**Step 1: Identify the relevant industry for "HERA S.P.A."** HERA S.P.A. is an Italian multi-utility company involved in water, gas, electricity, and waste management services. The provided methodologies include "Regulated Utilities," "Oil And Gas Exploration And Production," "Unregulated Power And Gas," and "Transportation Infrastructure." Given that HERA operates essential infrastructure services (water, gas distribution, waste) subject to regulatory frameworks in Italy, it falls under the **Regulated Utilities** sector. Specifically, it fits the "Multi-utilities" subsector. The methodology notes that for regulated utilities, we assess regulatory advantage and use specific financial metrics. While HERA has some unregulated activities (e.g., trading, energy sales), the core business is regulated infrastructure. The prompt asks to estimate S&P's credit trend using the provided facts and methodology. We will apply the Regulated Utilities framework, noting that S&P typically uses EBITDA and FFO-based ratios for these entities, often adjusting for leases and pension deficits. **Step 2: Estimate the 2021 "Adjusted_EBITDA"** First, we reconstruct EBITDA for 2021 (period 2021-01-01 to 2022-01-01). Reported Data for 2021: - Revenue: 10,555,300,000 EUR - Other Revenue: 400,100,000 EUR - Raw Materials And Consumables Used: 6,668,500,000 EUR - Services Expense: 2,464,600,000 EUR - Employee Benefits Expense: 592,800,000 EUR - Other Expense By Nature: 66,500,000 EUR - Other Work Performed By Entity And Capitalised: 60,800,000 EUR (This is income/add-back to costs or reduction of expense, effectively increasing operating profit) - Amortisation Depreciation And Provisions: 612,100,000 EUR - Profit Loss From Operating Activities (EBIT): 611,700,000 EUR Let's verify EBIT calculation: Total Operating Income = Revenue + Other Revenue + Other Work Capitalised Total Operating Income = 10,555,300,000 + 400,100,000 + 60,800,000 = 11,016,200,000 EUR Total Operating Expenses (excluding D&A) = Raw Materials + Services + Employee Benefits + Other Expense Total OpEx (excl D&A) = 6,668,500,000 + 2,464,600,000 + 592,800,000 + 66,500,000 = 9,792,400,000 EUR EBITDA (calculated) = Total Operating Income - Total OpEx (excl D&A) EBITDA (calculated) = 11,016,200,000 - 9,792,400,000 = 1,223,800,000 EUR Check with reported EBIT: EBIT = EBITDA - Amortisation/Depreciation EBIT = 1,223,800,000 - 612,100,000 = 611,700,000 EUR. This matches the reported "Profit Loss From Operating Activities". So, Reported EBITDA 2021 = 1,223,800,000 EUR. Adjustments for Regulated Utilities: - **Leases**: S&P typically adds back lease expenses to EBITDA if they are embedded in operating expenses, or adjusts debt. However, the baseline formula says `Adjusted_EBITDA = EBITDA + adjustment_leases`. In IFRS, lease interest and depreciation are separate. The "Services Expense" or "Other Expense" might contain operating lease costs if pre-IFRS 16, but under IFRS 16, depreciation and interest are shown. The reported "Amortisation Depreciation And Provisions" likely includes Right-of-Use (ROU) asset depreciation. To get a cash-flow proxy comparable to pre-IFRS 16 or to align with S&P's "Adjusted EBITDA" which often adds back ROU depreciation, we should check if an adjustment is needed. S&P's standard adjustment for leases in EBITDA is to add back the depreciation of ROU assets (which is in EBITDA deduction) and treat the principal repayment as debt service. However, the prompt's baseline formula `Adjusted_EBITDA = EBITDA ... + adjustment_leases` suggests adding back lease-related charges excluded from EBITDA or normalizing them. Usually, S&P defines Adjusted EBITDA