DBRS Ratings GmbH (DBRS Morningstar) confirmed both the Issuer Rating and the Euro Medium Term Notes (EMTN) rating on Madrileña Red de Gas Finance B.V. (MRG Finance or the Issuer) at BBB (low) with Stable trends. MRG Finance is the financing entity for Madrileña Red de Gas, S.A.U. (MRG, the Company or the Guarantor) and all the current debt issued by MRG Finance is guaranteed by MRG. As such, the ratings on the EMTN are based on the credit quality of the Guarantor.
KEY CREDIT RATING CONSIDERATIONS
The rating confirmation is supported by MRG´s (1) stable regulated business and (2) relatively strong franchise area. MRG is a regulated natural gas distributor operating in Madrid. DBRS Morningstar considers MRG’s regulatory framework under the Comisión Nacional de los Mercados y la Competencia (CNMC) to be reasonable for the BBB rating category as it provides a steady stream of earnings and cash flow. Almost all of MRG’s operations are regulated (98% in 2022). The current regulatory period for 2021–26 is consistent with the previous framework where the base remuneration was adjusted based on the annual changes in the volume of natural gas distributed and the number of connection points. DBRS Morningstar notes that the regulatory framework provides remuneration based on the growth in demand and connection points rather than assets, also incentivising to optimise operating and capital expenditures (capex). As a consequence, DBRS Morningstar notes that MRG's capex requirements (maintenance capex of around EUR 2.0 million to EUR 3.0 million annually) are not material. Most of the expansionary capex is discretionary.
In recent years, the Company has managed its cash generation to maintain average cash flow-to-debt within the 9.0% to 11.5% range, standing at 10.2% at the end of 2022. Despite MRG's debt-to-capital ratio reaching 55% at the end of 2022 because of the capitalisation of the EUR 675 million intercompany loan with its parent company in equity, it should be noted that the funds for the intercompany loan came from the current debt issued by MRG Finance and were fully guaranteed by MRG. The Company’s EBIT-to-interest coverage ratio remained quite stable at 3.7x in 2022. DBRS Morningstar expects MRG's debt-to-capital and cash flow-to-debt ratios to improve over the next regulatory period given the expected deleveraging efforts, and should therefore continue to support the ratings.
In May 2021, it was updated Article 62.6 of the Hydrocarbons Sector Law 34/1998 to forbid regulated companies from granting loans or providing guarantees to companies outside the regulated framework. The Company therefore underwent an extensive restructuring exercise to revert a loan that was granted to the parent company in 2019, which the CNMC could consider incompatible with the law. In 2023, the CNMC notified the Company that the drawdown of EUR 101.2 million of such loan was in direct violation of the law. In the same resolution, the CNMC notified the Company to carry out the necessary actions to revert the provisions of EUR 101.2M in a manner compatible with Law 34/1998, within a maximum period of three months from the date of notification of the resolution. As a consequence, the Company has requested a suspension and appeal of the resolution. There is currently little visibility over the CNMC's final decision, but the Company could be subject to a fine of about 10% of its 2022 turnover. A full penalty and increased regulatory scrutiny could indirectly have a negative effect on the credit metrics. DBRS Morningstar is currently monitoring the situation for any material credit implications that may consequently arise.
CREDIT RATING DRIVERS
Based on the final framework for the 2021-26 regulatory period, the CNMC has established a final haircut of EUR 24.5 million to be phased in over the six-year period. While this amount is lower than the preliminary haircut estimate of EUR 34.1 million, earnings and cash flows will both decline over the medium term exerting pressure on key credit metrics. DBRS Morningstar will consider a negative rating action if MRG is unable to manage the remuneration haircut, resulting in the cash flow-to-debt ratio falling below 9.0% over an extended time frame. DBRS Morningstar also notes that, because the remuneration haircut is to be phased in gradually, some metrics may not be maintained over the medium term. Nevertheless, MRG´s flexible dividend policy could help mitigate the potential negative remuneration impact.
DBRS Morningstar considers a positive rating action in the medium term to be unlikely given the CNMC’s current litigation and lack of visibility with regards to future developments. However, DBRS Morningstar notes that, if the CNMC’s litigation is solved without a relevant impact on the credit metrics and if MRG is prudent in its dividend and debt management policies in order to maintain key credit metrics near the current levels on a sustained basis (cash flow-to-debt above 10%, debt-to-capital above 65%, and EBIT-to-interest coverage above 1.5x), DBRS Morningstar may take a positive rating action in the longer term.
CREDIT RATING RATIONALE
The restructuring exercise that MRG underwent in 2022 with the conversion of the EUR 675 million intercompany loan into equity at MRG from its parent Company has no direct impact on the current financial leverage as funds for that intercompany loan were provided by MRG Finance. The new bank loan of MRG used to repay the MRG Finance bond with a maturity date in 2023 and MRG Finance's entire debt is fully guaranteed by MRG and rank pari passu.
DBRS Morningstar has assumed, over a six-year period, earnings will likely decline by up to EUR 24.5 million
with a corresponding decrease in cash flow. Under this scenario, the cash flow-to-debt is expected to weaken over
the forecast period; however, DBRS Morningstar expects the debt-to-capital metrics to improve given the expected deleverage remaining supportive of both the BBB (low) ratings, given the stable business risk assessment. DBRS Morningstar expects MRG to be prudent in its dividend and debt management policies in order to maintain key credit metrics at current levels, which should support the BBB (low) rating.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the “DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings” (4 July 2023) at https://www.dbrsmorningstar.com/research/416784
All figures are in euro unless otherwise noted.
DBRS Morningstar applied the following principal methodologies :
• “Global Methodology for Rating Companies in the Regulated Electric, Natural Gas, and Water Utilities Industry” (13 September 2022) - https://www.dbrsmorningstar.com/research/402616
The following methodology has also been applied:
• “DBRS Morningstar Global Criteria: Guarantees and Other Forms of Support” (28 March 2023) - https://www.dbrsmorningstar.com/research/411694
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
A description of how DBRS Morningstar analyses corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.
The primary sources of information used for these credit ratings include audited financial statements, management projections and budgets, and external correspondences. DBRS Morningstar considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.
DBRS Morningstar does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar trends and credit ratings are under regular surveillance.
For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.
The sensitivity analysis of the relevant key credit rating assumptions can be found at https://www.dbrsmorningstar.com/research/418716.
These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.
Lead Analyst: Laura Gutierrez, Assistant Vice President, Credit Ratings.
Rating Committee Chair: Victor Vallance, Managing Director.
Initial Rating Date: 17 August 2020.
Last Rating Date: 2 August 2022.
Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at firstname.lastname@example.org.
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