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 below.

Snam's ratings reflect its solid business profile, with the vast majority of EBITDA generated from high-quality regulated activities in Italy and equity stakes in other regulated or contracted gas transport companies abroad. Despite higher capex under the newly-announced strategic plans leading to negative free cash flow (FCF) in 2023-2026, we expect funds from operations (FFO) net leverage to remain within the 'BBB+' negative rating sensitivities of 7.3x.

Snam's rating is also supported by our forecast of ample headroom under net debt/(regulatory asset base (RAB)+associates), credit-supportive financial policy, and significant financial flexibility.

Key Rating Drivers

Capex Focuses on Gas Infrastructure: The newly-announced strategic plan for 2022-2026 increases capex to around EUR10 billion, with heightened focus on gas infrastructure and slightly lower capex on energy transition. The plan includes the development of the Adriatic Network and reverse flow (EUR0.9 billion in 2022-2026), the purchase of two floating storage regasification units to be commissioned in 2023 and 2024 (EUR1.3 billion), and the replacement of more than 1,000km of pipeline.

Fitch understands that this is needed to maintain network resilience and enhance flexibility, given the materially different sources of gas entering Italy due to the war in Ukraine and the energy crisis. As a result, we expect an increase in RAB from EUR21 billion in 2021 to around EUR26.3 billion in 2026. Capex for energy transition is forecast at EUR1 billion (down from EUR1.3 billion in the previous plan), with a focus on biomethane, increasing the portfolio to more than 200 million cubic metres/year by 2026, energy efficiency (EUR200 million) and hydrogen (EUR100 million).

Upside From High Inflation: 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 allowed operating spending base to factor in inflation, albeit with a lag. In the current inflationary environment, these features are positive, especially for net debt/RAB, which we estimate at 55.6% in 2023 and around 60% for 2024-2026 (negative sensitivity of 67%). The RAB deflator average in 2022-2026 is forecast at 2.3% (vs 1.3% in the previous plan). We also forecast an increase in WACC in 2024, mirroring the current interest-rate forwards, to 6.4% for storage (6.0% in 2025-2026) and 5.8% for transport (5.4% in 2025-2026).

Negative FCF Impacts Leverage: We forecast net debt and FFO net leverage to be better in 2022 than we previously forecast thanks to a temporary positive change in working capital that we expect will fully reverse in 2023. We expect the high capex to lead to cumulative negative FCF of EUR6.2 billion in 2023-2026, including the working capital reversal. As a result, we expect FFO net leverage to peak at 7.3x in 2024, and to average 7.2x in 2023-2026 with little rating headroom for the negative rating sensitivity of 7.3x.

Fitch believes that Snam has strong financial flexibility and several tools to reduce leverage, if needed, considering the equity stakes held in several gas companies and some ancillary businesses.

Income From Equity Stakes: Snam has a portfolio of equity stakes in gas-related companies in Italy and abroad with an estimated total invested capital of EUR2.7 billion as of end-2022. These assets provide overall good visibility of results and we expect annual dividends from them of EUR0.2 billion on average in 2022-2026 (around 10% of the group's FFO). We also expect the contribution from Italian assets to increase over the plan period.

Vision 2030 Focus On Energy Transition: The Vision 2030 plan includes capex of more than EUR20 billion over 2022-2030, implying capex of more than EUR10 billion for 2027-2030, with an increasing focus on energy transition and hydrogen, in which Snam will also heavily invest beyond 2030. Snam expects to increase spending on new storage capacity and the development of the 'Italian Hydrogen Backbone' (H2) by building new capacity or repurposing existing infrastructure. Total spending on the H2 backbone is forecast at EUR 4 billion throughout 2030-2032.

Snam's plans for asset repurposing are on track. According to the company, 99% of its network is ready for hydrogen transport and it has performed field tests with H2 and natural gas blending mix up to 10% on key gas Turbines. We see Snam as a frontrunner among gas utilities in its approach to energy transition.

Regulatory Transition to Totex: The Italian regulator's (Autorita di Regolazione per Energia Reti e Ambiente) final orientation for the next regulatory period of gas transport service confirms the transition towards the total expenditure (totex) approach, currently in place in the UK, compared with the current system that considers operating costs and investments separately. The framework will have a sector-specific regulatory period of four years. It will have reporting schemes to verify expenditure and achievement of system output, technical performance, and quality with adjustments to protect from inflation risk.

We do not have sufficient information to assess the impact on Snam. However, we expect it to be neutral given the Italian authorities' positive record of consistency and predictability.

Derivation Summary

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

Snam's business risk is also lower than that of the Czech distribution system operator Czech Gas Networks Investments S.a r.l (CGNI; BBB/Stable) due to better regulatory features and a longer record of fully independent regulation, which mainly explains the rating differential as CGNI's leverage is similar to Snam's.

Enagas S.A. and REN - Redes Energeticas Nacionais, SGPS,S.A. have a lower rating (BBB/Stable) than Snam due to higher business risk. We view Snam as having higher debt capacity than these two peers (threshold between BBB+ and BBB is 7.3x compared with 5.3x Enagas and 6.3x for REN).

Key Assumptions

Transport WACC of 5.1% in 2023, 5.8% in 2024 and 5.4% in 2025, 2026;

Storage WACC of 6% in 2023, 6.4% in 2024, and 6% in 2025-2026;

Average investment deflator of 2.3% and inflation of 2.9% per year to 2026;

RAB to expand to almost EUR26.3 billion by end-2026 from EUR21.4 billion in 2022;

Average EBITDA margin of 62.6% per year to 2026;

Annual average cash up-streamed from equity investments of around EUR0.2 billion for 2022-2026;

Total capex of around EUR10 billion in 2022-2026 (including external growth);

Dividends in line with management policy.

RATING SENSITIVITIES

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

Positive rating action is unlikely, given the large capex that Snam will implement over the coming period. However, net debt /(RAB+associates) below 58%, FFO net leverage lower than 6.5x and FFO interest cover above 5.5x, all on a sustained basis, coupled with neutral FCF would be positive for the rating.

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 or net debt/(RAB+associates) approaching 67% over a sustained period, 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

As of 31 December 2022, Snam had cash and equivalents of around EUR 1.7 billion and undrawn revolving credit facilities and liquidity lines of EUR5.8 billion. This is compared with short-term bond maturities of around EUR0.7 billion, short-term bank debt of EUR0.3 billion and commercial paper debt of EUR1.1 billion due by end-2023. We expect negative FCF of around EUR3.1 billion, after acquisitions and divestures in 2023, also due to the reverse of the cash generated from working capital in 2022.

Issuer Profile

Snam is the Italian gas transport system operator and manages Europe's largest gas network that includes transport, storage and regasification infrastructure. The company benefits from low business risk with almost negligible price and volume risk underscored by a transparent and stable regulatory framework in its key segments. The company further owns equity stakes in various international pipelines (TAP, TAG, ADNOC), subsidiaries related to the energy transition (De Nora) 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 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. However, Fitch believes 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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