Fitch Ratings has revised Acea SpA's Outlook to Negative from Stable and affirmed its Long-Term Issuer Default Rating (IDR) and senior unsecured ratings at 'BBB+'.

A full list of rating actions is detailed below.

The revision of the Outlook reflects our view that Acea's higher-than-expected leverage will persist in 2023, due to sizeable working-capital drain and investment acceleration. We expect the group's industrial plan to clarify their structural leverage tolerance (reported net debt / EBITDA of 3.0x is the historical target communicated by the group) and their strategic ambitions, which will provide key inputs for the rating trend.

The rating mainly reflects the largely regulated nature of Acea's cash flows, its solid operational performance and increasing capex needs.

Our projections do not factor in the potential realisation of the large waste-to-energy plant serving the City of Rome, for which Acea has submitted an 'expression of interest' to the Municipality of Rome.

Key Rating Drivers

Leverage Breach: Fitch estimates Acea's funds from operations (FFO) net leverage in 2022 to have slightly breached its 5.0x negative sensitivity. We now expect the breach will continue this year, after management guidance for 2023 points to a net leverage increase to levels that would not be consistent with 'BBB+' and with the reported 3.0x net debt/EBITDA embedded in Acea's historical target.

Long-Term Business Plan Key: We view management's estimate for 2023 as prudent, which is based on an overall adverse energy scenario, without fully considering potential extraordinary measures to mitigate an expected negative free cash flow (FCF) of around EUR700 million. In light of the above, we deem the clarification of Acea's leverage commitment and industrial strategy key for the trend of the rating.

Rising Net Debt: Under our updated projections, Fitch-defined EBITDA is unchanged at EUR1.4 billion in 2024 but net debt (excluding the adjustment for factoring) is now estimated at EUR5 billion, marking an almost EUR0.4 billion increase from our July 2022 estimates for the same year and an EUR1.1 billion increase from the 2021 actual figure. This mainly reflects expected greater working-capital absorption of almost EUR0.1 billion, and investments now structurally at EUR1 billion per year for 2023-2024 versus EUR0.8 billion-EUR0.9 billion previously estimated.

Solid Operating Performance: Acea's EBITDA was solid in 2022, with almost all divisions marking a year-on-year increase, denoting strong resilience in a very volatile energy environment. Even for 2023, management are targeting another 2%-4% increase, which we deem achievable. However, FCF generation was negative at more than EUR450 million in 2022, which we expect to worsen in 2023 leading to pressure on net leverage.

Standalone GRE Rating Drivers: Fitch views Acea as a government-related entity (GRE) under its criteria, given the City of Rome's majority ownership (51%). This drives our assessment of 'Strong' control and ownership, which is counterbalanced by 'Weak' support track record and expectation, 'Moderate' socio-political implications of a default, and 'Weak' financial implications of a default.

Limitations of Shareholder Links: We continue to assess Acea at its 'bbb+' Standalone Credit Profile (SCP) level, reflecting also our assessment of 'insulated' access and control by the parent based on Acea's public listing status, the presence of strong minority shareholders and negligible financial integration with Rome. Legal ringfencing is seen as overall 'porous', in light of Acea's publicly and clearly defined leverage policy and record of adherence. Under our criteria Acea has reached the maximum rating differential from the City of Rome's, constraining rating upside in the short term.

Derivation Summary

Acea has a better business profile than other Fitch-rated Italian multi-utilities such as Iren S.p.A. (BBB/Stable) and Alperia S.p.A. (BBB/Negative), as it benefits from a higher EBITDA contribution of fully regulated activities at around 80% compared with around 50% at Iren and 20% at Alperia. In contrast, compared with fully regulated gas distributor Italgas S.p.A. (BBB+/Stable), Acea has a lower debt capacity for the same rating (downgrade at 7.0x FFO net leverage for Italgas versus 5.0x for Acea), due mainly to the presence of unregulated activities and a less mature regulatory framework for water than gas in Italy.

