DBRS Ratings GmbH (DBRS Morningstar) assigned an Issuer Rating of BBB (low) with a Stable Trend to Eesti Energia AS (EE or the Company).
CREDIT RATING RATIONALE
Esti Energia´s Issuer rating is supported by the following key factors: (1) a market-leading position in its local market, (2) the Company’s regulated distribution activity, which provides earnings stability, and (3) the implicit sovereign support from the Estonian state. However, the following factors constrain Eesti Energia´s Issuer rating: (1) EE’s limited geographical footprint, (2) the planned high capex needed to phase-out most of the Company’s oil-shale derived electricity generation, (3) overall high capex requirements over the following years, and (4) limited financing flexibility at the parent company level. The Stable trend reflects DBRS Morningstar’s view that EE´s credit metrics will remain supportive of a BBB (low) Issuer rating in the foreseeable future.
KEY CREDIT RATING CONSIDERATIONS
Eesti Energia is an Estonian state-owned company mainly involved in the production, sale, and distribution of electricity. Electricity generation is largely sourced from the Company’s production of oil shale and its derivatives. Through its listed subsidiary Enefit Green (EG) in which it owns a 77.2% stake, EE has been boosting its capacity in alternative sources of energy such as wind, solar, and cogeneration. To meet customer demand, the company also purchases energy from the Nord Pool, the power market operating in Northern Europe and the Baltics. Aside from its home market sales, EE’s other markets include other Baltic countries and Poland given the proximity and interconnectivity of these markets. As of 2022, the Company produced 6.3TWh of energy and sold 10.5TWh. Distribution, which is based on a regulated fee structure, is primarily done through a Company-owned and operated low and medium voltage grid in Estonia that covers 93% of the nation. EE distributed 6.7TWh of electricity through the grid in 2022. The remaining activities include the sale of heat and shale oil, which are byproducts of its core activities along with natural gas distribution.
The credit rating is supported by the Company´s market-leading position in its home market in the electricity (power generation and sale) and distribution (low- and mid-voltage grid operation covering 93% of the Estonian territory) segments. Electricity distribution is a regulated business and as such, provides the company with more stable revenues and earnings. Furthermore, given (1) the relative importance of EE to the Estonian economy, (2) the essential service that it provides to the Estonian population, and (3) 100% state ownership, DBRS Morningstar estimates that the Estonian state would be highly incentivised to provide financial support to the company in the event of distress. For this reason, DBRS Morningstar has assigned two notches of uplift based on the Estonian state´s implicit support relative to the standalone company´s rating.
Conversely, the rating is constrained by the company´s limited geographical diversification considering 97% of its revenue comes from the Baltic states and Poland. The high carbon intensity of EE´s operation also poses risks on several fronts. EU policies restrict carbon emissions of its member states, which limits the Company´s ability to use its thermal plants at full capacity. In order to compensate for this and to reduce carbon emissions, the Company needs to make large capex investments on renewable project developments and to refit the thermal power plants. Lastly, DBRS Morningstar considers that the Company´s ability to obtain financing is constrained. The elevated CO2 emissions generated by the Company in DBRS Morningstar’s view could temper investor interest in provide financing at the parent company level. This situation was apparent based on the conditions set forth in the syndicated loan that was signed in February 2023.
EE’s electricity business segment had a particularly good financial performance in 2022 given the extraordinarily high average electricity price in the Baltics and more specifically in Estonia. Average electricity price reached EUR 193/MWh (+122% compared with 2021), which helped EE deliver a 32% increase in EBITDA in this segment. On the other hand, the distribution EBITDA fell 40% because of higher fixed costs in addition to variable costs incurred to cover the 280MWh of energy grid losses at higher energy prices. This reduced the distribution segment´s EBITDA contribution to 12% in 2022 from 28% in 2021. The Company´s financial metrics by the end of 2022 were significantly above its rating category. As of H1 2023 the distribution segment has improved as higher tariffs approved have resulted in an increase in revenue and the payment of grid losses at lower prices have delivered better profit margins. The distribution segment´s EBITDA contribution recovered to 22% (31% in Q2 2023 alone). In Q2 2023 electricity production revenue dropped almost 50% given the average price reduction of 48% compared with the same quarter in the previous year, thus making oil shale electricity production less profitable.
DBRS Morningstar expects the Company’s overall credit risk profile and its key credit metrics to decline throughout 2023 and 2024, driven mainly by the EUR 2 billion capex planned as part of the Company’s 2022-2026 strategic plan to reach 1,900MW of renewable energy capacity and to refit its thermal power plants. In the regulated business, additional investments are needed in order to weatherproof the electric grid. DBRS Morningstar deems the expected cash flow generation during the investment period to be insufficient to cover the investment requirements and therefore the Company will need to raise debt to make up for the expected cash flow shortfall. In conjunction with an expected increase in debt, the EUR 600 million floating-rate sustainability-based syndicated loan signed in February 2023, which will be mostly used to repay the EUR 500 million bond maturing in September 2023, will pressure credit metrics further. In consideration of a higher interest rate environment, this will raise the average interest costs and cause interest coverage metrics to weaken.
CREDIT RATING DRIVERS
DBRS Morningstar expects the current rating to remain stable over the foreseeable future. Nevertheless, DBRS Morningstar would consider a positive rating action if the EBITDA contribution from the distribution activity increases to around 50%. Conversely, a negative rating action could result if the EBITDA from this business were to fall below the 20% threshold over the medium term, which would reduce the stability of cash flows. Changes in the Company’s financial policy allowing for additional capex in order to meet higher or earlier renewable capacity, which results in a deterioration in the Company´s financial risk profile below DBRS Morningstar’s current expectation could also result in a negative rating action. A downgrade of Estonia’s DBRS Morningstar sovereign rating could also be a trigger for a negative rating action.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
Carbon and GHG costs are deemed as significant environmental factor.
The high carbon intensity of EE´s operation limits the usage of the installed thermal power capacity because of EU policies restricting carbon emissions. The elevated CO2 generated by EE is limiting its ability to obtain financing.
There were no 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” (July 4, 2023); https://www.dbrsmorningstar.com/research/416784
All figures are in euros unless otherwise noted.
DBRS Morningstar applied the following principal methodologies:
-- Global Methodology for rating Companies in the Independent Power Producer Industry (May 9, 2023), https://www.dbrsmorningstar.com/research/413646/.
-- Global Methodology for Rating Companies in the Regulated Electric, Natural Gas, and Water Utilities Industry” (September 13, 2022), https://www.dbrsmorningstar.com/research/402616.
The following criteria have also been applied:
-- DBRS Morningstar Global Criteria: Guarantees and Other Forms of Support” March 28, 2023), https://www.dbrsmorningstar.com/research/411694.
-- Global Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (October 26, 2022), https://www.dbrsmorningstar.com/research/404334.
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 this credit rating include annual reports including audited financial statements, quarterly results reports and presentations, presentation transcripts, publicly available regulatory information. DBRS Morningstar considers the information available to it for the purposes of providing this credit rating to be of satisfactory quality.
With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.
With Rated Entity or Related Third-Party Participation: NO
With Access to Internal Documents: NO
With Access to Management: NO
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/420972/.
This credit rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.
Lead Analyst: Pablo Santin Filloy, Assistant Vice President.
Rating Committee Chair: Victor Vallance, Managing Director.
Initial Rating Date: 25 September 2023
Last Rating Date: Not applicable as there is no last rating date.
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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