Rating Action: Moody's affirms Centrica's ratings; changes outlook to negative
Global Credit Research - 28 Jul 2020
London, 28 July 2020 -- Moody's Investors Service (Moody's) has today affirmed the Baa2 issuer and senior unsecured ratings, and the Ba1 junior subordinated debt ratings of Centrica plc (Centrica). The Prime-2 short-term commercial paper rating has been also affirmed. Concurrently, Moody's has changed the outlook on Centrica to negative from stable.
A full list of affected ratings is provided towards the end of this press release.
-- RATIONALE FOR RATINGS AFFIRMATION--
The rating affirmation follows Centrica's announcement on 24 July that the company has entered into an agreement to sell its North American (NA) energy supply, services and trading business -- Direct Energy, to NRG Energy, Inc. for USD3.6 billion (equivalent to approximately GBP2.8 billion) in cash . The transaction is subject to customary regulatory approvals, with expected completion in the fourth quarter of 2020.
The disposal of Direct Energy is in line with Centrica's strategic objective to focus its activities predominantly in the UK and Ireland. The disposal will improve the company's financial metrics but, in Moody's view, the reduction in diversification and scale will weaken Centrica's business risk profile. The NA business, combining consumer and business divisions, accounted for 26%, or GBP233 million, of Centrica's adjusted operating profit in 2019. Notwithstanding robust competition, Direct Energy's performance has been supported by strong retail energy supply margins relative to Centrica's UK business, where profitability has been hit by the introduction of a price cap and increased competition. While energy supply to NA business customers has been subject to greater working capital volatility, it has also been a positive contributor to Centrica's earnings and cash flows.
Centrica has said that it will use the cash proceeds for a significant reduction in net debt and a material contribution to the group's defined benefit pension schemes, subject to the negotiation of the final payment terms with the Trustee. As of end-June 2020, Centrica's reported net debt stood at GBP2.8 billion. This amount excludes Centrica's net pension liability of GBP522 million reported on balance sheet, or the estimated pension funding deficit of GBP2.4 billion. While Moody's adjusted debt does not consider the amount of an actuarial pension deficit, the significant rise in liabilities -- from GBP1.4 billion based on the last triennial valuation, would increase Centrica's annual pension contributions. Moody's therefore views positively the company's intention to contribute some of the cash proceeds to the pension schemes as it will lead to lower annual cash outflows over the medium term.
Overall, the Baa2 rating affirmation recognises (1) Centrica's leading market position in the UK supply segment; (2) a well-established brand and market position in the services division in the UK; (3) the company's track record and stated commitment to strong credit quality; and (4) good liquidity. These factors are balanced by (1) strong competitive dynamics in the UK retail supply, given low barriers to entry; (2) limited potential for improvement in margins, given the UK default tariff cap; (3) low profitability of the business supply segment, coupled with exposure to commodity markets and weather; (4) uncertainty around the company's ability to sustainably improve profitability in the context of the ongoing business restructuring; and (5) presence of the loss-making businesses that are yet to bring positive cash flows.
The Ba1 long-term rating on the hybrid securities, which is two notches below the issuer rating of Baa2 for Centrica, reflects the features of the hybrids that receive basket 'C' treatment, i.e. 50% equity or "hybrid equity credit" and 50% debt for financial leverage purposes.
--RATIONALE FOR NEGATIVE OUTLOOK--
As part of its interim results announcement on 24 July, Centrica confirmed its intention to divest certain other businesses, including its exploration and production (E&P) and nuclear power businesses, again in line with the company's strategic objective to shift towards the customer-facing activities . While Centrica had previously anticipated completion of the sale of the Spirit Energy E&P business and its nuclear interest by the end of this year, both processes have been delayed and are currently paused, given falls in commodity markets and the impact of the coronavirus outbreak on asset prices.
The planned disposals will lead to a simpler and leaner corporate structure but, in the view of the rating agency and subject to execution, they will also further erode Centrica's scale and diversification. While the company's exposure to commodity markets will decrease and credit metrics will be bolstered by the disposal of the NA business, there is uncertainty around the extent and sustainability of the improvement in Centrica's financial profile and debt reduction, given execution risks associated with the disposal of the E&P and nuclear businesses, and yet to be negotiated terms regarding the company's contribution to the pension schemes.
Centrica's activities are subject to various pressures in the context of a difficult operating environment. The spread of the coronavirus, which has, amongst other things, resulted in a reduction in electricity demand from business customers because of restrictions to business activity, and the falls in commodity prices reduced the company's earnings by some GBP425 million in the first half of 2020. In this regard, Centrica's performance showing a GBP56 million decline in adjusted operating profit to GBP343 million was fairly strong owing to management mitigating actions. While Centrica remains focused on actions to preserve cash flows, and has so far not reported any deterioration in bad debt, the outlook for the business remains uncertain.
The change in outlook to negative thus takes account of Centrica's evolving business risk profile and the uncertainty regarding the final shape of the group and its financial profile -- as the company pursues its strategy to divest Spirit Energy and nuclear interest -- in the context of persistently difficult operating environment.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
A rating upgrade is unlikely in the near term given continued regulatory and competitive pressures in Centrica's key markets of operations and exposure to commodity markets. The outlook could be changed to stable if there was sufficient clarity over the future evolution of Centrica's business profile in conjunction with financial metrics commensurate with a Baa2 rating, taking into account the shape of the business.
Downward rating pressure could arise if Centrica appeared unlikely to maintain a financial profile in line with the current ratings, namely funds from operations (FFO)/net debt above 35% on a sustainable basis. This ratio guidance factors in Centrica's planned sale of the NA business, but it could be revised in the context of further disposals, including Spirit Energy and nuclear interest, once these appear sufficiently likely.
The principal methodology used in these ratings was Unregulated Utilities and Unregulated Power Companies published in May 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1066389. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
LIST OF AFFECTED RATINGS ..Issuer: Centrica plc Affirmations:
....LT Issuer Rating, Affirmed Baa2
....Junior Subordinated Regular Bond/Debenture, Affirmed Ba1
....Senior Unsecured Bank Credit Facility, Affirmed Baa2
....Senior Unsecured Commercial Paper, Affirmed P-2
....Senior Unsecured Regular Bond/Debenture, Affirmed Baa2
..Issuer: Centrica plc
....Outlook, Changed To Negative From Stable
Centrica plc is the UK's largest energy supplier. It provides gas and electricity to residential and commercial customers, mostly under the British Gas brand. The company also provides energy-related services, mainly comprising maintenance and repair. In North America, Centrica supplies energy to commercial and residential customers via its Direct Energy subsidiary.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.
These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.
Joanna Fic Senior Vice President Infrastructure Finance Group Moody's Investors Service Ltd. One Canada Square Canary Wharf London E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Neil Griffiths-Lambeth Associate Managing Director Infrastructure Finance Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Releasing Office: Moody's Investors Service Ltd. One Canada Square Canary Wharf London E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454
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