I'll work through this step-by-step. ## Step 1: Identify the relevant industry Naturgy Energy Group SA is a Spanish energy company with operations in regulated gas and electricity distribution, power generation (both regulated and unregulated), and gas supply. It's a multi-utility company. The most relevant methodology is **Regulated Utilities** combined with **Unregulated Power and Gas**, as Naturgy has significant regulated utility operations (gas and electricity networks) alongside unregulated generation and supply activities. For a diversified utility like Naturgy, I'll apply the regulated utilities framework as the primary methodology. ## Step 2: Estimate 2021 Adjusted EBITDA The reported EBITDA for 2021 (period 2021-01-01 to 2022-01-01) is **€3,529M**. S&P adjustments: - **Lease adjustments**: Add back lease depreciation (right-of-use asset depreciation is embedded in D&A). S&P capitalizes operating leases. The current lease liabilities (2022-01-01) = €196M and noncurrent lease liabilities = €1,325M, total = €1,521M. The lease payment (interest + principal) is part of cash flows. For S&P, we add back the lease expense and treat it as a financing item. The approximate annual lease expense ≈ current lease liabilities as a proxy for annual payments ≈ €196M. However, a simpler approach: S&P adds lease depreciation to EBITDA. Since ROU assets went from €1,229M to approximately similar levels, annual ROU depreciation ≈ €200M (rough estimate). But this is already in reported EBITDA since EBITDA is before D&A. Actually, reported EBITDA ("Beneficio Bruto De Explotacion Ebitda") at €3,529M likely already includes operating lease costs as an expense. Under S&P methodology, we need to add back the operating lease rental expense (which under IFRS 16 is already capitalized, so depreciation of ROU + interest on lease liabilities replaces the old lease expense). Under IFRS 16, EBITDA already excludes lease depreciation and lease interest. So the reported EBITDA is already "S&P-friendly" in terms of lease treatment - no further adjustment needed since IFRS 16 is applied. - **Non-recurring items**: - 2021 employee benefits expense was €940M which seems elevated (vs €547M in 2022), possibly including restructuring. However, without clear breakdown, I'll be conservative. - "Other Gains Losses" 2021: +€133M (gain) - this could include non-recurring items. S&P would subtract non-recurring gains. - Discontinued operations: €117M profit - typically excluded from adjusted EBITDA. - **Pension adjustments**: Not enough data to quantify precisely. For simplicity and consistency: - Reported EBITDA: €3,529M - Add lease interest (approximation): Lease liabilities ~€1,521M at ~3% ≈ €46M - Adjusted EBITDA ≈ €3,529M + €46M ≈ **€3,575M** Let me reconsider. S&P typically adds operating lease interest to EBITDA. Under IFRS 16, lease interest is already below EBITDA, so the reported EBITDA already captures this correctly. The key S&P adjustment for leases is adding the imputed lease interest back to EBITDA if it wasn't already there. Actually, under IFRS 16, the income statement shows: - EBITDA excludes both ROU depreciation and lease interest - So reported EBITDA already treats leases as S&P would want I'll use: **Adjusted EBITDA 2021 ≈ €3,575M** (reported €3,529M + ~€46M lease interest adjustment for S&P, since S&P treats entire lease payment as debt-like) Wait - let me reconsider S&P's approach. S&P adds the full lease depreciation to EBITDA (already done under IFRS 16) and also treats lease interest as a financing cost (already done under IFRS 16). So reported EBITDA under IFRS 16 is essentially already S&P-adjusted for leases. The only thing S&P does is add lease obligations to debt. **Adjusted EBITDA 2021 ≈ €3,575M** (I'll keep a small adjustment for conservatism) ## Step 3: Estimate 2021 FFO FFO = Adjusted EBITDA - cash interest - cash taxes - Cash interest paid (2021): €488M (from cash flow statement "Interest Paid Classified As Operating Activities") - Add lease interest: approximately €46M - Total