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One Notch, Not Two

10 October 2019 by jbchevrel

Fortum Oyj (FUMVFH) provides a full range of energy related P&S. It generates, distributes, sells power, and operates power plants, mainly in Northern Europe (Estonia, Finland, Norway, and Sweden) but it has been growing elsewhere, in particular in Russia. FUMVFH was the worst performing CDS in iTraxx Main s32 today, the 5y was wider by +6bp. S&P has put Fortum’s BBB rating on negative watch following the announcement that it is increasing its stake in Uniper to 70%. As a result the name is now Baa2n/BBBwn. The S&P comment mentioned the negative impact on FUMVFH’s business risk due to Uniper’s carbon footprint, increased exposure to merchant generation and Uniper’s sizable commodities business. That being said, the overall FUMVFH business risk will remain in the “satisfactory” category. Furthermore, S&P highlighted “the significant likelihood of a one-notch downgrade once the deal closes, although the degree of downside risk will depend on possible remedy measures and market conditions." Also, gaining a majority share in Uniper increases FUMVFH 's exposure to Russia, commodity trading and fossil-fuel generation, which are cyclical, and can be volatile. On the positive side, synergies could be meaningful and make FUMVFH more diverse geographically. The purchase is expected to be completed by early-2020. S&P’s mention of remedy measures suggests FUMVFH could avoid a downgrade to BBB-, but will the incentive for FUMVFH be big, given that they are only committed to stay an investment grade. The 5y CDS pays 58bp, so the downgrade to BBB- might not be totally priced in, given that the name remains tighter that other BBB-rated constituents of the Main (example: Solvay SOLBBB 5y @ 60 rated BBB/BBB/Baa2 and reversely EDP Finance B.V. EDPPL 5y @ 67 rated BBB-/BBB-/Baa3), and surely a downgrade to HY isn’t.