Fitch Downgrades Eni S.p.A. (E) to 'A-'; Outlook Stable

Fitch Ratings has downgraded Eni SpA's (NYSE: E) Long-term Issuer Default Rating (IDR) and senior unsecured rating to 'A-' from 'A'. The Outlook on the IDR is Stable.

The downgrade reflects our assessment of the impact of lower oil prices on Eni's key exploration and production (E&P) segment, as well as the company's overall credit metrics. We expect funds from operations (FFO) net leverage to total 3.4x and 2.6x in 2016 and 2017, respectively, and to fall to 2.5x in 2018. We lowered our oil price forecasts in February 2016 and expect Brent to average USD35 per barrel (bbl) in 2016, before gradually recovering to USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl in the long term.

Difficulties in the company's gas and power (G&P) and refining and marketing (R&M) divisions remain and we do not expect any significant improvement, delaying any positive financial contribution in the short to medium term. We assess Eni's vertical integration to be weaker than its peers, which may limit its ability to offset the decline in oil prices with a better downstream performance. Better-than-expected performance in G&P and R&M may lead to a positive rating action.

KEY RATING DRIVERS
Response to Lower Oil Prices
Eni reported a 64% yoy drop in reported adjusted EBIT in 2015 because of lower oil prices. The company announced a number of measures to protect its financial performance and position at its strategic update in March 2016. Capital expenditure is expected to total EUR37bn in 2016-2019, compared with EUR45bn in the earlier four-year plan to 2018. Forty-two per cent of capex for 2017-2019 is uncommitted, which provides a margin of safety to cut spending in case of weaker-than-expected oil prices. Eni also expects cost savings of EUR 3.5bn in the four years to 2019.

Eni's 2016 strategy presentation to investors maintained the target of increasing upstream production by 3% per annum to 2019. This could be ambitious given the company's capex reductions, which will be mainly in the upstream business. Eni has a pipeline of prospective upstream projects, but the key ones are still in early phases of development such as the large Zohr gas field in Egypt. This may pose operational and financial risks, especially because of low oil prices. For the purposes of financial modelling, we assume an annual production growth rate of 2% to 2019.

Weaker credit metrics
Eni forecasts its capital expenditure to be covered by cash flow from operations (CFO) assuming an oil price of USD50/bbl in 2016 and to reach organic FCF after dividend neutrality in 2017 if oil trades at USD60/bbl.
We forecast Eni's FCF after dividends will be negative mainly due to weaker performance at R&M and G&P, while its leverage will be between 3.4x and 2.4x in 2016-2019. Leverage metrics will be weaker than we previously expected. This together with the more difficult macro environment in the upstream segment is the key reason for the rating downgrade to 'A-' from 'A'.

Downstream Turnaround
In 2015 G&P reported an adjusted EBIT loss of EUR126m (EUR168m profit in 2014), while R&M made a positive EBIT of EUR387m (loss of EUR65m in 2014). The combined adjusted EBIT of these segments accounted for 7% of the total consolidated adjusted EBIT.
Eni continues its turnaround of these segments and expects them to provide EUR5.7bn in cumulative CFO in 2016-2019. Our forecasts are more cautious because of the challenges faced by the European gas and refining sectors in the medium and long term. A faster-than-expected improvement in performance in the G&P and R&M will be positive for Eni's ratings.

Ambitious Asset Disposals
Eni plans to dispose of EUR7bn assets by 2019. This could be difficult while oil prices are low because of a more limited pool of potential buyers and several competitors also selling assets to shore up their balance sheets. We assume disposals of EUR5bn in our forecasts.
Eni achieved 90% of planned disposal proceeds for 2015-2019 in 2015. This was mostly possible because of the sale of a 12.5% plus one share stake in Saipem SpA to Fondo Strategico Italiano SpA, an arm of state-controlled Italian lender Cassa Depositi & Prestiti. The transaction value was EUR0.5bn, but resulted in an additional EUR4.8bn debt reduction at Eni.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Brent & WTI gradually recovering from USD35/bbl in 2015 to USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl in the long term
- NBP gas prices USD5/mcf in 2016, USD6/mcf in 2017, USD6.5/mcf in 2018 and USD7/mcf in 2019.
- Capex EUR9bn in 2016 rising to EUR9.5bn in 2018
- Annual dividend payment of EUR3bn.
-Disposals of USD2bn per annum in 2016 and 2017

RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to a downgrade to 'BBB+':
- Failure to maintain R&M and G&P segments profitability
- FFO net adjusted leverage above 3.0x.
- FFO fixed charge coverage consistently below 8x.

Positive: Other future developments that may lead to positive rating action (e.g. an upgrade to 'A'):
- Increased production to more than two million barrels per day
- Improved performance at G&P and R&M in line with management's forecasts
- FFO net adjusted leverage consistently less than 2.5x
- FFO fixed charge coverage consistently greater than 6x

LIQUIDITY
Eni's short-term debt at end-2015 was EUR8.4bn, while its cash position was EUR8.5bn (including our estimate for securities held for trading of EUR3.3bn as adjusted by Fitch). We expect the asset sales to partly fund the negative FCF. In addition, the company has good access to capital markets.

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