Empresas Publicas De Medellin E.S.P.(EPM)

Transcription

1 SEPTEMBER 3, 2014 CORPORATES PRE-SALE REPORT Empresas Publicas De Medellin E.S.P.(EPM) Table of Contents: SUMMARY RATING RATIONALE 2 OUTLOOK 3 WHAT COULD CHANGE THE RATING - UP 3 WHAT COULD CHANGE THE RATING - DOWN 3 CORPORATE PROFILE 4 DETAILED RATING CONSIDERATIONS 6 LEADING MULTI-UTILITY IN COLOMBIA NO STRUCTURAL SUBORDINATION CONSIDERATIONS APPLY 7 ITS AGGRESSIVE EXPANSION STRATEGY (MEGA 2022) IS NOT WITHOUT RISKS 8 MATERIAL INVESTMENTS AND CONSTRUCTION RISK ASSOCIATED WITH ITUANGO WILL FURTHER INCREASE EPM'S EXPOSURE TO THE UNREGULATED POWER GENERATION SECTOR 10 ALBEIT CASH FLOW PREDICTABILITY ENHANCED BY COMMERCIAL POLICIES, RELIABILITY PAYMENTS AND REGULATED OPERATIONS 12 CREDIT METRICS EXPECTED TO SCORE WITHIN THE RATING CATEGORY 13 LIQUIDITY PROFILE 14 APPENDIX 1: EPM CORPORATE ORG- CHART 15 APPENDIX 2: EPM S INSTALLED GENERATION CAPACITY IN COLOMBIA 16 APPENDIX 3: 2009-JUNE 2014 SPOT VERSUS CONTRACTED POWER PRICES; ENFICCS 18 APPENDIX 4 20 Analyst Contacts: NEW YORK Natividad Martel,CFA Vice President - Senior Analyst natividad.martel@moodys.com» contacts continued on page 20 This Pre-Sale Report provides an in-depth discussion of credit rating(s) for Empresas Publicas De Medellin E.S.P.(EPM) and should be read in conjunction with Moody s most recent Credit Opinion and rating information available on Moody's website.» Headquartered in Medellin, Empresas Publicas de Medellin E.S.P. (EPM; Baa3 positive) renders directly or indirectly via its subsidiaries water, sewage and waste management (Water Business Unit) as well as natural gas and electric vertically integrated services (Energy Business Unit).» EPM ranks as the largest multi-utility group in Colombia (Baa2 stable), mainly in the Antioquia region. In 2010, EPM started extending its international footprint via subsidiaries that operate in Guatemala (Ba1 stable), El Salvador (Ba3 stable), Panama (Baa2 stable), Chile (Aa3 stable), Mexico (A3 stable) and Costa Rica (Baa3 negative).» Given that it is fully owned by the Municipality of Medellin (Baa2 stable) EPM falls under the scope of Moody's rating methodology for government-related issuers (GRIs). Their Governance Framework Agreement limits political interference and dividend distributions.» The group renders its regulated operations under overall stable and transparent frameworks, a credit positive. In Colombia, its natural gas and electricity sector operations are subject to the purview of the Comision de Regulacion de Energia y Gas (CREG), while its water, sewage and waste management activities are under the jurisdiction of the Comision de Regulacion de Agua Potable y Saneamiento Basico (CRA).» EPM will use the proceeds raised in connection with this 10-year Colombian Peso denominated issuance due in 2024 (Global Notes) largely to aid the financing of its 8 unit 2,400 MW Ituango hydro-electric project. A material milestone was reached in early 2014; however, the first unit is scheduled to start operation in December 2018 and the last three units in 2022.» This multi-year program exposes EPM to material construction risk. In addition, when completed it will further increase EPM s significant exposure to unregulated power generation in terms of EBITDA contribution with current 3,513MW (EPM standalone) installed capacity (hydro: 85.6%), another credit negative.» That said, EPM s overall prudent commercial policy and its regulated operations under the relatively transparent and stable Colombian regulatory framework help to enhance the visibility of its power generation operations, two credit positive.. THIS REPORT WAS REPUBLISHED ON 4 SEPTEMBER 2014 WITH A CORRECTION IN THE 2012 ENERGY BUSINESS UNIT PROXY EBITDA DISPLAYED IN EXHIBIT 2 FROM COLPS 62,964,131MILLION TO COLPS 2,961,131 MILLION

