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Rating Action:

Moody's assigns A3 rating to PGE Polska Grupa Energetyczna S.A.; stable outlook

02 Sep 2009

First-time issuer rating

Prague, September 02, 2009 -- Moody's Investors Service has today assigned an A3 long-term issuer rating to PGE Polska Grupa Energetyczna S.A. ("PGE"), a holding company for the leading Polish vertically integrated energy group involved in lignite mining, electricity and heat generation, wholesale trade, distribution and supply. The outlook is stable.

Given its 100% ownership by the government of Poland, PGE falls within the scope of Moody's rating methodology for government-related issuers (GRIs). In accordance with the methodology, PGE's A3 issuer rating incorporates an uplift for potential government support to its standalone credit quality. This is expressed by Moody's as a Baseline Credit Assessment (BCA) of 8 (on a scale of 1 to 21, where 1 represents the lowest risk and 8 is equivalent to a Baa1 rating). The uplift to the BCA, currently at one notch, results from the credit quality of its government shareholder and Moody's assessment of medium probability of government support in the event of financial distress as well as high default dependence (i.e. degree of exposure to common drivers of credit quality).

The A3 rating is underpinned by PGE's leading position in Poland's energy sector, a market that is currently relatively closed with electricity prices lower than in neighbouring Germany and thus with potential of positive price developments as further market integration is achieved. "Moody's also recognises that PGE's business profile further profits from well balanced vertical integration, as PGE covers (with the exception of the highest and high voltage grid) the whole spectrum of the electricity sector," says Richard Miratsky, a Vice President-Senior Analyst in Moody's Infrastructure Finance Group. The coal deliveries from PGE's own lignite mines cover 68% of its generation needs and mitigate the company's exposure to fluctuation in coal prices. The downstream integration, represented by PGE's eight distribution and retail companies that off-take up to 55% of the generated electricity and supply over 5 million customers, provides further stabilisation to PGE's business profile.

Although the solid operational performance of PGE's relatively young generation fleet represents a competitive advantage over its Polish peers, the rating is constrained by low diversification of its fuel mix, dominated by CO2-intensive coal-based generation. Although Poland has large reserves of relatively cheap coal, such a high concentration on coal will require the PGE to undertake very significant capital expenditure in order to develop renewable sources to fulfil EU energy directives and diversify the fuel mix to avoid high CO2 costs. Although Poland will continue to receive free CO2 permits after 2013, the allocated quota will be gradually decreasing to zero by 2020 and the need to purchase missing permits could expose PGE to a significant cost disadvantage in the future compared to the European average fuel mix.

The rating also takes into account PGE's strong historical financial performance with solid debt coverage metrics. "However, PGE's strong financial profile is expected to weaken in the medium term, mainly due to the company's sizeable capex plan that will result in significant pressure on leverage," cautions Mr. Miratsky. Moody's has factored into the assigned rating the challenging capex programme planned by PGE and the associated expected deterioration in financial profile. However, credit metrics falling persistently and materially below the levels of FFO Interest Cover of 6x, FFO/Net Debt of 40% and RCF/Net Debt of 30% would not be seen by Moody's as commensurate with the current rating level.

PGE's solid short-term liquidity position benefits from strong cash flow generation, a comfortable debt maturity profile and sufficient headroom under its committed credit lines. However, Moody's expects PGE's liquidity profile to weaken in the medium term, as the sizeable capital investment programme will continue to consume funds, resulting in negative free cash flow and increased leverage. "Although PGE's current leverage is low compared to its utility peers, Moody's expects PGE to follow prudent liquidity and debt management policies as reliance on market access for new debt funding increases with the implementation of the investment programme," explains Mr. Miratsky. Furthermore, PGE's currently favourable debt maturity profile shows certain repayment accumulation in 2010 and 2012 as the company's bonds mature, representing increased refinancing risk. Moody's further notes that PGE's liquidity and leverage profile is dependent on proceeds from a successful IPO, planned by the end of 2009, as well as the future development of relatively unpredictable proceeds from compensations for termination of long-term power purchase agreements (PPAs).

The stable outlook reflects Moody's expectation that PGE will remain the leading electric utility in Poland and the company's significant financial flexibility to deal with the challenges of its corporate development and investment plans in the medium term. However, Moody's cautions that rating stability over the longer term will ultimately depend on PGE's ability and willingness to adjust its ambitious capital investment programme according to the development of its operating and financial performance.

The principal methodology used in rating PGE was Global Unregulated Utilities and Power Companies and The Application of Joint Default Analysis to Government Related Issuers, which can be found at www.moodys.com in the Credit Policy & Methodologies directory, in the Ratings Methodologies sub-directory. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Credit Policy & Methodologies directory.

Headquartered in Warsaw, Poland, PGE generated 56.1TWh of electricity, served over 5 million retail customers and generated EUR5.9 billion in revenues in the year ended December 2008. PGE is 100% owned by the government of Poland.

London
Monica Merli
Managing Director
Infrastructure Finance
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Prague
Richard Miratsky
Vice President - Senior Analyst
Infrastructure Finance
Moody's Central Europe
Telephone: +420-22-422-2929

Moody's assigns A3 rating to PGE Polska Grupa Energetyczna S.A.; stable outlook
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