DBRS Morningstar Assigns an Issuer Rating of BBB (high), Stable Trend, to AB Ignitis grupe

DBRS Ratings GmbH (DBRS Morningstar) assigned an Issuer Rating of BBB (high) with a Stable trend to AB Ignitis grupe (Ignitis or the Company).

CREDIT RATING RATIONALE

AB Ignitis’ Issuer rating is supported by the following key factors: (1) a market-leading position in its home market, (2) the regulated distribution operations providing a source of stable cash flows, and (3) the implicit sovereign support from the Republic of Lithuania. However, the following factors constrain AB Ignitis’ Issuer rating: (1) limited electricity volume sold through long-term contracts, exposing the Company to power price volatility, (2) limited diversification both geographical and in terms power sources, and (3) the high capital expenditure requirements over the next few years. The Stable trend reflects DBRS Morningstar’s view that Ignitis’ credit metrics will remain supportive of a BBB (high) Issuer rating for the foreseeable future.

KEY CREDIT RATING CONSIDERATIONS

Headquartered in Vilnius, Ignitis is the largest electric and gas utilities company operating in Lithuania and one of the main utility companies in the Baltics. The Republic of Lithuania (DBRS Morningstar rated A (high) with a Stable trend) has a direct control of the Company through its 74.99% ownership held by the ministry of finance. Ignitis’ regulated business carried out by its subsidiary Energijos Skirstymo Operatorius ESO, owns and operates 99.5% of the electric grid and the whole gas network in Lithuania. The Company is the largest generator of electricity in the country and sells power through the Nord Pool energy exchange. Ignitis’ generation capacity is made up of hydro (44%) and gas fired facilities (46%) with the remaining 10% from wind and waste. Ignitis plans to grow its wind and solar generation capacity in Lithuania and its neighbouring countries. The Company also provides electricity and gas supply services in the Baltics, Poland, and Finland. As of 2022, Ignitis produced 1.83 terawatt hours (TWh) from its green and flexible generation assets and distributed 10 TWh of electricity through its wholly owned grid.

The credit rating is supported by Ignitis’ market-leading position in its home market with regard to power generation and its distribution business, which includes operating the electric grid that covers over 99.5% of the addressable market along with countrywide coverage of the gas distribution network. Both the electric and gas distribution businesses are state regulated; as such, DBRS Morningstar considers that they will provide a source of stable cash flows. Furthermore, given (a) the essential service that Ignitis provides to the Lithuanian population, (b) the significant geographical coverage of the electric grid and gas networks, and (c) its 74.99% public ownership, DBRS Morningstar is of the opinion that the Republic of Lithuania would be incentivized to provide financial support to the Company in the event of distress. For these reasons, DBRS Morningstar factors in an uplift in the rating for implicit support.

Conversely, the credit rating is constrained by the Company’s power generation business’ limited proportion of revenue derived from long-term contracts exposing it to electricity price volatility. DBRS Morningstar does recognize that the Company’s hedging activities covers a portion of the expected production over the next several years. From a business-risk perspective, DBRS Morningstar considers that contracted revenue from arrangements, including power purchase agreements (PPAs) or contracts for differences (CfDs), provide more stable cash flow over the medium and long term than hedging strategies alone. DBRS Morningstar also acknowledges that a portion of the renewable power generation capacity under construction will be covered by contracted revenues. However, given the potential construction delays, DBRS Morningstar will take these assets into consideration as a business-risk mitigant once the assets are operational. The limited diversification is another constraint for the credit rating considering that by the end of 2022, 46% and 44% of the installed capacity was related to gas powered and hydroelectric facilities respectively, all of which are located in a narrow slice of the Lithuanian territory, with only about 112 megawatts of installed capacity are located outside of Lithuania. However, DBRS Morningstar notes that the Company plans to extend its footprint of power generation assets to other Baltic and nearby countries. According to the 2023–26 strategy, Ignitis plans to invest between EUR 2.2 billion and EUR 2.8 billion in order to increase its renewable power generation capacity and to improve and increase its regulated asset base. These large investments will exceed expected cash generation capacity over the next few years and will require a substantial amount of debt financing over the period.

Performance in 2022 was mainly driven by the higher electricity prices in the Baltic region. Lithuania’s annual average price reached EUR 230/megawatt hour (MWh), which was 155% higher than the previous year. The bulk of the higher revenue comes from the Customers & Solutions business line, which is the most sensitive to price changes, by itself accounting for around EUR 2 billion of the revenue increase. As most of the green generation revenues are related to merchant sales, the adjusted EBITDA from this division grew by 135%, but Ignitis was not able to capture all of this increase because 54% of the production was hedged at an average price of EUR 105/MWh. The higher contribution from the electricity generation assets caused the EBITDA contribution from regulated activities to decline to 39% in 2022 from 57% in 2021. H1 2023 performance reflects the electricity price contraction seen over the period as Lithuania’s average electricity price decreased to EUR 92/MWh, causing revenues to drop by 21%. With the exception of green energy generation, which is the business line most affected by electricity price volatility in terms of margins, the adjusted EBITDA in all other segments grew, particularly the networks business, which was driven by higher tariffs. During H1 2023, the regulated EBITDA contribution reached 44%.

CREDIT RATING DRIVERS

DBRS Morningstar estimates that over the medium term, on average, at least 40% of the EBITDA contribution will be sourced from the Company’s regulated activities, underpinning the stability of the credit rating. From a cash flow perspective, DBRS Morningstar considers the regulated activities to be more stable than the power generation business. On the one hand, a significant reduction in the contribution from the regulated activities would be considered credit negative and could negatively affect the credit rating. In addition, a downgrade of Lithuania’s DBRS Morningstar sovereign rating could also trigger a negative credit rating action. On the other hand, a positive credit rating action could be considered when the new renewable assets become operational and provide more stable revenue from long-term contracts along with greater geographical diversification.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Environmental (E) Factors
There were no Environmental factors that had a relevant or significant effect on the credit analysis.

Social (S) Factors
There were no Social factors that had a relevant or significant effect on the credit analysis.

Governance (G) Factors
There were no Governance factors that had a relevant or significant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (4 July 2023); https://www.dbrsmorningstar.com/research/416784.

Notes:
All figures are in euros unless otherwise noted.

DBRS Morningstar applied the following principal methodologies:

-- Global Methodology for Rating Companies in the Independent Power Producer Industry (9 May 2023),
https://www.dbrsmorningstar.com/research/413646/

-- Global Methodology for Rating Companies in the Regulated Electric, Natural Gas, and Water Utilities (27 September 2023), https://www.dbrsmorningstar.com/research/421106

The following methodology has also been applied:

-- DBRS Morningstar Global Criteria: Guarantees and Other Forms of Support (28 March 2023), https://www.dbrsmorningstar.com/research/411694

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

A description of how DBRS Morningstar analyses corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.

The primary sources of information used for this credit rating include audited financial statements, quarterly results reports and presentations, presentation transcripts, publicly available regulatory information. DBRS Morningstar considers the information available to it for the purposes of providing this credit rating to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third-Party Participation: NO
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar trends and credit ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/423162/.

This credit rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Pablo Santin Filloy. Assistant Vice President, Credit Ratings.
Rating Committee Chair: Victor Vallance. Managing Director, Credit Ratings.
Initial Rating Date: November 10, 2023
Last Rating Date: Not applicable as there is no last rating date.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at [email protected].

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