OREANDA-NEWS. Fitch Ratings has affirmed Energie Baden-Wuerttemberg AG's (EnBW) Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'A-' and Short-term IDR at 'F2'. Fitch has also affirmed EnBW's subordinated note rating at 'BBB'. The Outlook on the Long-term IDR is Stable.

The affirmation reflects Fitch's view that the recently announced transaction with EWE AG (EWE) and EWE-Verband, following which EnBW will become the majority shareholder in Verbundnetz Gas Aktiengesellchaft (VNG) will not materially affect EnBW's credit profile. Furthermore, we estimate that EnBW's strong liquidity position, lower financial leverage than many of its peers and flexible financial policy mitigate some of the effects stemming from the structural challenges in the power generation segment, execution risk in implementing its strategy and the uncertainty related to funding nuclear decommissioning costs.

KEY RATING DRIVERS
VNG to Increase Diversification
EWE AG will sell its 74.2% shareholding in VNG to EnBW. At the same time, EnBW will divest its 26% EWE shareholding over a period of time. This stock will be purchased by EWE-Verband (16%) and by EWE itself (10%). As part of this transaction, EnBW will provide EWE and EWE-Verband with a total cash settlement of EUR125m. The transaction is subject to regulatory approvals. In our view, the deal supports EnBW's business profile through further integration across the value chain. VNG is one of the top gas suppliers in Germany and is active in various businesses from E&P to supply, with high presence in trading, storage and regulated grids. VNG's largest business segment in terms of operating cash flow is regulated gas transportation and distribution grids.

Transaction Risks Mitigated by Regulated Earnings
We consider there are some risks associated with the lack of clarity on capex requirements for E&P, the material size (100 TWh) of long-term contracts with gas suppliers or unpredictable trading dynamics. In the long term, we believe that some of these risks will be mitigated by regulated earnings contributions from gas transportation and distribution grids (more than 50% of earnings) with no material capex requirements and from potential synergies in trading and supply.

Strategy Execution Risk
Since announcing its strategy in 2013, EnBW's EBITDA has continued to decline, and according to the company's expectation has yet to reach the trough. From 2017, the company expects to grow in three areas: Networks, Renewables and Customer Solutions, while in 2020 EBITDA should reach EUR2.4bn (pre-VNG), a level similar to 2012. We find this target ambitious, particularly considering the highly competitive environment in Renewables and Customer Solutions in Germany. Our estimates remain about 10% below EnBW's targets.

Political Risk Remains
Recent communication from the German government, who publicly stated that they will take into account the "economic capabilities of utilities" when implementing new laws, has led to improved sentiment. Additionally, the stress tests on nuclear decommissioning costs concluded that the existing provisions accumulated by the utilities are sufficient. Nonetheless, political risks remain, with further clarity needed on the future financing system of the nuclear phase out but also on broader topics such as the implementation of the lignite reserve.

Limited Headroom
EnBW's ratings have only limited headroom to absorb negative changes in its credit metrics. While contribution from better performing businesses (networks, renewables - with only a gradual ramp up of wind capacity even with the commissioning of 288MW in 2015 with Baltic II) increases, in our view it does not fully offset the weaker trading and generation dynamics. Additionally, the positive EBITDA contribution from the VNG transaction will be partially counterbalanced by adding EUR575m of VNG's debt to the balance sheet.

Better Funded Nuclear Provisions
EnBW's nuclear provisions are better funded than its German peers. We assume for our leverage estimate that the company does not have a shortfall with respect to the nuclear provisions. For YE15 we estimate FFO adjusted net leverage of around 2.2x, an improvement from 3.1x in 2014 partly thanks to a one-off positive cash tax contribution and positive working capital movements. We project FFO adjusted net leverage in the 2.5x-3x range in 2016-2017. For 2015 we also estimate FFO fixed charge coverage of around 4.4x and slightly positive free cash flow (FCF) of EUR200m.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for the issuer include:
- 2015 EBITDA at the lower end of EnBW's guidance (-5% yoy)
- A more conservative view (about 10% below) on 2020 EBITDA target of EUR2.4bn pre-VNG, mainly due to increased competition for renewable projects and customer solutions
- Full consolidation of VNG from 2017; EBITDA contribution of about EUR220m from the VNG transaction and additional debt of EUR575m
- Gross capex of EUR10.5bn for 2015-2020 at EnBW group level, and EUR6.6bn net of asset disposals for the same period
- Dividends of EUR200m/year

RATING SENSITIVITIES
Negative: Future developments that may lead to negative rating action include:
- Lease- and nuclear- adjusted FFO net leverage materially and sustainably above 3.0x.
- Loosening investment discipline related to capital expenditure.
- Faster than anticipated worsening of conventional generation business profile not compensated by improved performance in the renewables and regulated segments.

Positive: Future developments that may lead to positive rating action include:
- Rating upside is currently limited by EnBW's business profile features, including execution risk on the proposed strategy and structurally weak fundamentals in the generation segment.

LIQUIDITY
At 30 June 2015 EnBW had cash and cash equivalents of EUR2.8bn, an undrawn syndicated loan facility of EUR1.5bn maturing in 2020 and undrawn bilateral short term credit lines of EUR507m. Short-term debt was EUR929m. We consider refinancing risk is limited until 2017, which is the first call date for the 2072 hybrid. In our view, EnBW's good access to capital markets, well-funded position and financial flexibility including in capex and dividends offer some near-term support for the rating.