Iberdrola Debt Retrenchment Calms Bondholders: Corporate Finance

Iberdrola SA Chairman Ignacio Sanchez Galan
Iberdrola SA Chairman Ignacio Sanchez Galan spelled out his two-year plan for Iberdrola on Oct. 24, when the world’s largest wind-farm operator reported a 12 percent increase in net income to 2.4 billion euros, driven by growth in its renewable energy business. Photographer: Simon Dawson/Bloomberg

Iberdrola SA Chairman Ignacio Sanchez Galan is soothing bondholders with plans to reorganize Spain’s biggest utility and cut debt as the nation’s five-year economic slump deepens.

Galan is pledging to lower borrowings to 26 billion euros ($34 billion) from 31 billion euros by 2014 and sell 2 billion euros of assets after power generation fell seven quarters in a row. Iberdrola bonds outperformed the Bank of America Merrill Lynch’s EMU Corporates Utilities index this month, returning 2.73 percent compared with an average 0.82 percent.

Iberdrola’s predicament is much the same as Spain’s as both company and country struggle to generate growth while cutting costs as demand falls. Spanish retail sales dropped 11 percent in September from a year ago, the Bank of Spain estimated last week that gross domestic product declined for a fifth quarter and figures on public finances and consumer prices are today forecast to confirm a deteriorating economy.

“All the announced measures are intended to improve Iberdrola’s cash flows, so that’s good for bondholders,” said George Satlas, the Athens-based head of investments at Mutual Funds of Postal Savings Bank and Hellenic Post, which owns Iberdrola bonds. “It’s a good compromise to reduce concerns from investors regarding its exposure to the Spanish sovereign, which is the Damoclean Sword hanging over Iberdrola.”

Wind Farms

Galan spelled out his two-year plan for Iberdrola on Oct. 24, when the world’s largest wind-farm operator reported a 12 percent increase in net income to 2.4 billion euros, driven by growth in its renewable energy business.

As well as lowering debt, the company will cut about 1,200 jobs, amounting to about 4 percent of its staff, adding to the nation’s jobless rate of more than 25 percent.

“Iberdrola will slow down its investment and rely on the disposal of non-strategic assets,” Galan told analysts at a meeting in London. “Even in a stressed scenario we have identified a number of divestment opportunities ready to be executed.”

They’ll have “minimal impact on profit and loss accounts,” he said.

An official at Iberdrola, who wouldn’t be identified citing company policy, declined to comment.

Iberdrola, which has been operating for more than 150 years, supplies electricity to about 27 million customers with 43 percent of production in Spain, 15.6 percent in the U.K. and 10.6 percent in the U.S., according to the company’s website.

Debt Reductions

The prospect of debt reductions helped make credit-default swaps on Iberdrola the best-performing contracts in the past three months in the Markit iTraxx Europe index linked to 125 investment-grade companies, according to data compiled by Bloomberg. The swaps were quoted at 259 basis points today from a record 561 on June 28.

Iberdrola swaps are the lowest of all companies relative to contracts on their host countries after Italian power generator Enel SpA, according to data compiled by LBBW. It costs 259,000 euros annually to insure 10 million euros of Iberdrola’s debt for five years, 45,000 euros less per year than swaps on Spanish government debt, Bloomberg data show.

The number of companies that trade lower than their sovereigns fell to 12 from 20 last month, according to LBBW analysts Jochen Korb and Marcy Ryll.

Debt Rankings

Iberdrola’s debt is ranked BBB+ by Standard & Poor’s, which placed the company’s grade on “watch negative” on Oct. 15, five days after the ratings company downgraded Spain to BBB-, two levels lower.

S&P said it would assess whether Galan’s strategic plan will be enough to counterbalance the “challenging macroeconomic and business environment in Spain” as well as the rating company’s forecasts for a weak power market.

The company will have to maintain the relationship between the funds it gets from operations compared with debt to about 20 percent, according to S&P. The leverage indicator was at 17 percent at the end of 2011, the rating’s firm said. That compares with 16.6 percent of Electricite de France SA, which is rated three steps higher at A+ by S&P.

The average yield investors demand to hold Iberdrola bonds compared with the safest government debt tightened to 237 basis points from 544 basis points at the end of June. That compares with a 73 basis-point drop to 140 basis points in the period for bonds tracked by Bank of America Merrill Lynch’s Euro Utilities Index. That gauge includes German power generator E.ON AG, which is ranked A- by S&P and EDF.

Downgrade Review

Moody’s Investors Service ranks Iberdrola at Baa1, the same level as S&P, and has the company’s debt on review for a possible downgrade.

“We positively view the various measures aiming to boost group credit metrics and liquidity profile,” said Ivan Pavlovic, a Paris-based credit analyst at Natixis. “Iberdrola is taking the appropriate steps to maintain its current rating levels.”

The company reported earnings before interest, tax, depreciation and amortization for the first nine months at 5.78 billion euros, in line with analyst estimates. Profit from the utility’s international business advanced 52 percent, while dropping 36 percent in Spain.

Asset Sales

Iberdrola isn’t saying which assets it will sell, although the company did say it will hold on to core businesses in Spain, the U.K., the U.S., Brazil and Mexico, according to an Oct. 25 report from independent research firm CreditSights Inc. The company’s Scottish Power unit is the third-biggest power distributor in the U.K., and its 2008 acquisition of Energy East Corp. made it the biggest Spanish investor in the U.S.

The company has renewable power assets in France, Germany and Romania which, CreditSights, said were “possible disposal candidates.”

The research firm recommended investors hold Iberdrola’s 750 million euros of bonds due June 2015 because they are “comfortably covered” by the company’s 11.3 billion euros of cash. The 3.5 percent notes yield 2.14 percent, according to Bloomberg prices. That’s equivalent to 171 basis points above the asset swaps rate, compared with 517 basis points on June 28.

“Any effort to deleverage is good for bondholders in the short term, but its strategy has to show growth outside its core markets,” said Matteo Cazzini, a Milan-based fund manager at UBI Pramerica SGR SpA, which manages 30 billion euros of assets including Iberdrola bonds. “So if it sells overseas assets its exposure to Spain will grow, and that is not great.”

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