cash interest: €534M - Cash taxes paid (2021): €864M - Interest received: €32M (offset) FFO = €3,575M - €488M - €864M + €32M = **€2,255M** Actually, S&P's FFO calculation: FFO = Adjusted EBITDA - net cash interest - cash taxes - Net cash interest = €488M - €32M = €456M (but we should also consider lease interest is already in the €488M under IFRS 16) Under IFRS 16, interest paid already includes lease interest. So: FFO = €3,575M - €488M + €32M - €864M = **€2,255M** Wait, let me be more careful. The lease interest is already included in the €488M interest paid figure since under IFRS 16, lease interest is classified as interest. So I shouldn't double-count. FFO = €3,529M (reported EBITDA) - €488M (interest paid, includes lease interest) + €32M (interest received) - €864M (taxes paid) = **€2,209M** ## Step 4: Estimate 2021 Adjusted Debt Balance sheet as of 2022-01-01 (end of fiscal 2021): - Long-term borrowings: €13,786M - Current borrowings: €1,493M - Noncurrent lease liabilities: €1,325M - Current lease liabilities: €196M - Other noncurrent financial liabilities: €3M - Other current financial liabilities: €9M - Total reported debt + leases = €13,786M + €1,493M + €1,325M + €196M + €3M + €9M = **€16,812M** Adjustments: - **Pension deficit**: Included in noncurrent provisions (€1,146M) - but not all provisions are pension. Without specific breakdown, I'll estimate pension obligations at perhaps 20-30% of provisions ≈ €250M - **Cash deduction**: S&P typically allows some surplus cash deduction. Cash = €3,965M. For utilities, S&P might deduct some operating cash. Conservative: deduct minimal, say €200M of surplus cash. Adjusted Debt 2021 ≈ €16,812M + €250M (pension estimate) - €200M (surplus cash) = **€16,862M** For simplicity, let me use a cleaner approach: - Gross debt (borrowings): €13,786M + €1,493M = €15,279M - Lease liabilities: €1,325M + €196M = €1,521M - Pension/provisions estimate: €250M - Less surplus cash: ~€200M Adjusted Debt 2021 ≈ **€16,850M** ## Step 5: 2021 Adjusted Debt / Adjusted EBITDA = €16,850M / €3,529M ≈ **4.8x** (Using reported EBITDA of €3,529M as the base for consistency) Let me recalculate with adjusted EBITDA: = €16,850M / €3,575M ≈ **4.7x** ## Step 6: 2021 FFO / Adjusted Debt = €2,209M / €16,850M ≈ **13.1%** ## Step 7: Estimate 2022 Adjusted EBITDA Reported EBITDA for 2022 (period 2022-01-01 to 2023-01-01) = **€4,954M** S&P adjustments similar to 2021: - Lease liabilities end 2022: NC €1,309M + C €177M = €1,486M - Lease interest ≈ €45M Adjusted EBITDA 2022 ≈ **€4,954M** (reported, with lease treatment already aligned under IFRS 16) For consistency with 2021 approach: **€5,000M** ## Step 8: Estimate 2022 FFO - Cash interest paid (2022): €520M - Interest received: €87M - Cash taxes paid: €762M FFO = €4,954M - €520M + €87M - €762M = **€3,759M** ## Step 9: Estimate 2022 Adjusted Debt Balance sheet as of 2023-01-01 (end of fiscal 2022): - Long-term borrowings: €12,689M - Current borrowings: €2,110M - Noncurrent lease liabilities: €1,309M - Current lease liabilities: €177M - Other noncurrent financial liabilities: €1M - Other current financial liabilities: €15M - Total = €12,689M + €2,110M + €1,309M + €177M + €1M + €15M = **€16,301M** Adjustments: - Pension estimate: ~€300M (provisions increased to €1,656M) - Less surplus cash: ~€200M - Cash: €3,985M Adjusted Debt 2022 ≈ €16,301M + €300M - €200M = **€16,401M** ## Step 10: 2022 Adjusted Debt / Adjusted EBITDA = €16,401M / €4,954M ≈ **3.3x** ## Step 11: 2022 FFO / Adjusted Debt = €3,759M / €16,401M ≈ **22.9%** ## Step 12: Classify the trend **Signal 1: Leverage change** Change = 3.3x - 4.7x = **-1.4x** → ≤ -0.2x → **Improving** **Signal 2: Cash-flow coverage change** Change = 22.9% - 13.1% = **+9.8 percentage points** = +0.098 → ≥ +0.03 → **Improving** Both signals agree: **Improving** The significant improvement is driven by: - EBITDA growth from €3,529M to €4,954M (+40%) - Debt reduction (borrowings decreased from €15,279M to €14,799M) - Strong operating cash flow of €4,242M vs €1,001M in 2021 Improving