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Rating action

Scope Ratings GmbH (Scope) has today assigned a first-time issuer rating of BBB+/Stable to Norwegian utility Arva AS. Scope has also assigned a first-time rating of BBB+ to senior unsecured debt and a S-2 short-term debt rating.

Rating rationale

Arva’s issuer rating reflects a strong business risk profile and a weaker financial risk profile. The business risk profile (assessed at A+) is backed by Arva’s sole exposure to fully regulated power distribution, which is associated with very low industry risk. The company has a monopoly as a grid operator with more than 120,000 customers within its service territory in the Nordland and Troms regions in Northern Norway, and lack of product and geographical diversification is therefore less important. Arva’s market position is also strengthened by Scope’s view on Norway’s robust and stable economy, and a well-established regulatory framework governed by NVE-RME with a tariff system that allows for timely pass-through of an increased cost base. Arva was established in late 2020 through a merger of Troms Kraft Nett and Nordlandsnett. Over the next few years, Scope expects that cost synergies of up to NOK 50m and more streamlined operations will contribute positively to regulatory efficiency measures and profit margins.

The financial risk profile (assessed at BB-) is constrained by Arva’s relatively high leverage and negative free operating cash flow. The latter is not expected to improve in the foreseeable future due to the company’s large 10-year investment programme of approximately NOK 8.5bn, combined with continued dividend payouts. The Scope-adjusted debt/EBITDA ratio is expected to average around 6.0x in the short- to medium term, and the ratio may see some upward pressure initially as peak investment levels are expected already in 2023-24. Negative discretionary cash flows will necessitate additional external financing in upcoming years, and combined with recent rises in interest rates, Arva’s debt protection, as measured by Scope-adjusted EBITDA/net interest, is expected to decline towards the 4-5x range.

Scope assesses Arva’s liquidity as adequate based on no upcoming debt maturities before mid-2024, and the company’s good access to both bank and bond financing. This should provide flexibility when deciding on a long-term capital structure. Moreover, Arva has established a financial policy which states that net debt/EBTIDA should be below 7x. The policy also includes targets for duration and interest rate hedging, amongst others.

The issuer rating reflects Arva’s standalone credit assessment of BBB and a one-notch uplift for GRE status. The uplift is driven by the anticipated capacity and willingness of Arva’s indirect Norwegian municipality owners to provide support if needed. No adjustment is made for financial policy as Arva’s policy is assessed to be sound, with an ambition to have an investment grade rating. Although Arva is a majority-owned subsidiary of integrated utility Troms Kraft AS, it is fully responsible for its own financing, and thus the policy is independent from the parent.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s view that Arva will continue to generate solid operating cash flows from its monopolistic and fully regulated power grid operations. The Outlook further reflects Scope’s forecasts that Scope-adjusted debt/EBITDA will stay around 6x going forward, and that free operating cash flow will be negative due to high capital expenditures. The agency also assumes the company will remain indirectly majority-owned by Norwegian municipalities.

A positive rating action could be warranted if Arva’s leverage as measured by Scope-adjusted debt/EBITDA, fell towards 5x on a sustained basis, resulting in an improved financial risk profile.

A negative rating action could be motivated by an increase in Scope-adjusted debt/EBITDA to well above 6.5x and interest cover falling below 4.0x, both on a sustained basis. This could be triggered by higher debt-financed growth than anticipated, or an adverse operational development leading to reduced profitability and cash flows, without any lower capital expenditures or dividends. A reduction in indirect municipal ownership to below 50% and the loss of GRE status could also trigger a downgrade.

Long-term and short-term debt ratings

Scope rates Arva’s senior unsecured debt at BBB+, the same level as the issuer rating.

The S-2 short-term debt rating reflects Arva’s underlying BBB+/Stable issuer rating and is supported by adequate liquidity, good banking relationships, and adequate access to diverse funding sources.

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

Methodology
The methodologies used for these Credit Ratings and/or Outlook, (General Corporate Rating Methodology, 15 July 2022; European Utilities Rating Methodology, 17 January 2023; Government Related Entities Rating Methodology, 6 May 2022), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity and Scope Ratings' internal sources. Historical data used for these Credit Ratings is limited.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. Scope Ratings notes that the Credit Ratings are based on limited historical data. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed.
Lead analyst: Per Haakestad, Senior Analyst
Person responsible for approval of the Credit Ratings: Sebastian Zank, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 29 March 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
© 2023 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis 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.