Rating Action Overview

• Brookfield-managed infrastructure funds (45.4%) together with five other infrastructure investors (54.6%) will complete the acquisition of AusNet group on Feb. 16, 2022. All approvals are in place and AusNet Services Ltd. will be delisted upon completion of the transaction.
• The new owners will add about A$2 billion in debt to AusNet's balance sheet, diluting the ratio of funds from operations (FFO) to debt to 8%-8.5% over the next three years, and target to maintain the ratio in line with a 'BBB+' rating.
• We therefore lowered the long-term issuer credit rating on AusNet Services and rated subsidiaries by one notch to 'BBB+'. The outlook is stable. We affirmed the 'A-2' short-term rating on AusNet Services Holdings Pty Ltd., the financing vehicle of the group. At the same time, we lowered the rating on AusNet's senior debt to 'BBB+' and on the group's two hybrid instruments to 'BBB-'.
• The stable outlook reflects an expectation that the Brookfield infrastructure funds (via a contractual arrangement with other shareholders) will exercise control of, and manage AusNet's balance sheet consistent with their policy of maintaining the 'BBB+' rating.

Rating Action Rationale

The lowered ratings primarily reflect AusNet's higher debt under the new ownership.  Brookfield infrastructure funds and five other pension funds will own 100% of AusNet group effective Feb. 16, 2022. Upon acquisition, AusNet's debt balance will increase by about A$2 billion, reaching an estimated A$9 billion (our adjusted debt basis) at March-end 2022. This will dilute the cash flow leverage (ratio of FFO to debt) to about 8.5% in fiscal 2023 (year ending March 31, 2023), the first full year under the new owners. Thereafter, the ratio is likely to stay at around 8% subject to the level of dividend reinvestments to support capital expenditure (capex) and the balance sheet. Brookfield has stated a policy to maintain the ratio at a level corresponding with a 'BBB+' rating. We have revised our assessment of AusNet's financial risk profile to aggressive from significant based on these factors.

The rating on AusNet's hybrids remains two notches below the issuer credit rating.  This reflects the subordination and deferability of the hybrid coupon. At the current issuer credit rating, the change of control clause is not expected to trigger any issuer redemption rights or coupon step-up on the outstanding hybrids of A$1.7 billion. Consequently, the current hybrids will remain on the balance sheet under the new ownership.

Brookfield group has represented that it will have simple majority control of AusNet via a contractual arrangement for decision-making with the other co-owners.  We believe this will be important to manage AusNet's balance sheet via appropriate dividend reinvestments given AusNet's large capex needs and the new Western Victoria transmission project over the next five years. Based on our financial forecasts, dividend reinvestments could be 50%-75% per year over the next five years. Brookfield has a track record of reinvesting dividends in its other investments, as needed, across Australia and globally. We have therefore included the dividend reinvestment in our assessment.

We see the acquisition structure as neutral to the rating.  The structure comprises a Holdco (and a series of intermediate entities) that will own AusNet and will together form a tax-consolidated group. The scheme of arrangement will be completed for a total consideration of about A$10.1 billion. Of this, about A$2 billion will be additional debt within the AusNet group. The balance has been funded via a combination of ordinary equity and shareholder loans at the new Holdco by Brookfield and each co-investor in proportion to their ownership interests. The shareholder loans at the Holdco are structurally subordinated to all the indebtedness at AusNet with limited rights. Therefore, we don't expect the loans to cause any potential stress for the rated AusNet senior debt or hybrid securities.

Brookfield has represented that the Holdco and intermediate entities are passive entities and have no intention to conduct additional activities.  If these entities were to incur additional debt or undertake new activities, we will have to assess the impact of such changes on AusNet's credit profile as and when such developments occur.

Any material change to the business composition or strategy of AusNet is unlikely under the new owners. We continue to assess AusNet's business risk profile as excellent. AusNet's portfolio of three distinct regulated businesses provides cash flow stability and contributes about 90% of its EBITDA. These cashflows provide a platform to support growth in the unregulated segment, primarily focused on connecting renewable projects to the electricity grid. We will continue to assess the direction and size of growth in the unregulated space over the next three to five years, including on how such growth is funded.

We expect AusNet's liquidity to remain adequate with the consent process successfully completed from senior lenders. Also, at the current rating, the change of control is not expected to trigger any refinancing obligations for the outstanding bonds or any coupon step-ups. AusNet's existing debt and undrawn committed bank lines are likely to remain in place to support the capex program. The additional debt of A$2 billion is funded via a two-year bridge with an intention to term out the debt through a capital market issuance over the next six months or so. We expect Brookfield to adopt appropriate refinancing and hedging arrangements to reduce interest or currency risk to the debt portfolio.

Outlook

The stable outlook on AusNet reflects the group's strong and stable portfolio of three distinct regulated businesses that provide cash flow visibility. Based on the shareholders' target rating of 'BBB+', we expect Brookfield to manage AusNet's balance sheet through dividend reinvestments to support the business, including investments in new assets and through regulatory resets. We therefore forecast AusNet's ratio of FFO to debt will remain at or above 8% over the next two to three years.

Downside scenario

We could lower the ratings by one notch if AusNet's FFO-to-debt ratio were to approach 7.5% with no clear plan to restore the metric back toward 8%. This could occur if AusNet cannot manage its capital structure due to pressure on earnings, opportunistic growth in unregulated businesses leading to higher capex, or higher debt-funded capex.

