Morningstar DBRS Confirms Issuer Rating on Západoslovenská energetika, a.s. at A (low), Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Issuer Rating on Západoslovenská energetika, a.s. (ZSE or the Group) at A (low) with a Stable trend.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmation is driven by ZSE's solid financial performance during 2023, with revenues and EBITDA at EUR 2,322
million and EUR 424 million, respectively, which is above Morningstar DBRS' expectations thanks to the rising compensation revenues. In addition, the predictable and recurring EBITDA and cash flow generation contributed to the credit rating confirmation.

The Stable trend reflects the Group's expected improvement in both financial (i.e., EBITDA and cash flow generation) and operational (i.e., rising volumes, customer base, and regulated asset base) terms resulting from the integration of Východoslovenská energetika Holding a.s. (VSE) in November 2023. Morningstar DBRS expects the Group to successfully integrate VSE and to benefit from certain economies of scale as it becomes the main distribution system operator (DSO) in Slovakia with a 70% share of power distribution compared with 50% at the end of 2022. However, considering the Morningstar DBRS sovereign credit rating of "A" with a Negative trend on the Slovak Republic and the government's 51% participation in ZSE, the credit rating on ZSE could be negatively affected if the sovereign credit rating deteriorates by more than one notch from its current position of A (negative).

CREDIT RATING DRIVERS
Morningstar DBRS would consider a positive credit rating action if (1) the Group successfully completes the integration of VSE while maintaining the cash flow-to-debt ratio above 25.0% and debt-to capital ratio below 45.0% on a sustained basis and (2) Morningstar DBRS' sovereign credit rating on the Slovak Republic remains at least at "A" with a Stable or Positive trend. Conversely, Morningstar DBRS could consider a negative credit rating action if (1) ZSE fails to integrate VSE, affecting the Group's financial and operational performance; (2) the EBITDA contribution from the Group's regulated business consistently declines below 80% over the medium term, thereby reducing the stability and predictability of cash flow generation; (3) ZSE introduced changes to its financial policy that resulted in increasing gross debt and deterioration in its cash flow-to-debt ratio below 10.0% and its debt-to capital ratio above 50.0% over an extended time frame; or (4) Morningstar DBRS downgrades its sovereign credit rating on the Slovak Republic to below ZSE's credit rating.

EARNINGS OUTLOOK
Looking ahead, Morningstar DBRS expects a moderate increase in earnings thanks to the full-year consolidation of VSE, which only contributed one month's income in 2023. EBITDA and cash flow from operations should reach around EUR 350 million and EUR 260 million annually, respectively, during the next three years. In addition, Morningstar DBRS expects some improvement in profitability in the short to medium term driven by economies of scale and management synergies.

FINANCIAL OUTLOOK
Morningstar DBRS notes the Group's aggressive dividend policy, expecting a high level of dividend payout ratio in 2024; however, Morningstar DBRS expects ZSE to manage its financial leverage with a debt-to-EBITDA ratio below 3.0 times and a debt-to capital ratio below 50.0%. Morningstar DBRS also notes that there is no substantial debt maturity until 2026 and takes comfort in the Group's stable and recurrent cash flow generation, ample cash balance, and well-diversified financial sources as well as the government's implicit support.

CREDIT RATING RATIONALE
ZSE's Issuer Rating is supported by (1) its status as the largest DSO in Slovakia, holding a monopolistic position in Western and Eastern Slovakia; (2) its regulated activities, which account for approximately 86% of total EBITDA; (3) its predictable and stable cash flow generation; and (4) implicit support from the Slovak Republic. However, ZSE´s Issuer Rating is constrained by its (1) limited geographical footprint, (2) high energy price volatility for its nonregulated business, (3) aggressive dividends policy, and (4) operational risk.

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 DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk 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 ZSE, the BRA factors are considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of ZSE, the FRA factors are considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of ZSE, 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 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 methodologies have also been applied:
-- DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk 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 public audited financial statements, investor presentations, and other public information. Morningstar DBRS 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, these are unsolicited credit ratings. These credit ratings were 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

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/442736.

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: 9 November 2023
Last Rating Date: 9 November 2023

Information regarding Morningstar DBRS 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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