MONTERREY, Mexico--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB-' rating with a Stable Outlook to Fermaca Enterprises, S. de R.L. de C.V.'s (Fermaca) US$550 million notes due 2038 at 6.375% interest rate.
The rating mainly reflects i) an experienced sponsor which has successfully operated one of the assets for almost 11 years, ii) the fact that both pipelines are operating under long-term firm-basis contracts with 'BBB+' counterparties within a highly regulated industry, and iii) stable and predictable revenue and profit base and leverage and coverage ratios that adequately compare with other availability-based projects in the energy sector that are currently rated by Fitch, as well as with the indication from the applicable criteria.
The rating also incorporates the view that the provisions included in the early termination clauses of the ship-or-pay agreement with Mexico's Federal Electricity Commission (CFE) to pay for unrecovered sunk costs and lost profits would likely be sufficient to cover the debt outstanding balance should a termination due to the reasons alleged therein occur. This protection, coupled with the significance of the asset for CFE, is considered consistent with a low investment-grade rating.
KEY RATING DRIVERS
LOW OPERATIONAL RISK: Pipeline operation has a low technical complexity and quite predictable operation and maintenance (O&M) expenses. Though the foremost pipeline has been functional for only eight months, the other one has successfully operated for more than 10 years with no incidents, penalties or revenue deduction. The management team is experienced and has strong incentives to increase operations' efficiency and profitability. [Operations Risk - Stronger]
ALMOST FULLY CONTRACTED CAPACITY: Over 90% of the total capacity is contracted under long-term ship-or-pay agreements with 'BBB+' rated counterparties within a well-regulated industry. Revenue has been and is expected to continue being stable as tariffs are predetermined or self-regulated. Although early termination provisions in the ship-or-pay agreement of the main pipeline do not explicitly ensure full debt compensation, Fitch considers contract protections to be sufficient to assume that the outstanding debt balance would likely be covered. Furthermore, Fitch regards the services provided by such pipeline to CFE as strategic to its long-term operations. [Revenue Risk - Midrange]
ASSETS' REMAINING LIFE EXCEEDS DEBT TENURE: Assets are connected to main consumption centers and, if properly maintained, it is expected their remaining life will last for decades. There is no reserve account for lifecycle costs, though it is estimated such disbursements will be highly stable and foreseeable. [Infrastructure Development & Renewal - Midrange]
CONVENTIONAL DEBT STRUCTURE: Senior secured debt is at a fixed interest rate and tenure matching that of the main services agreement which represents roughly 90% of total revenue. Typical project provisions include a six months reserve account, distribution test at 1.20x, and limitations for permitted investments and additional indebtedness. [Debt Structure - Midrange]
STABLE DEBT SERVICE COVERAGE PROFILE: Leverage is consistent with the rating category, as reflected in Fitch's Base Case debt to EBITDA ratio at 8.41x at its highest level reached in 2016. In this scenario, debt service coverage ratio (DSCR) is 1.23x minimum and 1.29x average, and loan life coverage ratio (LLCR) is 1.30x. Fitch's Rating Case has DSCR of 1.14x minimum and 1.26x average, with LLCR of 1.26x. The projected ratios compare to other projects of similar characteristics that are rated by Fitch, as well as to the applicable sector-specific criteria.
RATING SENSITIVITIES
A positive rating action could be triggered if cash flow available for debt service increases on a sustainable basis as a result of the establishment of new service agreements to sell Tarahumara Pipeline's currently unused capacity on an interruptible basis and/or the expansion of its expanded capacity via the installation of a compression facility.
The main factors that individually, or collectively, could trigger a negative rating action include:
--Fitch Base Case LLCR under 1.20x;
--Recurring two-digit increase in operation expense that would negatively affect cash flow, or not having enough flexibility to reduce costs in case it is needed;
--Operational underperformance leading to downtime periods over two days per year.
