EUR62.5 per megawatt hour (MWh)

Hydro generation in Iberia averaging at 10TWh a year, with achieved prices tracking current OMIP futures for baseload energy

Hydro generation in Brazil decreasing towards 2TWh, from 6TWh in 2022, with prices steadily increasing towards BRL260/MWh

Stable thermal generation margin in Iberia, with no coal generation by end-2025, and gas generation decreasing by 20% annually and trending towards 3TWh by 2026

Electricity supply, excluding solar distributed generation, decreasing by 2% annually towards 32TWh, with stable gas supply at 7TWh, while the margin per TWh falls by 2% on a yearly basis

The regulated asset base in Iberia and Brazil evolving in line with EDP's strategic plan and stable remuneration as a proportion of the regulated asset base

Effective interest rate averaging at 4.4%, with and effective tax rate of 24%

Dividends in line with the communicated dividend floor of 19.0 cents in 2023, 19.5 cents in 2024 and 2025, and 20.0 cents in 2026

Working capital outflow averaging EUR175 million a year

Capex averaging at EUR6.2 billion a year, net asset rotation and disposal proceeds at EUR1.6 billion a year

Tax equity proceeds averaging at EUR1 billion a year

EUR2 billion capital increase already executed in 2023

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Improvement of the business mix towards a higher weight in regulated activities.

FFO net leverage below 4.0x and FFO interest coverage above 4.6x on a sustained basis, assuming no major changes in activity mix other than that expected by Fitch.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

FFO net leverage above 4.7x and FFO interest coverage below 4.1x for a sustained period, for example, as a result of delays in asset rotation.

Evolution of the business mix towards higher-risk activities or countries could weaken EDP's debt capacity.

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: EDP had EUR5.0 billion of readily available cash and EUR6.3 billion of available committed credit lines as of December 2022, of which EUR3.7 billion are due after 2025. The liquidity position is sufficient to cover EUR4 billion maturities in 2023, benefiting from the EUR2 billion capital increase and EUR1 billion hybrid refinancing completed during 1Q23.

Issuer Profile

EDP is the leading integrated utility in Portugal and holds a second-tier position among European utilities by size. It has a total installed capacity of 28GW, 55% of which is wind and solar, 25% hydro and 20% thermal. In the distribution segment, EDP operates a EUR7 billion regulated asset base, consisting of electricity distribution networks in Iberia and Brazil, with a smaller contribution from transmission networks in Brazil. The company has over 9 million electricity and gas supply customers across Portugal, Spain and Brazil.

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

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