2 » The total EPM s standalone indebtedness of around US$3.3 billion (including this new Global Notes issuance) to be incurred to finance this plant will contribute to the weakening of EPM s credit metrics; however, they are expected to remain commensurate with the lower end of the Baarating category according to the guidelines provided under Moody s Unregulated Utilities and Power Companies methodology.» EPM s 2022 Mega Strategy Plan focuses not only on growth but also on the enhancement of the group's overall profitability, a credit positive. We expect prudent implementation of this strategic plan considering that EPM's financial documentation limits its consolidated debt to EBITDA at 3.5x. We further assume that there will be no material changes in the dividend payout ratio that has hovered around 55%. Summary Rating Rationale The Baa3 rating and positive outlook reflect EPM's ownership structure and linkages with the Municipality of Medellin. Given it is fully owned by this Municipality, it falls under the scope of Moody's rating methodology for government-related issuers (GRIs). Its application underpins EPM's Baa3 senior unsecured rating which results from the following four input factors (i) our estimates of a high level of dependence, (ii) a strong-level probability of extraordinary support from the Municipality in the case of financial distress, (iii) the sub-sovereign rating of the City of Medellin (Baa2) and (iv) EPM's Baseline Credit Assessment (BCA) of ba1. The BCA is a representation of the group's intrinsic creditworthiness before taking into account possible extraordinary support from the sub-sovereign. EPM s BCA considers:» No structural subordination. The parent company has incurred most of the group's outstanding indebtedness and has operating assets that generate the majority of the consolidated cash flows;» Its diversified and leading business position as a major power and utility service provider in Colombia;» Its significant exposure to unregulated power operations that is expected to increase upon the completion of the 2,400MW Ituango hydro-facility;» Its overall prudent commercial policy and its regulated operations under the relatively transparent and stable Colombian regulatory framework underpins the visibility of EPM s cash flows;» Our expectation that the key credit metrics will remain commensurate with the Baa-rating category despite the expected deterioration compared to its strong historical credit metrics amid increasing leverage to fund its sizeable capital expenditure (capex) program, mainly in connection with the construction of the Ituango hydro-facility; This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history.» The diversification benefits associated with its international expansion; however, this also incorporates some concerns about the associated risks with those investments. That said, we assume a continued prudent implementation of the 2022 Mega Strategy Plan that focuses not only on growth but also on the enhancement of the group's overall profitability;» EPM s reliance on the capital markets in the absence of committed credit facilities to meet unexpected cash flow shortfalls. EPM is currently defining the balance of its financing strategy in addition to this Global Notes issuance (equivalent to up to US$500 million); 2 SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

3 » Some exposure to foreign exchange risks. The terms of this Colombian Peso denominated issuance helps further mitigate this risk. We understand that under its terms EPM bears no foreign exchange risk when servicing this debt. Instead, such risk is fully borne by the investors. The payments required to service this debt will depend on the exchange rate between the Colombian peso and US dollar at the time of the relevant payments. Importantly, to the extent that the Colombian peso depreciates relative to the US dollar, the payments of principal, interest and any other related amounts, if any, expected to be received on the notes in U.S. dollars would decrease. Moreover, if the Colombian peso were to depreciate against the U.S. dollar, the principal amount due at maturity, upon redemption or should a change of control payment occur could be less than the initial amount of principal originally invested. Alternatively, in the case where the Colombian peso were to appreciate against the U.S. dollar, those amounts could be higher than the initial amount of principal originally invested. Outlook EPM's positive outlook reflects our expectation that the company will be able to successfully manage the construction risk of its Ituango project, and finance initiatives under its Mega 2022 strategy in a prudent manner while maintaining an adequate liquidity position. The positive outlook anticipates that despite the expected increased leverage EPM's credit metrics will remain commensurate with the lower end of the Baa-rating category. What Could Change the Rating - Up EPM's rating will be upgraded following new evidence that the construction works at the Ituango project are progressing smoothly in terms of schedule and budget; such that, it successfully meets during 2015 and early 2016 the critical milestones laid out in its development schedule. Equally important, would be indications that any organic and external growth initiatives pursued under its Mega 2022 expansion strategy are financed in a prudent manner; and that planned construction advances are being carried out according to schedule and budget. Quantitatively, an upgrade could be triggered if EPM is able to report CFO pre-w/c debt higher than 20% and CFO pre-w/c interest coverage higher than 4.5x, both on a sustainable basis. Apart from a change in the standalone fundamental credit quality of EPM, the unsecured debt rating could be upgraded if the rating of the City of Medellin is upgraded. What Could Change the Rating - Down The BCA rating could be downgraded as a result of a perceived deterioration in the credit supportiveness of the Colombian regulatory framework or EPM's inability to recover costs in a timely manner. A rating action could also be triggered if the Ituango hydro project and/or any new expansion targets are poorly executed or result in the implementation of financial policies, such that the indebtedness increases significantly above anticipated levels resulting in a material deterioration of its credit metrics. Quantitatively, a negative rating action would be triggered if the interest coverage falls below 3.0x and the RCF to Debt declines below the mid-teens level. Apart from a change in the standalone fundamental credit quality of the issuer, the ratings of the notes could be downgraded if EPM decided to incur a material amount of secured debt as a proportion of total debt (currently all debt is unsecured). Moreover, a significant deterioration of the financial strength of the City of Medellin or a downgrade in Colombia's foreign currency ceiling could negatively affect EPM's ratings as well. 3 SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

