Fitch Affirms Italy's Snam at 'BBB+'; Outlook Stable

Fitch Ratings has affirmed Snam S.p.A.'s Issuer Default Rating (IDR) and senior unsecured debt at 'BBB+'.

The Outlook on the IDR is Stable. A full list of ratings is detailed below.

The rating of Snam mainly reflects its solid business profile, as it derives its cash flows almost entirely from high-quality regulated activities in Italy and equity stakes in other regulated or contracted gas transport companies abroad. Snam's financial profile remains consistent with the rating; however, higher capex included in its latest business plan and lower weighted average cost of capital (WACC) from 2022 lead to a breach in 2022-2023 of our funds from operations (FFO) net leverage negative sensitivity. This is offset by the company's high available financial flexibility and prudent approach to planning, in our view.

The Stable Outlook also reflects ample headroom under Snam's net debt/(regulatory asset base (RAB) + associates), a credit-supportive financial policy and the company's active involvement in the energy transition, which entails a manageable amount of capex through the plan.

Key Rating Drivers

Rising Capex: Snam has increased its capex plan (EUR8.1 billion in 2021-2025, from EUR7.4 billion in 2020-2024), in line with trend seen in the last two business plans. The plan remains mainly focused on investments for gas transport and storage, mainly aimed at the replacement of 1,300km of gas transport pipelines, digitalisation of its network and installation of dual fuel compression stations. Capex for projects in biomethane, hydrogen and energy efficiency are EUR1.3 billion, almost double the previous plan (EUR0.7 billion), but still limited to around 15% of the total and is generally characterised by reasonable visibility of returns.

Gearing Offsets FFO Net Leverage: The rising capex, coupled with a reduction of the allowed WACC to 5.1% from 2022 (from 5.7% in 2019-2021), will result in average funds from operations (FFO) net leverage of 7.4x in our rating case for 2021-2025 (with a peak of 7.8x in 2022), compared with an average 6.3x in 2017-2020 and our negative rating sensitivity of 7.3x. However, this is adequately offset by ample headroom under Snam's net debt/(RAB + associates), with an average of around 60% across the period versus a negative sensitivity of 67%. We deem the net debt/RAB particularly important for regulated networks, especially in high capex phases.

Available Financial Flexibility: We believe that Snam has several tools to reduce leverage, if needed, especially considering the equity stakes held in several solid companies and some business diversification, including the energy efficiency business that we see as non-core for the company. We see this as a positive credit factor differentiating Snam from most of its peers. Moreover, De Nora S.p.A is evaluating an IPO and we deem likely that, if it goes through, Snam will reduce its stake and benefit from a sizeable cash-in and capital gain. This would represent an upside to our rating case in credit ratios and capital exposed to merchant risk.

Moderate Regulatory Visibility: The current regulatory period will last until end-2023 for transport and 2025 for storage, while the recently updated WACC will be in place for 2022-2024 (certain parameters of the formula updated annually), offering good visibility especially for the first part of the plan. The new regulatory period for transport will likely see the introduction of a total expenditure approach, currently in place in the UK and recently introduced in Portugal. In the absence of consultation documents, it is not possible to assess its potential impact on Snam, which could go in either direction. However, the positive record of the Italian authority in consistency and predictability means we do not expect a substantial discontinuity of results.

Predictable Income from Equity Stakes: Snam's portfolio of equity stakes in gas-related companies has progressively increased through acquisitions of moderate size and currently represents total invested capital of EUR2.3 billion (compared with a tariff RAB of around EUR20.7 billion at end-2020). These assets have generally good result visibility and should bring an annual cash-in of around EUR0.2 billion on average in the medium term. Further, Snam has a stake of 13.5% in Italgas S.p.A. (BBB+/Stable) with a market value of around EUR0.6 billion.

Proactive Role in Energy Transition: Snam plans to increase its involvement in the energy transition, mainly through investments in biomethane (EUR0.85 billion capex in the plan), which we see as quasi-regulated, and hydrogen (EUR0.25 billion). It has invested around EUR0.45 billion for a 35.6% in De Nora, an Italian maker of components for green hydrogen production. Moreover, Snam has publicly communicated that 99% of its network is ready for hydrogen transport, while initial tests confirm the possibility to store hydrogen in depleted gas fields. We see Snam as a frontrunner among gas utilities in its approach to energy transition.

Vision to 2030: Snam has presented its 2030 vision, which includes EUR23 billion capex, of which EUR3 billion relates to the development of a hydrogen network, EUR2 billion to new developments for storage and EUR3 billion to green energy projects, all of them heavily skewed towards the second part of the decade. With this plan, the company outlines its potential role in the energy transition, mitigating the stranded asset risk also for the long term. However, since this implies almost doubling capex of around EUR15 billion in 2026-2030, managerial actions will be key to maintaining credit ratios that are consistent with the current rating in the medium-to-long term.