In comparison with pure international water network peers such the Spanish FFC Aqualia S.A. (BBB-/Stable), the Polish-based Aquanet S.A. (BBB+/Stable), Acea is more diversified (electricity networks, and waste services, etc.) and benefits from a more predictable and developed regulatory framework, granting a higher debt capacity at the same rating level. It shares a similar debt capacity with Spain's Canal de Isabel II, S.A. (BBB+/Stable), whose business mix is almost fully regulated, largely under its 50-year water concession agreement with the Region of Madrid.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

EBITDA of grid and water divisions to rise to almost EUR400 million and EUR700 million, respectively (excluding net income from associates), by 2024

Energy division's EBITDA to progressively increase to EUR165 million by 2024, with developed solar assets in JV contributing to FFO only through dividends of up to EUR15 million per year in 2024

Doubling of EBITDA contribution from the environment-services division by end of the business plan (around EUR115 million), with new investments and external expansion fueling waste-treatment volume growth

Working-capital outflow in 2023 of around EUR220 million, before almost fully reversing in 2024

Capex and selected acquisitions for EUR2.1 billion across 2023-2024

Cumulative dividends of more than EUR350 million in 2023-2024

Economics of the potential new waste-to-energy plant of Rome excluded

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Due to the Negative Outlook, an upgrade of Acea is unlikely. Furthermore, upside is constrained by our view of the creditworthiness of the City of Rome, Acea's majority shareholder

We would revise the Outlook to Stable if the new business plan points towards credible deleveraging, with FFO net leverage falling below 5.0x on a sustained basis, and/or towards a visible improvement of Acea's business profile

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Failure to reduce FFO net leverage to 5.0x or below by end-2024, or to maintain FFO interest cover above 3.5x on a sustained basis

A shift in the activity mix towards unregulated, undermining the predictability of cash flows

Deterioration, in our view, of the creditworthiness of the City of Rome, or stronger links between the City of Rome and Acea

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity: At end-2022, cash and cash equivalents amounted to slightly more than EUR750 million, including EUR190 million of short-term deposits. This, together with EUR700 million available revolving credit facilities and a recent EUR700 million bond issue in February 2023, will comfortably cover maturities within the next 12 months of around EUR430 million and expected negative FCF of around EUR550 million.

Issuer Profile

Acea is one of the largest Italian multi-utilities by revenue. It predominantly operates in the urban area of Rome, but it is also present in other parts of central Italy, mainly in Lazio, Umbria, Campania and Tuscany.

Criteria Variation

Fitch views the contractor business of Italian utilities in the context of approved eco-bonus on the energy requalification of buildings as a pass-through item. This is mainly due to a clear recovery framework through tax credits in the following years. In light of their presence in Acea's business plan, we reverse the impact on leverage metrics caused by related investments/working-capital drains.

The one-notch uplift for higher expected recoveries on senior unsecured debt instruments issued by regulated utilities has not been applied to Acea as this would have resulted in the instrument rating exceeding Italy 's sovereign IDR. As a result, the senior unsecured debt rating is aligned with Acea's IDR.

Rating the utility's unsecured debt instruments above the sovereign IDR would suggest that recoveries would remain above average even in the context of a highly depressed sovereign environment. Fitch believes however that higher rates of recoveries for utilities' senior debt are less predictable in a weaker sovereign environment than in an idiosyncratic default of any single utility, making the standard uplift not appropriate in this case.

Summary of Financial Adjustments

Factoring related to securitization, receivables sale and reverse factoring are added to debt

Short-term deposits are added to cash & cash equivalent

Third-party net income attributable to Gori, Acquedotto del Fiora, Aqua Azul, Aqua San Pedro and Servizio Idrico Integrato is deducted from FFO

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Acea has an ESG Relevance Score of '4' for group and governance structure, reflecting large third-party minority rights in the water business and potential intervention from majority shareholder, respectively. These, together with the weaker creditworthiness of the City of Rome, have a negative impact on the credit profile, and are relevant to the rating in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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