4 Corporate Profile Headquartered in Medellin, Colombia (Baa2 stable), Empresas Publicas de Medellin, E.S.P. (EPM) is a multi-utility group. Appendix 1 depicts EPM s org chart including its own operations and its local and international subsidiaries. EPM's portfolio of non-controlling interests in Colombia includes the country s largest transmission company ISA S.A. E.S.P. (Issuer rating: Baa2 stable; 10.17% ownershipstake;) and the power generation company Isagen S.A. E.S.P. (13.14% ownership interest; Issuer rating: Baa3 negative). The chart below illustrates EPM s current two business units. As depicted in the tables below the Energy Business Unit accounts for the bulk of the consolidated EBITDA: EXHIBIT 1 EPM's Energy and Water Business Units Source: EPM's OM dated September 2014 based on data as of June 30, 2014 Energy Business Unit has 3,579 MW (EPM standalone: 3,513MW ; hydro 85.6%) installed capacity. This unit also provides directly or indirectly via its subsidiaries electric distribution, generation, transmission and commercialization services to about 3.7 million customers. It further renders natural gas distribution and commercialization services to over 815 thousand end-users. 4 SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

5 EXHIBIT 2 Energy Business Unit recorded consolidated EBITDA EBITDA in ColPs million Electricity generation 2,199,470 2,787,388 2,700,029 Electricity transmission, distribution and commercialization 6,708,682 7,385,579 7,899,020 Natural gas distribution and commercialization 405, , ,894 Eliminations and discounts (591,644) (1,201,109) (1,435,532) Total Revenues 8,722,202 9,420,409 9,728,411 Total operating & administrative expenses excluding Provisions, 6,149,130 6,456,278 6,852,983 Depreciation & Amortization proxy EBITDA (1) 2,573,072 2,961,131 2,875,428 % Energy Business Units EBITDA over TOTAL EBITDA 89.6% 89.4% 89.7% (1) The difference between the consolidated EBITDA and the sum of the proxy EBITDAs is additional eliminations of operations between the business units Source: EPM's OM dated September 2014 based on data as of June 30, 2014 Water Business Unit provides water and sewage services to around one million customers. Since last year, it also renders waste management services in the Antioquia region via its wholly-owned subsidiary, Emvarias (cost: US$17 million). EXHIBIT 3 Water Business Unit recorded consolidated EBITDA EBITDA in Col Ps million Water 351, , ,365 Sewage 352, , ,143 Waste Management ,765 Eliminations and discounts (319) (5,519) (1,736) Total Revenues 702, , ,537 Total operating and administrative expenses excluding Provisions, 405, , ,138 Depreciation & Amortization proxy EBITDA (1) 297, , ,399 % Water Business Units EBITDA over TOTAL EBITDA 10.4% 10.6% 10.3% (i1) The difference between the consolidated EBITDA and the sum of the proxy EBITDAs is additional eliminations of operations between the business units Source: EPM's OM dated September 2014 based on data as of June 30, 2014 In August 2014, the strategic merger of EPM Telecomunicaciones S.A. E.S.P. (UNE; EPM 99.99%) and Colombia Movil (a Millicom subsidiary) was completed. Although EPM will maintain a 50% plus 1 share interest in the combined entity, Millicom will operate and consolidate the combined entity. As a result, EPM will no longer consolidate the telecommunication operations. At year-end 2013, this unit recorded around US$435 million in EBITDA with outstanding indebtedness at the end of June that approximated US$480 million. The table below depicts this unit s historical contribution. 5 SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

