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Rating action

Scope has today affirmed Uniper SE’s issuer rating of BBB+ with Stable Outlook. The S-2- short-term rating and BBB+ senior unsecured debt rating were also affirmed.

Rating rationale

The issuer rating continues to be constrained by the business risk profile (BBB-), weakened by significant merchant risks from the company’s dominant position in power generation and gas supply, and by increasing political risks regarding the phase-out of coal in different markets. This is partly offset by the gradual and ongoing expansion of EBITDA contributions from regulated and quasi-regulated segments. Moreover, Uniper’s credit quality is strongly supported by its financial risk profile (A) and sound financial policy which aims at preserving the rating level.

AGM could set the stage for changing Uniper’s future as an independent company in the mid to long-term

Scope’s rating case is based on Uniper being an independent company. Decisions taken at the AGM on 22 May 2019 could alter this status in the medium to long-term if proposals of activist shareholders Knight Vinke (KVIP International V L.P.) and Elliott (Cornwall GmbH & Co. KG) were to be implemented at some point. Fortum which has bulked up its share in Uniper to 49.99% after the end of the tender period in 2018, has not been able to take control due to restrictions in Russian Strategic Investment Law if it wanted to do so. In case Fortum truly wanted control over Uniper, it would have the chance to set the stage for a potential implementation of measures that could lead to obtaining control in the medium to-long term as Fortum and activist shareholders will have a combined share of 72.84% at the AGM (Fortum: 49.99%; Paul E. Singer and related entities [Elliott]: 17.84%; Eric Knight [Knight Vinke]: 5.02%).

While the further stocking up of Fortum’s share in Uniper signals the general intention, the question remains, however, as to whether Fortum actually intends on taking control of Uniper. This is given the so-called ‘fresh start’ between the two companies for future co-operation and the implied financial consequences for Fortum. At the AGM, all proposals of the activist shareholders could eventually lead to Fortum either taking full control in the following months or taking over a significant part of Uniper’s assets, the latter of which would be more complementary to Fortum’s asset portfolio and ESG profile. However, Scope will wait for the conclusions from the AGM before assessing any rating impact, also taking into account that – if agreed by the shareholders – the implementation of the proposals will require a significant amount of time.

Business risks continue to constrain the rating

Under the current status quo, Uniper’s business risk profile (BBB-) continues to constrain the overall rating. Although Uniper dominates in power generation in major Western European markets, ranking first in gas trading in Germany and second in Europe, its overall business risks remain affected significantly by industry-inherent and non-controllable factors acting on commodity prices, by generation disruptions, and unhedged currency translation risks, particularly regarding the Russian rouble.

Uniper’s European generation business is also increasingly under political/regulatory pressures to phase out coal. Germany aims for this by 2038 (see also Scope’s commentary: Mixed medium to-long term implications from Germany’s coal exit, January 2018); France envisages accelerated phase-out by 2021; the Netherlands intends it by 2030. This would have a significant impact on Uniper’s medium-to-long-term business risk profile, as around 20% of its European power generation relates to lignite and hard coal in these markets (adding up to around 6 GW). For its French generation activities, which include two hard coal power plants (1.2 GW), Uniper has already received a binding offer from Czechia’s Energetický a prumyslový holding, a.s. in December 2018.On the other hand, the coal exit is likely to be accompanied by adequate compensation payments. These could be reinvested in markets less exposed to such risks, invested in assets which fulfil Uniper’s current investment focus on regulated and quasi-regulated assets, or simply used to keep indebtedness low.

In this context, Scope’s assumptions of Uniper’s gradual transformation towards lower-risk utility segments and gradually increasing stabilisation of the business risk profile still hold. The assumption of a growing relative EBITDA contribution from regulated and quasi-regulated activities to more than 60% in 2020E no longer applies given the better-than-expected developments for unregulated merchant business. Instead, Scope expects EBITDA contributions from lower-risk utility segments (power generation in capacity markets as well as power generation under long-term contracts with industrials) to grow to above EUR 800m by 2020, which would correspond to around 50% of group EBITDA.

Scope expects Uniper’s EBITDA to reach a trough of around EUR 1.4bn in 2019E. This reflects Uniper’s hedge ratios and hedged prices in its main markets, Germany and Sweden, as well as the general commodity price rebound, which is expected to lead to a recovery in EBITDA beyond 2019 (Scope’s forecasts: 2020E: EUR 1.5bn; 2021E: 1.7bn). This is due to the hedged price secured at 22-26 euros/MWh in 2019 for 80% of outright power generation in Germany against 35 euros/MWh in 2020; the largely hedged price of 22-26 euros/MWh for outright power generation in the Nordpool against 24-28 euros/MWh in 2020; and the positive effect from the absolute pricing level of gas. Scope does not anticipate significant risks for deteriorating market fundamentals (achievable prices and margins) over the next three years in light of the shifts in the merit order system with the phase-out of nuclear and coal in Germany, and with CO2 pricing seeming to have found a floor at 20 euros/metric tonne.