as EBITDA + Share of profit of associates (if equity method) + other adjustments. - Let's look at the "Share Of Profit Loss Of Associates...": 13,200,000 EUR. This is included in EBIT? No, "Profit Loss From Operating Activities" is usually before associates. The line item "Share Of Profit Loss Of Associates..." is below EBIT. So EBITDA calculated above (1,223.8M) does *not* include associate profits. S&P often adds back the share of associates' EBITDA or just the profit if minor. Given the small size (13.2M vs 1.2B EBITDA), we might ignore or add it back if we want "Group EBITDA". Let's stick to the core operating EBITDA first. - **Pension Adjustments**: The prompt mentions `± pension_adjustments`. We have "Noncurrent Provisions For Employee Benefits". In 2021, this was 105,400,000 EUR. In 2022 (start of 2022, end of 2021), it was 105,400,000. At end of 2022, it was 92,000,000. The change is a release. S&P often adjusts for the service cost vs cash contribution. Without detailed cash contribution data, we might assume the expense in P&L (part of Employee Benefits) is the service cost. The "Adjustments For Increase Decrease In Employee Benefit Liabilities" in cash flow is -12,600,000 EUR. This suggests the liability decreased. - **Standard S&P Regulated Utility EBITDA**: Often simply Reported EBITDA + Share of Associates' EBITDA (if significant). Here, associates are small. - Let's assume **Adjusted EBITDA 2021 ≈ Reported EBITDA** = 1,223,800,000 EUR. - *Self-Correction*: The baseline formula includes `adjustment_leases`. Under IFRS 16, EBITDA excludes ROU depreciation. S&P often adds this back to make it comparable to operating lease treatment or to reflect cash generation before debt service. The ROU Depreciation is part of the 612.1M D&A. We don't have the split. However, S&P's "Adjusted Debt" includes leases. If we include leases in debt, we usually leave EBITDA as reported (which excludes ROU dep) or add it back? Actually, S&P's standard definition of FFO for industrials is EBITDA - Interest - Taxes. For utilities, they often use FFO = Net Income + D&A + Deferred Taxes - Change in Working Capital? No, the prompt gives a specific formula: `FFO = Adjusted_EBITDA - cash_interest - cash_taxes`. - Let's look at Cash Flow from Operations (CFO). CFO 2021 = 1,045,400,000 EUR. CFO = Net Income + D&A + Working Capital Changes + Other. Net Income 2021 = 372,700,000 EUR. D&A = 612,100,000 EUR. This doesn't sum up directly due to working capital and other items. Let's stick to the reconstruction: **Adjusted EBITDA 2021** = 1,223,800,000 EUR. (We will assume no material non-recurring items or lease adjustments that significantly change this top-line proxy for this exercise, as specific breakdowns of lease depreciation vs interest are not provided, and S&P often treats reported EBITDA as a starting point). **Step 3: Estimate the 2021 "FFO"** Formula: `FFO = Adjusted_EBITDA - cash_interest - cash_taxes` - **Cash Interest**: Reported "Finance Costs" 2021: 300,300,000 EUR. Reported "Finance Income" 2021: 82,300,000 EUR. Net Finance Cost: 218,000,000 EUR. However, we need *cash* interest paid. From Cash Flow Statement: "Finance Costs Paid Classified As Operating Activities" = 96,200,000 EUR. Wait, this seems low compared to finance costs of 300M. This might be net of capitalized interest or timing differences. Or it might be just the cash portion. S&P uses cash interest paid. Let's use **Cash Interest Paid = 96,200,000 EUR**. *Note*: Sometimes "Finance Income Received" is netted. "Finance Income Received Classified As Operating Activities" = 32,600,000 EUR. Standard FFO definition subtracts *net* cash interest? Or