NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed AES El Salvador Trust II's (AES El Salvador) Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at 'B+'. The Rating Outlook is Stable. In addition, Fitch affirms the USD310 million notes due 2023 at 'B+/RR4'. AES El Salvador Trust II is a special purpose vehicle created to issue notes guaranteed by four AES-controlled distribution companies in El Salvador: Compania de Alumbrado Electrico de San Salvador S. A. de C. V., AES CLESA y Compania, S. en C. de C.V., Empresa Electrica de Oriente, S.A. de C.V., and Distribuidora Electrica de Usulutan, S.A. de C.V.
KEY RATING DRIVERS
The rating affirmation reflects Fitch's expectations that AES El Salvador's cash flow generation will be unaffected amidst increased uncertainty surrounding continuity of existing subsidy scheme. Fitch expects AES El Salvador to collect subsidies for low consumption users from industrial and high consuming residential users after the recent news that the El Salvador government and its hydroelectric generation company will not be able to continue funding such subsidy. AES El Salvador ratings also consider the company's exposure to the sustained weakening macroeconomic conditions in El Salvador, which could affect electricity demand, collections and non-technical electric losses.
NEW SOURCES FOR SUBSIDY FUNDING UNDER DISCUSSION
There are significant downside risks to wholly defunding subsidies for Salvadorian user consuming less than 100kWh, which could affect AES El Salvador's cash flow generation. Based on first quarter 2016 (1Q16) invoicing, AES El Salvador is on track for approximately USD77 million of subsidized revenues for the full year 2016, or approximately 12% of total revenues under Fitch's base case assumptions. This amount compares with approximately USD80 million of expected EBITDA generation for 2016. Failure to find alternate funding sources for these subsidies would have social and economic consequences for the country, as roughly 60% of AES El Salvador's users qualify for subsidy support. If AES El Salvador's companies were forced to reflect the full energy cost on low-consumption users' bill, it would likely result in attrition from the formal distribution system and a higher incidence of non-technical losses. Alternately, a poorly communicated or executed tariff adjustment process could also precipitate similar responses from non-subsidized residential and commercial users who feel that cross subsidies would represent an undue burden.
Reasons to remain sanguine about the likelihood of relatively painless transition to a cross subsidy scheme that would not result in a meaningful cash flow impact for AES El Salvador include: a government commitment to cover subsidies up to June of 2016 and the expectation of a smooth transition into a new cross subsidy scheme. The government has already agreed to satisfy all subsidy-related invoices incurred in the first half of 2016 (1H2016), and has maintained its historically consistent payment cycle of around 55 days. Furthermore, the importance of a smoothly functioning electricity system has been recognized by the government as recently as 2013, when it revised the country's tariff structure to provide greater cost flexibility to the sector. While public reaction to the cross subsidy proposal has been largely negative, El Salvador, recently affirmed by Fitch at 'B+', benefits from better social development and governance indicators, as well as higher per capita income than its rating category peers. Finally, with AES El Salvador's broad geographic coverage, its companies are well positioned to negotiate with regulators for an effective solution.
The current uncertainty surrounding this issue follows the recent news that the Salvadorian state-owned hydroelectric company, Comision Ejecutiva Hidroelectrica del Rio Lempa (CEL), would be defunding its subsidies for low-consumption residential users. Consequently, the president and Minister of Economy signed and published a decree roughly outlining a proposal to modify the country's electricity tariff structure such that it would effectively create cross-subsidies within the system, due to begin July 16, 2016.
STRONG MARKET POSITION AND LOW BUSINESS RISK
AES El Salvador's low business risk results from its stable customer base and predictable cash flows. Although distribution service territories are not exclusive and distributors are free to compete for customers, the risk of new competition is low given that distribution companies possess significant economies of scale that make it inefficient for more than one company to operate in any particular geographic area. The ratings factor in the strong market position of AES El Salvador as the largest electric distribution group in the country.
The group serves approximately 1.3 million customers and covers 80% of El Salvador's electricity distribution area. The group supplied 76% of the total energy demand in the country during 2015 (60% in 2014, 63% in 2013). The company's operations are considered efficient compared with other distribution companies in the region. In 2015, energy losses were 9.52% (2014: 9.32%). The tariff allows for recovery of 100% of technical losses recognized through tariff and 50% of non-technical losses.
STRENGTHENING CREDIT FUNDAMENTALS SUPPORTED ON TARIFF STRUCTURE
The company's credit profile is supported by its stable and predictable cash flow generation and strengthening credit metrics as result of higher EBITDA levels as outcome of the tariff reset for the 2013-2017 period. The tariff reset was determined as per the new methodology that considers real costs of the companies based on El Salvador distribution grid instead of an optimized company model as it was considered in the past methodology. Fitch considers that although the new methodology is positive for the issuer, it continues to be exposed to government intervention. Latest 12 month (LTM) EBITDA for the period ended in March 31, 2016 is USD88 million, and leverage is 3.6x (2015 EBITDA: USD89 million, debt/EBITDA 3.6x).
KEY ASSUMPTIONS
--Minor, short-term impact to total demand and non-technical losses following the implementation of a cross subsidy program.
--Six months of subsidies are paid by CEL in 2016; all subsidies thereafter are passed through price adjustments.
--Company pays out cash above USD18 million as dividends.
--Spot energy prices gradually increasing through the medium term.
--Shrinking proportion of spot purchases versus PPAs.
RATING SENSITIVITIES
AES El Salvador's ratings could be negatively affected by any combination of the following factors: Failure to resolve the issue of subsidy funding sources in a timely manner; shortages of electricity supply resulting in lower consumption and lower cash flow generation; or further political or regulatory intervention that negatively affects the company's financial performance, including sustained deterioration in leverage above 4.5x.
AES El Salvador's ratings could be positively affected by consistent leverage reduction; regulatory stability; sustainable independence from the government funding, and improving macroeconomic conditions in El Salvador.
LIQUIDITY
AES El Salvador's liquidity is supported by its cash on hand, which as of March 2016 was approximately USD55 million (year end 2015: USD45.3 million), and USD43 million of undrawn short-term bank credit facilities. Liquidity could be affected in case of higher energy prices for final users that could lead to higher aging account receivables. Should distribution companies be forced to issue additional debt to fund their working capital requirements, while they continue distributing dividends, their credit quality could deteriorate.
In 2015, subsidies received by AES El Salvador totaled USD89.2 million compared to USD136.1 million in 2014. This reflects both a reduction in subsidy-eligible users and lower fuel and energy prices. Based on the first three months of 2016, AES El Salvador is on pace for USD77.7 million of subsidy charges for the full year 2016 (not including the possible 13% energy surcharge).
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
AES El Salvador Trust II
--Long-Term Foreign Currency IDR at 'B+';
--Long-Term Local Currency IDR at 'B+';
--Senior unsecured notes rating at 'B+/RR4'.
The Rating Outlook is Stable.
Date of Relevant Rating Committee: July 12, 2016.
Additional information is available on www.fitchratings.com.
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
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