OREANDA-NEWS. Fitch Ratings has affirmed Infinis plc's Long-Term IDR at 'BB-', but revised the Outlook to Negative from Stable. Fitch has affirmed the rating of the senior secured notes at 'BB-'.

The company's 'BB-' rating reflects free cash-flow generation underpinned by the contracted position until 1H18. However, price volatility lowers visibility longer term and the prospect of a new shareholder and possible early refinancing may modify the capital structure. We expect FFO adjusted net leverage to breach rating guidelines in the financial year to March 2017 (FY17) and FY18, while the uncertainty from FY19 also implies a shift in Outlook to Negative from Stable.

KEY RATING DRIVERS

UK Regulation

Around 40% of Infinis's revenues benefit from the renewables obligation (RO) incentive scheme. The UK government has confirmed its commitment to grandfathering existing incentive schemes and we assume the RO will continue to receive the same level of support until 2027. The bulk of the RO, renewables obligation certificates (ROC) buy-out are indexed to inflation. The smaller element, ROC recycle, should increase as long as the UK's renewable obligation increases at a faster rate than the increase in volume of renewable electricity generated. Infinis has appealed the government's decision to discontinue the Climate Change Levy (CCL) exemption in July 2015. A hearing is due in late autumn 2016.

Power Price Exposure

Around 50% of Infinis's revenues are exposed to wholesale price risk under the RO scheme, which could lead to price volatility and have a substantial impact on cash flows and the rating. Weak gas prices and the prospect of a generation capacity market have meant further weakness in UK wholesale baseload electricity prices. Latest forwards indicate GBP42/MWh for FY18 and GBP39 from FY19 compared with GBP42 previously. Although Infinis typically hedges ahead for six to 12 months, the long-term impact is negative. The latest contracted position covers more than 50% of 1H18 volumes sold forward at GBP36/MWh.

Declining Output

Fitch expects landfill gas (LFG) output to show a gradual continuous decline of 4%-6% per year. However, with a half-life of around 11 years, output can continue until 2047. While reliance on a single technology is a weakness, the portfolio is well diversified by region, with the top 10 sites accounting for around 40% of total capacity of 301MW. Exported generation in the three months to June 2016 was 405GWh, a fall of 6.9% due to a combination of the natural decline in landfill gas, drier weather conditions and outages at Calvert & Poplars sites. This is comparable with management's forecast for FY17 of -6.5%.

Refinancing Risk

Fitch expects Infinis to refinance the GBP350m bond maturing in 2019 with debt issuance sized at 3.5x EBITDA. There is no partial redemption facility to pay down debt earlier and reduce refinancing risk. Repayment will depend on retaining adequate cash levels as EBITDA is estimated to be lower than previously estimated, with FY19 of GBP69m against GBP75.5m previously, as a result of lower wholesale prices, offset by dividend lock-up covenants, implying a theoretical debt quantum of around GBP240m. However, refinancing will almost certainly be a decision taken by the new owners once the sale process is complete. The sale process is the most likely, but not the only, trigger for repayment of the GBP20m intercompany loan to Infinis plc by parent company Infinis Energy Holdings Ltd (IEHL).

Sale Process

Infinis plc is looking to sell the LFG business to interested parties. However, the parallel sale of the wind business by parent company, Infinis Energy Holdings Ltd (IEHL), would also allow the repayment of the GBP20m intercompany loan made by Infinis plc to IEHL. Other UK industry players after Infinis plc, with a 40% landfill market share, include Viridor, Biffa, EDL, CDP, Viridis, Suez-Sita, Veolia Environnement S. A. (BBB/Stable) and Ener - G. As it is in natural decline, the long-term appeal to buyers of the LFG business is grid access, a flexible, valuable asset in a power market moving away from a centralised dispatching structure towards distributed energy. We assume that the sale closes early next year. We believe that refinancing of the 2019 bond issue depends on the sale process and will reflect the views of the new owners. However, there is no mandatory redemption on change of control if net debt to EBITDA is below 3.5x, otherwise there is a standard put option at 101.

KEY ASSUMPTIONS

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

- Power prices reflect contracted volumes and prices as at July 2016, with current UK forwards for uncontracted volumes beyond Summer 2017 (FY18), GBP42/ MWh for FY18 and GBP39/ MWh from FY19. We use Fitch Sovereigns' updated CPI forecasts from August 2016 as a basis for RPI FY18-19 used to roll forward the ROC component (GBP44.77/MWh in FY17) of the total achieved price.

- Bond refinance assumed in FY19 at 3.5x EBITDA, implying a refinancing quantum of GBP240m (or GBP220m if the GBP20m intercompany is not repaid).

- No repayment of GBP20m intercompany loan, as this depends on the sale of wind or LFG for repayment. However, assuming repayment in FY18 would lower estimated FFO adjusted net leverage from 4.6x to 4.2x and lower the average for the rating horizon from 4.2x to 3.9x.

RATING SENSITIVITIES

Positive: The Outlook is Negative and a positive rating action thus is unlikely, future developments that could nevertheless lead to positive rating action include:

An increase in wholesale electricity prices or LFG recovery above Fitch expectations leading to FFO net adjusted leverage sustainably below 3x and FFO interest cover sustainably above 4x.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

-Recoverable LFG depletion faster than we currently assume or wholesale electricity prices substantially lower than the forward curve so that FFO net adjusted leverage is sustainably above 4x and FFO interest cover sustainably below 2.5x.

Slower deleveraging, based on FFO net adjusted leverage, as the refinancing deadlines approaches could also lead to negative rating action.

LIQUIDITY

Based on solid FCF generation, we expect the company's liquidity position to be healthy. Available liquidity consists only of cash on the balance sheet in the absence of a revolving credit facility in the restricted group. As of June 2016, readily available cash stood at GBP64.4m, before the latest dividend payment of GBP4.5m. There is no uplift from the IDR for the senior notes, in view of average expected recoveries. Limited retail hedges and asset concentration are reflected in greater than average volatility in LFG valuations, although this is offset by potentially valuable grid access.