Morningstar DBRS Upgrades the Issuer Rating and the Euro Medium Term Notes Rating on Madrileña Red de Gas Finance B.V. to BBB from BBB (low) With Stable Trends and Removes the Under Review with Positive Implications Status

DBRS Ratings GmbH (Morningstar DBRS) upgraded Madrileña Red de Gas Finance B.V.'s (MRG Finance or the Issuer) Issuer Rating and Euro Medium Term Notes (EMTN) rating both to BBB from BBB (low). All trends are Stable. Morningstar DBRS also removed the Under Review with Positive Implications status of the credit ratings where they were placed on 21 May 2024.

KEY CREDIT RATING CONSIDERATIONS
The credit rating upgrades follow the publication of the final resolution of the litigation between Madrileña Red de Gas (MRG) and the Comisión Nacional del Mercado de la Competencia (CNMC or the regulator), confirming that the Group has taken necessary actions to comply with the legally binding decision of 16 March 2023 replacing the guarantee provided by MRG on the bond issuances of MRG Finance (EUR 300 million maturing in 2025, EUR 300 million maturing in 2029, and EUR 75 million maturing in 2031), with a guarantee from Elisandra Spain V, S.L. (Elisandra V, or the new Guarantor), the parent and sole shareholder of both MRG and MRG Finance. All the mentioned outstanding bonds are to rank pari passu with the intercompany loans between Elisandra V and MRG Finance and with the bank loan facility at Elisandra V. With this capital restructuring, MRG has successfully resolved the litigation in a manner consistent with Article 62.6 of Law 34/1998, of 7 October. The resolution exhausts the administrative channel and is not susceptible to appeal of position.

Considering the above, the Issuer rating and the credit rating on the EMTN of MRG Finance are now based on the new Guarantor's credit quality, whose consolidation perimeter includes MRG, MRG Finance, and Aliara Energia, with the latter focusing on the Group's non-regulated activity to complement and supports MRG's core business of gas distribution.

CREDIT RATING DRIVERS
Although a credit rating upgrade is not likely at this time, Morningstar DBRS could consider an upgrade if the cash-flow-to-debt ratio were to improve to well above 12.5%, debt-to-capital were to decline below 50.0%, and EBIT-to-interest were to improve well above 3.0 times (x) on a sustained basis. Conversely Morningstar DBRS could consider a negative credit rating action if MRG failed to manage the remuneration haircut, resulting in the cash flow-to-debt ratio falling below 9.0% and debt-to-capital rising above 65%, both over an extended time frame. Morningstar DBRS also notes that, because the remuneration haircut is to be phased in gradually, some credit metrics may not be maintained over the medium term. Nevertheless, MRG´s flexible dividend policy could help mitigate the potential negative remuneration impact.

EARNINGS OUTLOOK
Morningstar DBRS expects Elisandra V's revenues to continue to be composed primarily of regulated business from MRG over the next three years, with very low contribution from Aliara Energía. Looking ahead, with the regulatory haircut in place for the remainder of the current regulatory period, Morningstar DBRS expects MRG's earnings to slightly decrease during the next three years. In addition, Morningstar DBRS notes that earnings could be affected by lower gas demand as a result of warmer temperatures, as it happened in 2023. However, Morningstar DBRS also considers this possibility to be partially mitigated by the lower energy prices expected for at least the next year.

FINANCIAL OUTLOOK
Morningstar DBRS expects the Group to maintain its current capital structure with debt-to-capital below 55%. Apart from the partial refinancing of the EUR 300 million bond maturing in 2025, which has been successfully executed with a EUR 180 million bank loan facility to be drawn at the maturity date of the bond, only minimal amounts of debt are expected to be raised in the next two years under the currently undrawn EUR 75 million revolving credit facility. However, if relevant additional debt is raised at Aliara's Group or MRG, Morningstar DBRS would consider adjusting the credit ratings for structural subordination.

CREDIT Rating rationale
The credit ratings recognise MRG´s (1) stable regulated business, which accounted for 98% of total revenues in 2023; (2) relatively strong franchise area; and (3) a stable regulatory framework, with the current regulatory period for 2021-26 consistent with the previous framework, providing remuneration based on the growth in demand and connection points rather than assets and the incentive to optimise operating and capital expenditures. The credit ratings are constrained by (1) the haircut applied for the current regulatory period.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.
 
A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)

(A) Weighting of BRA Factors 
In the analysis of MRG Finance, the relative weighting of the BRA factors listed in the Regulated Utilities section was approximately equal.

(B) Weighting of FRA Factors 
In the analysis of MRG Finance, the FRA factor listed in the Regulated Utilities section, cash flow-to-debt was considered more important.

(C) Weighting of the BRA and the FRA 
In the analysis of MRG Finance, the BRA carries greater weight than the FRA.

Notes:
All figures are in euros unless otherwise noted.

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Companies in the Regulated Utility and Independent Power Producer Industries (27 June 2024) https://dbrs.morningstar.com/research/435127.

Morningstar DBRS credit ratings may use of one or more sections of the Morningstar DBRS Global Corporate Criteria (15 April 2024) - https://dbrs.morningstar.com/research/431186 which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodology has also been applied:
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

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

A description of how Morningstar DBRS analyses corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

The primary sources of information used for these credit ratings include the Final Resolution published by the CNMC related to the Accreditation of Compliance with the legally binding decision in relation to the credit facility agreement entered into between MRG and Elisandra V, and information provided by MRG. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

Morningstar DBRS 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. Morningstar DBRS trends and credit ratings are under regular surveillance.

For further information on Morningstar DBRS 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 Morningstar DBRS 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://dbrs.morningstar.com/research/441188.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Laura Gutierrez, Assistant Vice President
Rating Committee Chair: Anke Rindermann, Managing Director
Initial Rating Date: 17 August 2020
Last Rating Date: 21 May 2024

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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