SECURITY
The notes are mainly secured, subject to permitted liens, by first priority liens on i) equity of Fermaca, the guarantors and all of the related subsidiaries; ii) all assets of the operating companies; iii) all intercompany debt of the guarantors and intercompany receivables held by such guarantors; iv) personal property, insurance proceeds, collection rights and rights under all revenue contracts; v) any other assets of the guarantors not located in Mexico; and vi) the collateral accounts.
TRANSACTION SUMMARY
Fermaca issued US$550 million notes at a fixed 6.375% interest rate due in 2038. Executed transaction documents have been received in accordance with the terms Fitch analyzed.
Debt is amortized following a predefined biannual schedule commencing in 2014. Cash waterfall is as typically seen in most project finance deals.
There is a six-month debt service reserve account initially funded with a US$15 million letter of credit (LOC) from ANZ Bank, based in New Zealand and rated 'AA-', Stable Outlook by Fitch. The first debt service payment due on Sept. 30, 2014 is US$13.4 million, so the LOC adequately covers such payment. The company will keep this letter of credit in place and the difference for the next payments will be funded with part of the generated cash as it flows through the waterfall of payments.
Even though the transaction structure does not contemplate reserves for operation and maintenance (O&M) or lifecycle costs, Fitch does not see this as a concern as these expenses are expected to be highly stable and to represent only around 10% of total revenue, generating enough cushion for potential non-recurrent variations.
Cash distributions are allowed only if historical and projected 12-month DSCR is at or over 1.20x, except for the first payment, when DSCR will be measured over the last six-month period. If this covenant is not met, excess cash will go to a Distribution Account and, in case it is on deposit for 24 consecutive months, it will be used to make mandatory debt prepayments.
Additional pari-passu indebtedness is permitted but only for very specific purposes, highlighting debt to finance additions to the pipelines such as the construction of compression facilities. New debt can only be incurred if projected DSCR is not lower than 1.25x for each year of the notes' remaining life and current credit ratings are confirmed.
Fermaca must deduct withholding taxes and pay them to the Mexican tax authorities from payments of interest on the notes made to holders who are not residents of Mexico. The issuer will pay to such holders all additional amounts that may be necessary so that every debt service payment after netting the withholding deduction will not be less than the amount provided by the notes. This extra cost has been considered in Fitch's projections.
The purpose of the rated debt was to refinance the company's total existing loans for an aggregate of US$518 million. Cash for payments is managed through a separate trust that isolates project cash flows from other parties' risks.
Fermaca is a Mexican company which started as a family business in 1960 and ventured into the natural gas transportation industry 19 years ago, in 1995. Among other minor businesses that are not part of the transaction, it currently owns and operates two natural gas pipelines: Tarahumara Pipeline (TP) and Tejas Gas de Toluca (TGT) that are managed through separate single-purpose vehicles (SPV) and ultimately owned by the issuer.
The company is currently owned and managed by Partners Group (87%), a Switzerland-based private equity investor, and its management team (13%), in which the former commissioner of the Mexican Energy Regulatory Commission (CRE) participates.
As of today, the organizational structure is complex, as there are a number of intermediate companies between TP and TGT, and the issuer, so that cash to repay the rated debt will flow from the operating companies through the intermediates up to the issuer in the form of dividends and intercompany loans. Fermaca is currently in the process of simplifying its structure and has committed to do so within the 18 months following the notes' issuance.
In the meantime, Fermaca together with TP, TGT and the intermediate companies (together, the guarantors) will be ruled by the 'Additional Indebtedness' covenants described in the transaction documents.
TP generates around 90% of total revenue and operates since July 2013 under a 25-year transportation services agreement (TSA) with Mexico's CFE that is due in 2038, a few weeks after debt matures.
TGT produces the other 10% of revenue and has operated since June 2003 with a 20-year TSA with CH4 Energia (CH4), a 50%/50% joint venture between a subsidiary of Mexico's federal oil and gas company Petroleos Mexicanos (Pemex) and Gas Natural Mexico (GNM), the local branch of Spanish Gas Natural SDG. This contract ends in 2030, eight years before debt maturity. Although a TGT contract renewal or extension is very likely, Fitch has not considered this in its projections.