6 EXHIBIT 4 Historical total consolidated EBITDA (including Telecommunications) proxy TOTAL Energy and Water Business EBITDA (ColPs million) 2,870,629 3,316,981 3,205,828 proxy TELECOMMUNICATION historical EBITDA contribution 448, , ,676 HISTORICAL proxy CONSOLIDATED EBITDA before EPM's definition adjustments 13.5% 14.4% 16.5% (1) The difference between the consolidated EBITDA and the sum of the proxy EBITDAs is additional eliminations of operations between the business units Source: EPM's OM dated September 2014 based on data as of June 30, 2014 International Subsidiaries In 2010 and 2011, EPM acquired a majority ownership-interest in the El Salvadorian and Panamanian electric utilities DELSUR (86.41%) and ENSA (51%), respectively, as well as a 100% interest in the Guatemalan Gesa and DECA II group. The latter among others holds a 80.90% stakeholder-interest in the electric utility Empresa Electrica de Guatemala (Ba1 stable). At year-end 2013, the Central American subsidiaries accounted for about 26% and 11% of EPM's consolidated revenues and EBITDA (including the telecommunications business). In 2013, EPM continued expanding its international footprint with the acquisition of the 110MW Los Cururos wind-farm (57 turbines) that started operations in the Chilean Sistema Interconectado Central (capex: US$217.7 million). It also acquired in Mexico an 80% indirect interest (cost: US$113 million) in Tecnologia Intercontinental (Ticsa), an engineering and operator that has eleven water treatment plants currently under operation with an additional three plants under construction (completion expected by 2015). EPM controls the 31.3MW hydro-plant in Panama (via its 97.09% owned subsidiary Hidroecologica del Teribe S.A.) that starting operating in It also acquired last year the subsidiaries Espiritu Santo Energy Panama and Espiritu Santo Colombia to better position the company should the interconnection between Colombia-Panama finally be realized. EPM also established a branch in Costa Rica. It further exports power to Ecuador (via the market operator XM). Detailed Rating Considerations Ownership Structure The 2007 Governance Framework Agreement outlines EPM's relationship with its single owner, the Municipality of Medellin (Baa2 stable). As a result of its ownership, EPM is subject to fiscal control under the General National Accounting Authority, and the Comptroller's Office of the City of Medellin, a credit positive. This Governance Framework Agreement was ratified in 2012 after the installation of the new mayor of Medellin. This is another credit positive as it limits the risk of political interference and provides visibility in terms of dividend distributions which includes a 25% extraordinary component on top of the 30% ordinary distribution. In December 2013, EPM declared an addition extraordinary dividend of ColPs320,000 million (around US$160 million) related to the UNE strategic merger. Total of ColPs 28,936 million were paid last year with the balance to distributed before the end of October SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