Good 9M21 Operating Results: In 9M21 Snam reported good operating performance, with EBITDA up 2.8% yoy. EBITDA benefited from increased investments in its regulated core business and growth in its energy-efficiency business. Snam increased capex by 13.6% to EUR0.9 billion and we estimate around EUR1.3 billion capex at end-2021. Large investments and working-capital outflows are expected to have contributed to negative free cash flow (FCF) of around EUR0.8 billion at end-2021, with net debt at around EUR14 billion. We expect FFO net leverage at 7.3x at end-2021, significantly above 2020's 6.6x, but offset by strong net debt/(RAB + associates) of 58.7%.

Derivation Summary

Snam has a robust business profile with negligible price and volume risk that is similar to Italgas (BBB+/Stable), which shares the same regulator, country and reference shareholder, CDP Reti (BBB/Stable). Italgas has slightly tighter sensitivities for the same rating (7.0x), due to its smaller size and higher cash flow volatility underscored by renewal risk to local gas distribution tenders in Italy.

The Spanish utility Enagas S.A. (BBB+/Stable) shares the same rating as Snam, notwithstanding its more conservative financial profile. We view Enagas's business profile as weaker following higher-risk acquisitions and given the Spanish regulatory framework's shorter record and less constructive approach. Redes Energeticas Nacionales, SGPS, S.A. has a lower rating (BBB/Stable), due to higher business risk and leverage. We see higher debt capacity in Snam than these two peers at 7.3x for a rating threshold between 'BBB+' and 'BBB' versus 5.3x for Enagas and 6.3x for REN.

Key Assumptions

Fitch's key assumptions within our rating case for the issuer include:

Average revenue growth of around 5% yoy to 2025

Average EBITDA margin of 68% to 2025

Updated WACC of 5.1% for transport and 6% for storage from 2022-2025

Average investment deflator of 1.6% and inflation of 2% y.o.y to 2025

EBITDA contribution from output-based incentives of around EUR200 million for 2022-2025

Annual average cash up-streamed from equity investments of around EUR0.2 billion for 2022-2024

Average corporate tax rate of around 25% until 2025

Average cost of debt at around 1% to 2025

Broadly neutral working capital to 2025

Technical investments (net of grants) of around EUR7.4 billion until 2025

Conversion of convertible bond with net proceeds of EUR400 million in 2022

Dividends in line with management policy

RATING SENSITIVITIES

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

FFO net leverage declining below 6.5x (FY20: 6.6x) on a sustained basis

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

Deterioration of FFO net leverage above 7.3x, FFO interest coverage below 4.0x (2020: 12.7x) or net debt/(RAB+ associates) approaching 67% over a sustained period (2020: 54.8%), for instance, as a result of higher-than-expected investments or adverse policy measures

Growing exposure to unregulated activities, upward revision to Snam's dividend policy or material debt-funded acquisitions abroad, without any offsetting measures

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

Strong Liquidity: As of 30 September 2021, Snam had cash and cash equivalents of around EUR1.9 billion and undrawn revolving credit facilities and liquidity lines of EUR3.2 billion. This compared with short- term bond maturities of around EUR1.1 billion, short-term bank debt of EUR0.8 billion and drawn commercial paper debt of EUR2.5 billion due by end-2022. We expect negative FCF of around EUR0.4 billion after acquisitions and divestures at end-2022.

In January 2022, Snam issued its first sustainability linked bond in two tranches for a total of EUR1.5billion (EUR850 million and EUR650 million) at 0.75% and 1.25%, respectively, with long tenors. Both tranches include step-up coupons linked to emission-reduction targets incorporated in the company's plan and net zero targets. This follows three bonds issuance of around EUR1.25 billion in 2021, which further strengthens the ability of Snam to deliver on its capex plan, its sustainable financing strategy and highlights its access to capital markets for debt funding.

Issuer Profile

Snam is the Italian gas transport system operator and manages Europe's largest gas network that includes transport, storage and regasification infrastructure. It further owns equity stakes in various international pipelines, subsidiaries related to the energy transition and in the Italian gas distribution company Italgas.

Criteria Variation

Fitch views the contractor business of Italian utilities in the context of approved eco-bonus on the energy requalification of buildings as a pass-through item. This is mainly due to a clear recovery framework through tax credits in the following years. Consequently, we adjust the working capital to neutralise its impact.

Summary of Financial Adjustments

Adjustment to working capital for 'ecobonus'

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 ACTIONS

Entity / Debt

Rating

Prior

Snam S.p.A.

LT IDR

BBB+

Affirmed

BBB+

ST IDR

F2

Affirmed

F2

senior unsecured

LT

BBB+

Affirmed

BBB+

senior unsecured

ST

F2

Affirmed

F2

Page

of 1

VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com