Upside scenario

Upward rating movement is unlikely given the trend in the metrics and Brookfield's approach to run the business to maintain the current credit quality. Management is likely to pass any improvements in cash flows on to shareholders. That said, an upgrade could occur if we believe AusNet can maintain its FFO-to-debt ratio well above 9.5% and shareholders are committed to an improved credit profile.

Company Description

AusNet owns and operates a portfolio of regulated electricity and gas networks in the Australian state of Victoria. The company is one of the largest network operators in Australia, with a pure regulated asset base of about A$10.0 billion as of March 31, 2021, and unregulated/contracted assets of A$1.2 billion.

Based on the acquisition plan, effective Feb. 16, 2022, Brookfield will establish a Holdco with a series of intermediate entities to own the AusNet group. Shareholding at the Holdco will comprise: Brookfield-managed Infrastructure funds (45.4%), SunSuper Superannuation Fund (15%), Healthcare of Ontario Pension Plan (9.9%), Investment Management Corp. of Ontario (9.9%), Alberta Investment Management Corp. (9.9%), and Canada's Public Sector Pension Investments Board (9.9%).

Our Base-Case Scenario

• Limited exposure to economic growth due to revenue cap mechanism or contracted cash flows.
• Minimal effects from COVID-19-related support to the industry.
• Regulated revenues for electricity transmission and distribution, and gas distribution, in line with approved regulatory allowances.
• Revenues from the unregulated growth and future network segment in the range of A$150 million (fiscal 2022) to about A$200 million over the next five years. Minimal revenues from Victorian western transmission link (WTL) over the next 12-24 months.
• EBITDA margins of 58%-60% over the next two years.
• Capex (excluding customer contributions) of A$850 million-A$950 million per year over fiscals 2022-2024. The numbers include connections to new renewable projects and work on WTL. Of the total capex, 65%-70% corresponds to regulated networks. Work on WTL to peak in fiscal 2024 and 2025, if construction begins in early 2023. Total net capex of A$4.1 billion over 2022-2026.
• Additional A$2 billion of acquisition-related debt, which will eventually be refinanced at the current AusNet issuer level over the next six months.
• Shareholder loans from the new owners are treated as non-common equity and are excluded from debt for calculation of our key financial metrics and ratios.
• Increase in gross dividends from AusNet to new owners over the next few years. However, based on representation by Brookfield, we assume dividend reinvestments of 50%-75% over the next two years to support metrics.
• Average interest costs of about 4.0%.
• No cash tax payments due to a step-up in the tax asset base from the acquisition.

Based on these assumptions, we forecast that:

• Adjusted EBITDA will be in the range of A$1.05 billion to A$1.15 billion in fiscal 2022 and the next five years.
• FFO-to-debt ratio will decline to about 8.5% in fiscal 2023, and further to about 8% from fiscal 2024.
• FFO-to-debt for fiscal year ending March 2022 will not be trend indicative due to the addition of A$2 billion of acquisition-related debt, which will be added upon completion of the acquisition.

Group Influence

The rating on AusNet does not have any explicit rating uplift from its ownership by Brookfield and other funds. This is because, under the new ownership and governance structure, certain important matters, including matters pertaining to capital structure, need the support of a super majority vote. We therefore believe no single fund has a majority control of AusNet.

Also, while Brookfield has simple majority voting rights, the ultimate controlling entity, Brookfield Asset Management, is the general partner of these funds but not the owner (equity) of these funds. As such, any notching benefit under our group rating methodology does not apply. Brookfield's simple majority voting rights will apply so long as Brookfield and its affiliated funds hold 40% of shareholding in AusNet.

Environmental, Social, And Governance

ESG credit indicators: E-2, S-2, G-2

ESG factors have an overall neutral influence on our credit rating analysis of AusNet. With 80% of the company's EBITDA derived from electricity transmission and distribution network operations, its environmental exposure is low and indirect. AusNet's service area has bush fire risk that is controlled through careful vegetation management, rapid earth fault current limiters and other equipment, and insurance coverage. About 20% of EBITDA is derived from gas distribution, which appears secure for the foreseeable future given the current economics of a possible alternative fuel, hydrogen. In addition, the gas networks are suitable to take a modest mix of hydrogen even today.

Ratings Score Snapshot

Issuer Credit Rating: BBB+/Stable/--

Business risk: Excellent

• Country risk: Very Low
• Industry risk: Very Low
• Competitive position: Excellent

Financial risk: Aggressive

• Cash flow/Leverage: Aggressive

Anchor: bbb

Modifiers

• Diversification/Portfolio effect: Neutral (no impact)
• Capital structure: Neutral (no impact)
• Financial policy: Neutral (no impact)
• Liquidity: Adequate (no impact)
• Management and governance: Satisfactory (no impact)
• Comparable rating analysis: Positive (+1 notch)

Stand-alone credit profile: bbb+

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• General Criteria: Group Rating Methodology, July 1, 2019
• General Criteria: Hybrid Capital: Methodology And Assumptions, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Criteria | Corporates | General: Reflecting Subordination Risk In Corporate Issue Ratings, March 28, 2018
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• Criteria | Corporates | General: The Treatment Of Non-Common Equity Financing In Nonfinancial Corporate Entities, April 29, 2014
• Criteria | Corporates | Utilities: Key Credit Factors For The Regulated Utilities Industry, Nov. 19, 2013
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

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