RIO DE JANEIRO--(BUSINESS WIRE)--Fitch Ratings has downgraded Eletropaulo Metropolitana de Eletricidade de Sao Paulo S.A.'s (Eletropaulo) foreign and local currency Issuer Default Ratings (IDRs) to 'BB+' from 'BBB-'. Fitch has simultaneously affirmed Eletropaulo's long-term National Scale Rating at 'AA(bra)'. The Rating Outlook for all ratings is revised to Negative from Stable. A complete list of rating actions is included at the end of this press release.
Key Rating Drivers
The rating downgrade reflects Eletropaulo's weakening credit profile due to significant reductions in cash flow from operations resulting from the last tariff revision coupled with higher energy costs. During the third tariff review process that was finalized in 2012, Eletropaulo saw its tariff decreased by 9.33%, significantly reducing its cash flow generation ability. Higher energy costs resulting from lower hydrology and higher thermoelectric dispatch in the country negatively affects cash flow generation. Although most part of these costs are being compensated by a sectorial fund on a monthly basis, the remaining portion will be collected back from end users only through annual tariff increase, which adds to working capital needs. Eletropaulo's credit metrics were also impacted in the first quarter of 2013 by the recognition of additional BRL2.8 billion of pension liabilities due to new regulation coming from Comissao de Valores Mobiliarios (CVM).
The Negative Outlook reflects the possibility of future pressure on cash flow generation that the company could face as a result of the obligation to return funds to end users and the potential of a negative tariff review in 2015. This may create challenges for the company to maintain its capital structure metrics in line with the assigned ratings. Eletropaulo's cash flow from operations will be negatively impacted during the next two years as the company returns to end users approximately BRL1.1 billion of excess funds collected between from July 2011 to June 2012, partially mitigated by non-manageable costs to be offset in the tariff, which already amounted to BRL422 million at the end of the first quarter of 2013. Eletropaulo's fourth tariff review, scheduled for July 2015, could also pressure company's payment capacity in the future.
Eletropaulo's ratings reflect the company's high financial leverage, which is somewhat mitigated by its robust liquidity position and by a lengthened debt maturity profile. The company benefits from its business profile, in view of its exclusivity rights to distribute electricity within its favorable concession area in the Metropolitan Region of Greater Sao Paulo. Fitch considers the Brazilian electricity sector regulatory risk as moderate, while the hydrological risk is, currently, above average.
Leverage Likely to Remain Above Historical Levels
Fitch expects Eletropaulo's financial leverage to be significantly higher than the conservative levels it reported prior to the 2012 tariff review. During the last 12 months (LTM) ended March 31, 2013, the company reported weak credit measures for its current ratings, with a leverage ratio, as measured by total debt-to-EBITDA, of 14.8 times (x) and 12.8x in a net debt basis. Total debt includes pension fund liabilities. These leverage metrics are significantly above the respective 6.1x and 4.8x recorded in 2012 and 1.8x and 1.1x, in 2011.
The deterioration in its credit measures due to new accounting rules and more pressured cash generation has already led Eletropaulo to renegotiate its debt financial covenants twice in the last 12 months. The increase in its maximum leverage levels and the new formulas for calculation of its financial covenants reduces the risk of such covenants to be exceeded in the future.
Strong Liquidity Position
Eletropaulo's robust liquidity position and lengthened debt maturity profile mitigate company's increased leverage. Cash and marketable securities have remained above 1.5x its short-term debt throughout the last few years. As of March 31, 2013, the company reported BRL930 million in cash and marketable securities, which represented 6.8x its short-term debt of BRL137 million, and 1.1x the debt to mature until 2015. During this period, the cash+funds from operations (FFO)/short-term debt ratio was 8.1x, while the cash+cash flow from operations (CFFO)/short-term debt ratio was 11.5x. Total debt of BRL6.9 billion is mainly composed by pension fund debt of BRL4 billion and debentures of BRL2.3 billion and BRL2.6 billion mature after 2020.
Cash Generation Under Pressure
The rules for the third tariff review cycle of Brazilian distribution companies have pressured Eletropaulo's EBITDA. The ultimate result of this process was an average reduction of 9.33% in the tariff repositioning to clients, beginning in July 2012. As such result was effective one year after initially expected, Eletropaulo will probably refund end-users approximately BRL1.1 billion over the next two years through tariff reduction.
The company's results were also impacted, mainly in the last quarter of 2012, by the increased costs due to higher dispatch from thermal plants and higher electricity spot market prices, in view of unfavorable hydrological conditions. As such increased costs are not manageable, they are later on recovered via tariff, except for those already recovered through sectorial fund. Nevertheless, they have a negative impact on company's EBITDA and reduce its liquidity.
Eletropaulo has used its best efforts to reduce annual expenses by around BRL100 million in order to face the more challenging environment of lower operating cash generation. Its EBITDA of BRL465 million during the 12-month period ended as of March 31, 2013 was lower than the BRL656 million recorded in 2012 which had already shown a sharp decline from the BRL2.1 billion recorded in 2011. March 2013 LTM EBITDA increases to BRL667 million after adjusting it for BRL202 million of pension expenses related to Fundação Cesp. This translates into a net leverage of 8.9x for the same period. Eletropaulo's annual regulatory EBITDA, estimated at around BRL1 billion after the third tariff review, could be again under pressure in 2015 due to the effect of the fourth tariff review cycle.
The reduction of CFFO to BRL648 million as compared to BRL1.4 billion in 2011 follows the same rationale as for the EBITDA and was not sufficient to cover BRL851 million of investments and BRL608 million of dividend payment. The company reported a negative free cash flow (FCF) of BRL811 million during the LTM ended March 2013, and FCF would likely stay negative over the next few years.
Increasing Demand
Eletropaulo's ratings incorporate the company's low business risk profile, with an exclusive right to distribute electricity within its favorable concession area in the Metropolitan Region of Greater Sao Paulo. The company will benefit from electricity demand growth in its service area, as a result of the country's expected economic growth. During the first quarter of 2013, electricity demand in Eletropaulo's concession area grew by 2.2%, as compared to the same period in the previous year and above the 1% recorded in 2012. The average annual demand growth was 2.3% for the period 2008 to 2012, mainly due to the residential segment performance, driven by lower unemployment rates and income expansion. These two factors have also contributed for the favorable performance of the commercial segment.
Rating Sensitivities
Eletropaulo's ratings would be negatively affected in case the company is not successful in returning its financial metrics to more conservative levels, or in view of deterioration in its liquidity position. In case the regulator imposes the company to return the BRL1.1 billion to customers in only one year, it can also pressure the ratings. Fitch will also continue to monitor the developments of the legal dispute involving Eletropaulo and Centrais Eletricas Brasileiras S.A. (Eletrobras), which could lead to increased indebtedness. A positive rating action is not likely over the short-term.
Fitch has taken the following rating actions on Eletropaulo:
--Foreign and Local Currency IDRs downgraded to 'BB+' from 'BBB-';
--Long-Term National Scale Rating affirmed at 'AA(bra)';
--9th debenture issue, in the amount of BRL250 million, due 2018 affirmed at 'AA(bra)';
--11th debenture issue, in the amount of BRL200 million, due 2018 affirmed at 'AA(bra)';
--Bank Credit Certificate (CCB) issue, in the amount of BRL300 million, due 2015 affirmed at 'AA(bra)';
--15th debenture issue, in the amount of BRL750 million, due 2018, affirmed at 'AA(bra)'.
The Outlook for all ratings is revised to Negative from Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'National Ratings Criteria' (Jan. 19, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460
National Ratings Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=595885
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=795077
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