Fitch Ratings has affirmed Italian utility Snam S.p.A.'s Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB+'.

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

The affirmation reflects Snam's solid business profile, with almost fully regulated domestic activity, a proactive approach towards energy transition, and various equity stakes in resilient assets, which could represent options to rebalance the financial structure, if needed.

Snam's funds from operations (FFO) net leverage is tight for the rating in 2022-2023 (close to the negative sensitivity at 7.3x), but we expect a solid net debt/regulatory asset base (RAB) and see some upside to our current conservative forecasts. Snam's upcoming business plan will be key for the future trajectory of the ratings.

Key Rating Drivers

Solid Current Trading: Snam reported broadly stable EBITDA of EUR1,706 million (-0.6% yoy) for 9M22, despite the negative impact of an allowed return decrease for EUR95 million, mainly due to RAB growth and favourable dynamics across all its businesses. Operating cash flow benefited from cash generation from working capital for EUR1.2 billion, although we expect this to largely reverse in the next few quarters. Capex was broadly stable with a 2% increase in 9M22. As a regulated network Snam is fully insulated from the extremely volatile European gas market, both in volumes and price.

Upside from High Inflation: The Italian regulation foresees a return on RAB based on a real weighted average cost of capital (WACC), with annual updates of the RAB and the operating spending base to factor in inflation, albeit with a time lag. In the current inflationary environment, these features are positive especially for the trend of net debt/RAB, which we estimate at around 55% in 2022. In 9M22 the RAB deflator stood at 3.7%. We expect a moderate increase in allowed WACC from 2024 after no change next year, mirroring the current interest-rate forwards.

Cost of Debt to Rise: Snam's cost of debt, currently very low at 1%, will increase only gradually, as around 75% of its existing gross debt is fixed-rate and its long-term debt has an average maturity of 5.7 years.

New Strategic Plan Upcoming: After the appointment of a new CEO in April 2022, Snam will present its new strategic plan in January 2023. We assume that the company will maintain its overall prudent approach and commitment to its rating. However, this will have to be confirmed in the new strategic plan and a material departure from our expectations could be negative for the rating.

High Capex Needs: We believe that the recent disruption of the gas market could ultimately result in higher capex for Snam. In particular we would expect it to take into account capex to install two floating storage regasification units (FSRU) in Italy in 2023-2024 and to optimise the network's structure in light of the materially different sources of gas entering Italy. However, Snam has several tools available to keep leverage at a level that is consistent with ratings, in our view, making management's approach to the targeted financial structure key for its ratings.

Derivation Summary

Snam has a robust business profile with negligible price and volume risk that is similar to Italgas S.p.A. (BBB+/Stable), which shares the same regulator, country and reference shareholder, CDP RETI S.p.A. (BBB/Stable). Italgas has slightly tighter downgrade sensitivities for the same rating (7.0x) due to its smaller size and higher cash flow volatility related to tenders and exposure to the Greek regulatory framework.

Snam has the same rating as the large and diversified Germany-based company E.ON SE (BBB+/Stable), notwithstanding its higher leverage, due to more predictable and transparent Italian regulation and almost no exposure to unregulated businesses (20% of EBITDA for E.ON).

Key Assumptions

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

Flat WACC for 2022-2023, with around a 50bp increase from 2024

Neutral working capital trend across 2022-2025

Capex for 2022-2025 broadly in line with the previous business plan

No sizeable M&A to 2025

Cost of new debt at around 4% to 2025

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 on a sustained basis

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

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

Adequate Liquidity: As of 30 September 2022, Snam had cash and cash equivalents of around EUR0.8 billion and undrawn revolving credit facilities and liquidity lines of EUR5.9 billion. This is compared with commercial-paper debt of EUR1.3 billion due by end-2022, short-term bond maturities of around EUR0.7 billion and short-term bank debt of EUR0.3 billion due by end-2023. We expect negative free cash flow of around EUR1.4 billion after acquisitions and divestures at end-2023.

Issuer Profile

Snam is Italy's gas transport system operator and manages Europe's largest gas network that includes transport, storage and regasification infrastructure.

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 following years.

In light of the extension of most of these bonuses and their presence in Snam's business plan, we reverse the impact on leverage metrics caused by related investments/working-capital drains.

The one-notch uplift for higher expected recoveries on senior unsecured debt instruments issued by economic-regulated utilities has not been applied to Snam as this would have resulted in the instrument rating exceeding Italy 's sovereign IDR. As a result, the senior unsecured debt rating is aligned with Snam's IDR.

Rating the utility's unsecured debt instruments above the sovereign IDR would suggest that recoveries would remain above average in a highly depressed sovereign environment. Fitch believes however that higher rates of recoveries for utilities' senior debt are less predictable in a weaker sovereign environment than in an idiosyncratic default of any single utility, making the standard uplift inappropriate in this case.

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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