7 EXHIBIT 5 Dividend distributions to the City of Medellin in ColPs m Ordinary distributions 295, , , , , , ,122 Extraordinary distributions 243, , , , , , ,435 TOTAL DISTRIBUTIONS 539, , , , , , ,557 % of consolidated NI 55% 47% 37% 60% 55% 55% 55% distributions related to UNE transaction (*) 218,936 Source: EPM audited statements, OM dated September 2014 based on data as of June 30, 2014 The Municipality of Medellin does not guarantee EPM's debt obligations rated by Moody's; however, in our opinion there is a "strong-level" probability of extraordinary support from the Municipality in case of financial distress for several reasons including EPM's strategic importance to the local economy as it represents roughly 24% of the Municipality's total revenues or reputational implications. Our estimate of "high" default dependence reflects the degree to which the Municipality is exposed to the same risks as those that would affect credit quality at EPM's domestic operations, and our expectation that there is an elevated likelihood that the Municipality and EPM would default simultaneously due to common risk factors. That said, these assessments of dependence and/or support may be reviewed if the importance of EPM's growth initiatives outside of Colombia increases significantly. Leading Multi-Utility In Colombia No Structural Subordination Considerations Apply Established before the 1994 reforms of the household public services industry and electricity sector, EPM was not required to unbundle its vertically integrated electric activities. Therefore, its BCA reflects its diversified and leading business position as a major power and utility service provider in Colombia, a credit positive. EPM's key market is still the region of Antioquia (including its capital Medellin) despite its expansion via organic growth and acquisitions in other regions of the country that started in According to the Colombian Public Information System, it also ranks among the largest players in terms of customer base in the commercialization and supply of electricity (around 24%), transmission (about 8%) as well as in the fragmented water and sewage sectors (around 14% market share), and ranks among the top five natural gas distribution (about 11.5%) companies in the country. The rating acknowledges the group's benefits from operational and geographic diversity. However, our analysis focuses mainly on the parent operating company. At the end of June 2014, this legal entity had incurred over 70% of the consolidated indebtedness with its debt approximating US$4.4 billion (including US$ 1.15 billion senior unsecured global notes but excluding this issuance). EPM also generates a significant portion of the cash flows (around 60% of the consolidated cash flows) while its assets approximate 62% of the consolidated assets. Our analysis also considers that any cash distributions received from its subsidiaries must first satisfy subsidiary level debt servicing requirements which are also often subject to satisfying certain financial covenants. EPM s BCA acknowledges the company s limited reliance on the dividends received from its subsidiaries. 7 SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

8 EXHIBIT 6 Breakdown Of EPM's Stand Alone Funds From Operations (FFO) Versus Dividends From Subsidiaries in ColPs million 2010 % 2011 % 2012 % 2013 % EPM's recorded FFO 1,733, % 1,800, % 1,809, % 1,810, % incl dividends from noncontrolled 39,161 42,605 47,966 47,620 subs Dividends controlled subs 54, % 80, % 353, % 769, % EPM's total FFO (Moody's 1,788,915 1,881,111 definition) 2,162,749 2,579,400 Source: EPM's audited financial statements In 2013, EPM s received dividends from its subsidiaries (considered in Moody's calculations of EPM's Funds from Operations) that increased again significantly and approximated US$385 million or almost 30% of EPM's FFO (2012: 16%; 2011: 4%). That said, we consider the 2013 spike a one-time event as it largely resulted from the payment received (aggregate ColPs340,000 million or roughly US$172 million) in connection with the planned merger of UNE and Colombia Movil (see chart above). As part of that transaction Colombia Movil was valued at almost US$1.3 billion while UNE's value was appraised at US$2.1 billion (including a US$150 million control premium). The payments included the prepayment of an intercompany loan granted in 2006 for over US$190 million. EPM s total up-streaming to the Municipality of Medellin in connection with this transaction will approximate US$575 million. Overall, we consider this arrangement to be credit neutral for EPM as its rating incorporated limited uplift from UNE. Its bylaws required the distribution of only 50% of its reported net income, while its indebtedness accounted for around 10% of the group's financial leverage, although EPM previously guaranteed almost US$40 million of UNE's indebtedness that matured in EPM's rating assumes that going forward the annual dividends it will receive from its subsidiaries will be comparable to the 2012 amounts and that it will continue to generate the majority of the group's FFO despite its various growth initiatives. Therefore, structural subordination will continue to not be a major consideration with respect to EPM's ratings. Its Aggressive Expansion Strategy (Mega 2022) Is Not Without Risks EPM's BCA rating captures the company's current aggressive growth strategy. Under Mega 2022 EPM's objective is to become one of the 50 most important economic groups in Latin America and to grow the group's consolidated revenues and EBITDA between 2012 and 2022 to around US$16 billion (2013: US$6.9 billion) and US$5.5 billion (2013: US$2 billion), respectively. To that end the company is expected to pursue organic (via participating in auctioned Greenfield projects) and external (via acquisitions) growth opportunities in its current markets but also to extend its footprint to new regional markets with stable and overall predictable regulatory environments. In the energy segment this includes Chile, Peru, Costa Rica, and Brazil and in the water segment Mexico and Peru. We believe this expansion is not without risks as it entails both execution and integration risks, particularly if EPM moves to less familiar markets and regulatory environments. That said, we acknowledge EPM s success with its acquisitions in Colombia (started in 2003) and in Central America (began in 2010) with around 11% to the group s EBITDA at year-end Last year EPM entered the Mexican and Chilean markets via the acquisition of TICSA and the Cururus wind-farm (total investments of around US$320 million), significant milestones which are also 8 SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