gross? The formula says `cash_interest`. Usually, this means net cash interest expense. Net Cash Interest = Cash Interest Paid - Cash Interest Received = 96,200,000 - 32,600,000 = 63,600,000 EUR. Alternatively, if the formula implies gross interest expense paid, we use 96.2M. Let's look at the magnitude. EBITDA is 1.2B. Interest is likely around 200-300M accrual. The cash paid is 96M. This discrepancy is large. It's possible that a significant portion of interest is capitalized or paid in investing/financing? "Payments Of Lease Liabilities Classified As Financing Activities" = 22,500,000 EUR. This is principal. Interest on leases is in operating. Let's assume **Cash Interest** in the formula refers to the net cash outflow for financing costs. Net Cash Interest Outflow = 96,200,000 (Paid) - 32,600,000 (Received) = 63,600,000 EUR. - **Cash Taxes**: From Cash Flow Statement: "Income Taxes Paid Classified As Operating Activities" = 156,300,000 EUR. - **FFO 2021 Calculation**: FFO = 1,223,800,000 - 63,600,000 - 156,300,000 FFO 2021 = 1,003,900,000 EUR. *Alternative Check*: S&P often defines FFO as Net Income + D&A + Deferred Taxes + Other non-cash items. Net Income: 372.7M D&A: 612.1M Deferred Tax: Change in Deferred Tax Liabilities (132.1 -> ?) and Assets. Let's stick to the prompt's explicit formula: `FFO = Adjusted_EBITDA - cash_interest - cash_taxes`. Let's refine Cash Interest. If we use Gross Cash Interest Paid (96.2M), FFO = 1,223.8 - 96.2 - 156.3 = 971.3M. If we use Net Finance Cost Accrual (218M) as a proxy for cash (often close enough if no huge capitalization), FFO = 1,223.8 - 218 - 156.3 = 849.5M. However, the prompt provides specific cash flow line items. "Finance Costs Paid" is 96.2M. "Finance Income Received" is 32.6M. In many utility contexts, "Cash Interest" for FFO calculation is the net cash paid for interest. Let's use **Net Cash Interest = 63,600,000 EUR**. **FFO 2021 = 1,003,900,000 EUR**. **Step 4: Estimate the 2021 "Adjusted_Debt"** Formula: `Adjusted_Debt = (reported_debt + leases + pension_deficit + guarantees + hybrid_debt_portion + other_debt_like_items) - eligible_cash` - **Reported Debt 2021** (as of 2022-01-01, which is end of 2021): Noncurrent Financial Liabilities: 3,716,000,000 EUR Current Financial Liabilities: 499,700,000 EUR Total Reported Debt = 4,215,700,000 EUR - **Leases**: Noncurrent Lease Liabilities: 53,200,000 EUR Current Lease Liabilities: 43,400,000 EUR Total Leases = 96,600,000 EUR - **Pension Deficit**: "Noncurrent Provisions For Employee Benefits" is 105,400,000 EUR. S&P adjusts for the underfunded status of defined benefit plans. We assume the provision represents the deficit or the liability. Without asset data, we treat the provision as the debt-like item. Pension Deficit = 105,400,000 EUR. - **Other Debt-like Items**: "Noncurrent Provisions For Risks And Charges" (Other Longterm Provisions): 528,000,000 EUR. S&P may treat certain provisions as debt-like if they are mandatory and fixed. However, "Risks and Charges" are often contingent. We will exclude them unless specified as debt-like. "Derivative Financial Liabilities": Noncurrent: 13,500,000 EUR Current: 1,703,300,000 EUR Derivatives are generally marked-to-market. S&P usually excludes MTM derivatives from debt unless they are deeply in-the-money and represent a funding obligation. Given the volatility, we might exclude them or include only the portion representing effective hedges. However, a common simplification in these exercises is to stick to Financial Liabilities + Leases + Pension. Let's stick to **Debt + Leases + Pension**. Gross Adjusted Debt = 4,215,700,000 (Fin Debt) + 96,600,000 (Leases) + 105,400,000 (Pension) = 4,417,700,000 EUR. - **Eligible Cash**: Cash And Cash Equivalents: 885,600,000 EUR. S&P allows netting cash against debt if it is unrestricted and available. Eligible Cash = 885,600,000 EUR. - **Adjusted Debt 2021**: 4,417,700,000 - 885,600,000 = **3,532,100,000 EUR**. **Step 5: Calculate 2021 "Adjusted_Debt / Adjusted_EBITDA"** Ratio 2021 = 3,532,100,000 / 1,223,800,000 Ratio 2021 ≈ **2.89x** **Step 6: Calculate 2021 "FFO / Adjusted_Debt"** Ratio 2021 = 1,003,900,000 / 3,532,100,000 Ratio 2021 ≈ **0.284** (or 28.4%) --- **Step 7: Estimate the 2022 "Adjusted_EBITDA"** Period: 2022-01-01 to 2023-01-01. Reconstruct EBITDA 2022: - Revenue: 20,082,000,000 EUR - Other Revenue: 548,200,000 EUR - Other Work Capitalised: 82,500,000 EUR - Total Operating Income = 20,082,000,000 + 548,200,000 + 82,500,000 = 20,712,700,000 EUR - Raw Materials: 16,730,000,000 EUR - Services Expense: 2,105,800,000 EUR - Employee Benefits: 601,100,000 EUR - Other Expense: 74,900,000 EUR - Total OpEx (excl D&A) = 16,730,000,000 + 2,105,800,000 + 601,100,000 + 74,900,000 = 19,511,800,000 EUR - EBITDA 2022 = 20,712,700,000 - 19,511,800,000 = **1,200,900,000 EUR**. Check with Reported EBIT: Reported EBIT (Profit Loss From Operating Activities) = 533,800,000 EUR. D&A = 667,100,000 EUR. EBITDA = 533,800,000 + 667,100,000 = 1,200,900,000 EUR. Matches. **Adjusted EBITDA 2022** = **1,200,900,000 EUR**. **Step 8: Estimate the 2022 "FFO"** Formula: `FFO = Adjusted_EBITDA - cash_interest - cash_taxes` - **Cash Interest**: Finance Costs Paid (Operating): 128,000,000 EUR. Finance Income Received (Operating): 41,800,000 EUR. Net Cash Interest = 128,000,000 - 41,800,000 = 86,200,000 EUR. - **Cash Taxes**: Income Taxes Paid (Operating): 165,900,000 EUR. - **FFO 2022 Calculation**: FFO = 1,200,900,000 - 86,200,000 - 165,900,000 FFO 2022 = **948,800,000 EUR**. **Step 9: Estimate the 2022 "Adjusted_Debt"** Data as of 2023-01-01 (End of 2022): - **Reported Debt**: Noncurrent Financial Liabilities: 5,689,900,000 EUR Current Financial Liabilities: 650,100,000 EUR Total Reported Debt = 6,340,000,000 EUR - **Leases**: Noncurrent Lease Liabilities: 55,100,000 EUR Current Lease Liabilities: 21,300,000 EUR Total Leases = 76,400,000 EUR - **Pension Deficit**: Noncurrent Provisions For Employee Benefits: 92,000,000 EUR. - **Gross Adjusted Debt**: 6,340,000,000 + 76,400,000 + 92,000,000 = 6,508,400,000 EUR. - **Eligible Cash**: Cash And Cash Equivalents: 1,942,400,000 EUR. - **Adjusted Debt 2022**: 6,508,400,000 - 1,942,400,000 = **4,566,000,000 EUR**. **Step 10: Calculate 2022 "Adjusted_Debt / Adjusted_EBITDA"** Ratio 2022 = 4,566,000,000 / 1,200,900,000 Ratio 2022 ≈ **3.80x** **Step 11: Calculate 2022 "FFO / Adjusted_Debt"** Ratio 2022 = 948,800,000 / 4,566,000,000 Ratio 2022 ≈ **0.208** (or 20.8%) --- **Step 12: Classify the credit trend** **Signal 1: Leverage (Adjusted Debt / Adjusted EBITDA)** - 2021 Ratio: 2.89x - 2022 Ratio: 3.80x - Change: 3.80 - 2.89 = **+0.91x** Thresholds: - ≤ -0.2x: Improving - -0.2x to +0.2x: Stable - ≥ +0.2x: Deteriorating Since +0.91x ≥ +0.2x, Signal 1 is **Deteriorating**. **Signal 2: Cash-flow coverage (FFO / Adjusted Debt)** - 2021 Ratio: 0.284 - 2022 Ratio: 0.208 - Change: 0.208 - 0.284 = **-0.076** Thresholds: - ≥ +0.03: Improving - -0.03 to +0.03: Stable - ≤ -0.03: Deteriorating Since -0.076 ≤ -0.03, Signal 2 is **Deteriorating**. **Combination:** Both signals are Deteriorating. **Conclusion:** The leverage increased significantly (by nearly 1 turn), and the cash flow coverage decreased significantly (by 7.6 percentage points). Both metrics indicate a weakening credit profile. Deteriorating