Spotlight On Italian Utilities: Outlook Stable Despite Complex Operating Conditions
By Vittoria Ferraris Standard & Poor's
Although the recession of 2009-2014 has officially ended, the operating environment for Italian utilities remains tough. A moderate economic recovery and a shift toward energy efficiency are reducing the demand for power. However, the Italian utilities rated by Standard & Poor's Ratings Services have lost none of the resilience they demonstrated toward the harshest recession in the country's history. For most Italian utilities we rate, this resilience is partly attributable to the share of regulated activities in their business mix, which has enabled stable financial performance despite weak economic conditions.
Overview
The outlook for our portfolio of regulated utilities in Italy is stable, primarily reflecting the supportiveness and predictability of the regulatory regime. · We believe that the operating environment for Italian utilities is becoming increasingly complex. Power prices are unlikely to rebound due to oversupply, and a cut in allowed returns on electricity and gas transmission and distribution from 2016 will weigh on profitability. · However, we anticipate that Italian utilities will maintain a relatively prudent approach toward investments, while keeping a tight rein on costs over 2016-2018. ·
In our view, growth opportunities for utilities with exposure to Italy are bound up with mergers and acquisitions (M&A). Increasing M&A activity could affect the ratings in our portfolio, although sizable cost synergies and credit-friendly transaction terms would mitigate this risk. We believe that the operating environment for Italian utilities is becoming increasingly complex. The expected drop in remuneration for regulated assets from 2016, along with the shallow economic recovery, cast doubt on the profitability of Italian utilities' future investments, on their long-term growth potential, and on their strategic response to changes in demand.
We believe that Italian utilities' growth prospects are linked to market consolidation, especially for those operating solely in the domestic market. However, although mergers and acquisitions (M&As) are increasing, we consider that local political resistance toward consolidation will persist.
The Outlook For Our Rated Italian Utilities Is Stable
The stable outlook on the utilities we rate in Italy contrasts with the increasing proportion of negative outlooks on the utilities we rate in the rest of Europe, as well as in the Middle East and Africa. Negative outlooks represent about 20% of the 120 utilities that we rate in EMEA, compared to about 11% in Italy. The greater proportion of stable outlooks in Italy is down to the following credit-supportive developments we have observed since last year: ·
-An end to the economic recession in Italy in the first quarter of 2015, according to quarterly GDP data; ·
-The stabilization of the outlook on our unsolicited 'BBB-' long-term local and foreign currency ratings on Italy in December 2014; ·
-The alleviation of fiscal pressure with the termination of the so-called "Robin Hood" tax on regulated utilities' corporate earnings and the remodeling of the taxable income base for IRAP (Imposta Regionale sulle Attività Produttive, or the Italian regional production tax); and ·
-Political support from the Italian central government for energy market integration.
In addition, since the beginning of the recession in 2009, rated Italian utilities have focused on adapting their cost bases to the changing market environment and rationalizing their investments, which has resulted in positive free cash flow generation and consequently, stable credit metrics. Cost synergies have also been among the drivers for M&As in this period.