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Rating Action:

Moody's upgrades HEP's ratings to Ba1 from Ba2; outlook stable

16 Nov 2020

Frankfurt am Main, November 16, 2020 -- Moody's Investors Service ("Moody's") today has upgraded Hrvatska Elektroprivreda d.d.'s (HEP) long-term corporate family rating (CFR) to Ba1 from Ba2, the probability of default rating to Ba1-PD from Ba2-PD, and the senior unsecured debt rating to Ba1 from Ba2. Concurrently, Moody's has changed the outlook on the ratings to stable from positive.

Today's rating action follows Moody's upgrade of the long-term rating of the Government of Croatia to Ba1 from Ba2 and the concurrent change in outlook to stable from positive on 13 November 2020. For additional details on the rationale for the sovereign rating action, please refer to the press release (https://www.moodys.com/research/--PR_434224).

RATINGS RATIONALE

The upgrade of the rating to Ba1 from Ba2 and the change of the outlook to stable from positive reflect the fact that HEP's current rating is aligned with the sovereign rating of the Government of Croatia (Ba1 stable).

Given its 100% ownership by the Government of Croatia and HEP's strategic importance to the country, HEP's rating would normally incorporate an uplift from its standalone credit quality expressed as a Baseline Credit Assessment (BCA) of ba1, to reflect the strong likelihood of extraordinary support from the government in case of financial distress. However, as the company derives most of its earnings from Croatia, it is exposed to domestic regulatory oversight and local economic conditions, so its rating would not be expected to exceed that of the Government.

The BCA of ba1 is supported by (1) HEP's position as the vertically integrated incumbent in the Croatian electricity market and its leading position as supplier, enjoying around 90% market share; (2) its electricity generation mix, with a high share of low cost and low CO2 hydro and nuclear output; and (3) a strong contribution from lower risk regulated electricity distribution and transmission activities, which in aggregate contribute around half of EBITDA.

HEP's BCA continues to reflect the company's lack of diversification in terms of market presence. Moreover, it takes account of a developing track record in regulation, with a framework that is less transparent and predictable than for Western European peers. Certain smaller business segments, such as district heating and gas retail and distribution, have a history of very low or even negative returns. In recent years, the company has demonstrated a flexible dividend policy, aligned to its net profit, which reflects the supportive stance of the Government.

The BCA also factors that HEP remains exposed to fluctuating hydro levels and hence variable output from its hydro-dominated fleet, which normally generates slightly less than half of its production. As a consequence, the company purchases an additional 20-40% of energy on the market to balance its supply and trading needs. This creates some earnings volatility, as the company's exposure to imports and more expensive input costs of its own thermal fleet increases in dry years.

The BCA additionally reflects Moody's expectation that the company will continue to demonstrate a strong financial profile, building on its solid track record in recent years. The financial profile, as reflected in funds from operations (FFO)/net debt of 216% as of December 2019, is likely to weaken through a larger investment programme than in the recent past, which includes planned new generation capacity and investments to upgrade its ageing asset base and expand its existing networks. Notwithstanding the capital expenditure programme, Moody's expects HEP to retain its robust credit metrics, such as FFO/net debt in the strong double digits in percentage terms over the next few years.

HEP falls under Moody's rating methodology for Government-Related Issuers. The Ba1 rating incorporates (1) HEP's BCA of ba1; (2) its 100% ownership by the Ba1-rated Croatian government; (3) the strong likelihood of extraordinary support in case of financial distress; and (4) high default dependence, reflecting the company's strong domestic focus with around 90% of sales emanating from Croatia.

RATIONALE FOR THE STABLE OUTLOOK

Moody's would not expect HEP's rating to be higher than that of the government. The rating outlook is stable, in line with that of the sovereign and reflects Moody's expectation that HEP will continue to operate with a solid business and financial profile commensurate with the current BCA.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

An upgrade in the rating of the Government of Croatia would likely result in an upgrade of HEP's rating, assuming no major deterioration in the company's business or financial profile in the meantime.

Downward pressure could develop on HEP's rating in the event (1) that the sovereign rating was downgraded; or (2) of a significant deterioration in the company's financial or liquidity profile or business risk characteristics, potentially as a result of a more challenging operating or regulatory environment.

A corporate family rating is an opinion of the HEP group's ability to honor its financial obligations and is assigned to HEP as if it had a single class of debt and a single consolidated legal structure. The Ba1 senior unsecured rating of HEP's outstanding global notes is the same rating level as HEP's CFR, and reflects the absence of structural and contractual subordination of noteholders to the claims of other HEP group lenders.

The methodologies used in these ratings were Unregulated Utilities and Unregulated Power Companies published in May 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1066389, and Government-Related Issuers Methodology published in February 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1186207. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.

Headquartered in Zagreb, Croatia, HEP is the parent company for Croatia's incumbent vertically-integrated utility group. HEP operates across three main segments: (1) electricity generation, transmission, distribution and supply; (2) district heating generation, distribution and supply; as well as (3) natural gas distribution and supply. The legally and operationally separate power transmission subsidiary, HOPS d.o.o., is part of the consolidated group. HEP reported EBITDA of some HRK2,285 million (around EUR302 million) in the six-month period ended 30 June 2020.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Mark Remshardt
Vice President - Senior Analyst
Infrastructure Finance Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Paul Marty
Senior Vice President/Manager
Infrastructure Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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