The counterparties and/or its guarantors to the two TSAs are rated 'BBB+', Stable Outlook. Given the terms and conditions of these contracts, Fitch believes no volume or price risks exist. Though supply risk is largely protected, as natural gas allocation in the pipelines is a responsibility of CFE and CH4, the eventual lack of the project's economic value could lead to an early termination of the contracts.
Both TSAs describe certain events that could lead to a premature contract end. Apart from force majeure, performance-related and other typical clauses, the TP contract also mentions the sole convenience of CFE, if it is demonstrated that the need to require the services has extinguished. With this regard, the TSA does not explicitly contain any termination provision that assures outstanding debt would be fully covered with termination payments. According to Fermaca's legal advisor, this clause is present in all natural gas TSAs in the country and its existence derives from the services provision nature of a ship-or-pay agreement.
Nonetheless, Fitch is of the opinion that early termination risk is mitigated to a certain extent by the good operational track record of the company, the strategic location and purpose of the pipelines and Mexico's federal government objective of increasing the use of natural gas, as stated in the Mexican Energy Strategy for 2013-2027 published in January 2013. Additionally, Fitch considers that the provisions included in the early termination clauses of the TSA with CFE to pay for unrecovered sunk costs and lost profits would likely be sufficient to cover the debt balance should a termination due to the reasons alleged therein occur.
Among other considerations, Fitch's base case assumed the U.S.'s and Mexico's inflation, respectively, at 2.5% and 4% fixed, O&M expenses at issuer's budget (validated by a third-party expert) plus 5%, one-day/year downtime for each pipeline (history for TGT has been zero day/year), TP revenue following the TSA tariff schedule, and TGT revenue assuming throughput at current level of 44 million cubic feet per day (mmcfd). Under this scenario, DSCR is 1.23x minimum and 1.29x average, with 1.30x LLCR.
Different from the base case, Fitch's rating case assumed O&M expenses at issuer's budget plus 10%, two-day/year downtime for each pipeline, and TGT revenue assuming only the base firm contracted capacity of 30 mmcfd. Under this scenario, DSCR is 1.14x minimum and 1.26x average, with 1.26x LLCR.
Other stresses were also run, finding that, given the revenue and cost structure, cash flow is very stable and highly resilient to aggressive sensitizations in inflation, exchange rate, O&M expense and downtime days. Several upsides have been identified, mainly: i) TP to sell its currently unused capacity on an interruptible basis; ii) TGT to have its TSA renewed or extended or to get into another contract after 2030 when the CH4 agreement ends; and iii) TP to expand its capacity via compression in order to achieve extra profits. None of these upsides have been incorporated in our scenarios.
TP is a 36-inch diameter and 383 kilometer (km) pipeline that extends from the U.S.-Mexico border to Chihuahua City. It receives gas from El Paso Natural Gas system in Texas and delivers it to a CFE power plant. It was built in anticipation of six additional power plants to be built that are planned to start operations between 2015 and 2025. TP has a total 850 mmcfd capacity contracted at a predefined tariff schedule.
TGT is a 16-inch diameter and 127-km pipeline that serves Toluca City by supplying natural gas to a significant industrial corridor in central Mexico, very close to Mexico City. TGT has a contract for 31.3% of its 96 mmcfd capacity at a tariff that is regulated by the CRE and periodically adjusted to reach a preset rate of return target. Therefore, revenue is completely isolated from throughput level.
Within the 18 months after the rated notes' issuance, Fermaca plans to install a compression station that would add 250 mmcfc to the current capacity of TP, in order to reach a 1,100 mmcfd capacity. The needed investment is estimated in approximately US$52.2 million and could be financed through additional debt. According to the notes' term sheet, that expansion project would be allowed, as it is described within the 'Permitted Indebtedness' section and would be subject to the 'Additional Indebtedness' covenants set forth.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Rating Criteria for Infrastructure & Project Finance' (July 11, 2012);
--'Rating Criteria for Availability-Based Projects' June 18, 2013).
Applicable Criteria and Related Research:
Rating Criteria for Availability-Based Projects
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710784
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=830546
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