Strong financial risk profile

Uniper’s financial risk profile (A) still strongly supports the rating. Debt protection, as measured by EBITDA/interest cover, remains comfortably above 10x in light of the limited need for expansion capex, new financing and the gradual improvement expected for group EBITDA beyond 2019. More importantly, Scope-adjusted debt/EBITDA, which includes Scope’s adjustments to long-term obligations for pensions and asset retirements but excludes margining liabilities, remains low at below 1.7x and forms the basis for the rating case (2018: 0.9x; 2017: 1.0x; 2016: 1.6x). Incorporating our assumptions about a strong reduction of margining liabilities (gross) as well as the partial usage of external bank financing related to growth capex, Uniper’s leverage is expected to stand at a higher level over the next three years. However, Scope does not expect Uniper to exceed the leverage threshold mentioned above over the next few years, based on envisaged needs for maintenance and growth capex as well as on dividend payouts, which grow gradually in line with policy. Scope’s underscores that our adjusted leverage is structurally lower than Uniper’s communicated leverage as net economic debt/EBITDA due to the agency’s adjustments and haircuts on long-term pension provisions, asset retirement obligations and margining, thereby reflecting the payout character and asset coverage of such debt obligations.

According to Scope’s sensitivity analysis, the company has headroom on both net debt and unexpected shortfalls in EBITDA before reaching the maximum leverage of 1.7x, the trigger for a negative rating action. All things being equal, Scope calculates Uniper’s potential headroom for additional debt (which could be used for growth capex beyond the EUR 400m communicated) to be around EUR 300m, based on the agency’s maximum leverage threshold of 1.8x. Similarly, the company’s EBITDA can fall short by around EUR 150m in 2019/20 (10% against our estimates) before reaching the agency’s leverage-based trigger for a negative rating action. Such decline in EBITDA is deemed unlikely given the aforementioned positive effects from commodity prices, hedged volumes for 2019 and 2020 in power generation, and price indications from oil and gas futures.

The rating is also supported by Uniper’s communicated target leverage of around 2.0x as it implies the company will not engage in growth projects that result in more volatile cash flow. Fluctuations around this level would predominantly be due to margining positions as at YE 2018 (excluded in Scope-adjusted leverage), when leverage as defined by Uniper stood at 2.1x. Furthermore, Scope’s opinion of a sustainably strong financial risk profile is further based on Uniper’s rating commitment, dividend payouts linked to free cash from operations (funds from operations minus maintenance or replacement capex).

Liquidity remains sound with ratios of consistently above 110% (both internal and external sources) at all times. After redeeming its EUR 500m corporate bond in December 2018, Uniper has outstanding debt totalling around EUR 1.9bn that needs to be covered between 2019-21, which includes the settlement of gross margining liabilities related to Uniper’s electricity and gas trading of about EUR 1.0bn as at YE 2018. While the margining liabilities are widely balanced by receivables, the remaining debt exposure from commercial paper, leases and bank loans is expected to be covered by the combination of an unrestricted cash cushion (EUR 1.4bn at YE 2018), free operating cash flows (consistently at least at breakeven), and the unused EUR 1.8bn syndicated credit facility committed until 2023. From Scope’s perspective, Uniper’s internal liquidity sources are expected to be sufficient to cover funding needs without needing to extent the usage of the EUR 1.8bn commercial paper beyond the current level (usage of around EUR 500m at YE 2018) or exploiting its EUR 2bn unused debt issuance programme, unless Uniper intended to pursue larger than expected growth opportunities.

S-2 short-term rating affirmed

Based on the sound liquidity and Uniper’s BBB+ issuer rating, Scope affirms its short-term rating of S-2. This rating reflects Scope’s perception of the company’s sustainable liquidity in terms of short-term debt coverage and access to external corporate funding. Including all internal and external sources of liquidity, coverage of short-term debt is projected at well above 110%.

Outlook and rating-change drivers

The Stable Outlook reflects the status quo of Uniper. Scope-adjusted leverage (Scope-adjusted debt/EBITDA) at up to 1.7x remains commensurate with the current rating, assuming business risks do not increase significantly. The Outlook further incorporates that Uniper will keep its current stance on financial policy with i) a focus on positive free operating cash flows; ii) gradual dividend increases; and iii) a commitment to a target economic net debt/EBITDA of around 2.0x.

A negative rating action could be required if at one point Uniper loses its status as an independent company and altered its financial policy towards a more aggressive stance on leverage and dividends. Uniper’s future as an independent company will be more clear following the AGM on 22 May 2019 should shareholders vote to instruct Uniper's management to implement some of the proposals by Elliot and Knight Vinke. Scope would reassess its rating, should Fortum or any other shareholder obtain a controlling stake in Uniper. Scope keeps the trigger for a potential negative rating action if it expected that Uniper’s financial risk profile will weaken, as measured by a Scope-adjusted debt/EBITDA of at least 1.8x over a prolonged period.

Scope believes that the possibility of a rating upgrade is remote, given the company’s communicated financial leverage and dividend policy. A rating upgrade is possible if Uniper’s leverage, as measured by Scope-adjusted debt/EBITDA, stabilised at below 1.0x over a prolonged time horizon.

Stress testing & cash flow analysis 
No stress testing was performed. Scope performed its standard cash flow forecasting for the company.

Methodology
The methodology used for this rating and rating outlook (Corporate Rating Methodology, Rating Methodology: European Utilities) are available on www.scoperatings.com.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rated entity participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, third parties and Scope internal sources.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst Sebastian Zank, Executive Director
Person responsible for approval of the rating: Werner Stäblein, Executive Director
The ratings/outlooks were first released by Scope on 13.06.2017. The ratings/outlooks were last updated on 12.06.2018.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2019 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.

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