9 expected to be part of the growth platform of the group's operations abroad. The Cururus windfarm started operations in 2014 and for the first five years will operate on a merchant basis to take advantage of the SIC's high spot power prices. The lack of a Power Purchase Agreement (PPA) is a credit negative but its relatively small size offsets any credit concerns. While we consider EPM's focus on also growing its EBITDA base is a credit positive with a targeted EBITDA-margin of around 34.4% via synergies and other profitability enhancement initiatives, this margin implies a significant improvement given the progressive deterioration registered over the last several years (2008: around 37%; 2012: 30%; 2013: 29%). Therefore, it remains to be seen if this margin improvement can be achieved given the challenges associated with implementing optimization processes coupled with integrating new acquisitions and projects. That said, we gain comfort from EPM's proven track-record of financial discipline in the implementation and funding of its historical growth initiatives. Investment practices for its growth initiatives typically include the use of a significant amount of internally generated resources. To this end, the rating acknowledges that EPM's consolidated Debt to EBITDA is capped at 3.5x under its local financial documents while EPM's dividend policy has also been relatively prudent. We expect that its target dividend payout ratio will continue to hover around 55%, particularly during the heavier construction years. Material Investments and Construction Risk Associated With Ituango... The group disclosed in July 2014 its plans to invest US$5.5 billion between 2014 and 2017 with EPM accounting for the vast majority of these capital outlays (US$4.3 billion; 78%). The bulk of the group's investments have been earmarked for the energy business unit (82%) with the water business unit representing the balance. The two key elements in EPM's current expansion strategy remain the construction of the 8 unit 2,400MW Ituango hydroelectric facility (capex: US$4.5 billion including around 18% in contingencies but excluding financing costs) and the US$572 million Bello Wastewater treatment facility. Completion of the latter is expected in 2015 after a 3-year construction period financed with a US$450 million IDB loan incurred by EPM at the end of 2011 that equates to around 77% debt financing, which we consider relatively high but manageable. EPM also plans to finance with debt around 60% of the total capex associated with the Ituango project while the balance will be funded with internally generated cash flows. As of end of June, EPM had already invested around US$975 million. Upon completion the multi-year Ituango project is expected to account for around 17% of the country s installed hydro-electric capacity and increase EPM's installed capacity to around 5.9GW (+68%) with an expected output of 13,930GWh. This project poses significant execution risk overall as we consider the construction of hydro-electric facilities among the most challenging endeavors among all power generation technologies. That said, we acknowledge EPM's track-record of completing hydro-electric facilities on budget and schedule, including the 4-unit 660MW Porce III hydro-facility that started operations in September 2011 (first unit: December 2010; capex: US$1.6 billion). EPM awarded the 6.3-year Ituango's EPC contract to the same Brazilian-Colombian consortium that built Porce III, Construcoes e Comercio Camargo Correa S.A. (one of the largest Brazilian construction companies that has been involved in several large infrastructure projects in the domestic market and abroad), Conconcreto S. A. and Coninsa Ramon H.S.A. The EPC contract (around US$900 million) was signed in October 2012 with civil works (including access road and tunnels) starting in mid-april SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

10 This facility has not faced challenges related to the relocation of local communities that were encountered at the 400MW Porce IV hydro-electric facility (capex: US$1.1 billion) which triggered that facility's indefinite suspension in December 2010 (completion initially expected in 2015); howeve,r we note that Hydro-Ituango faced some security attacks in 2011 and 2012 as well as some challenges to acquire certain pieces of land that contributed to some delays last year. That said, we understand that the company has been able to make satisfactory advances in the latter and also in gaining a better understanding regarding the geology of the rock which usually poses some of the major challenges in the development of hydro-projects. We also acknowledge that despite some challenges EPM managed to deviate the Cauca river in February Achievement of the river diversion was a significant milestone in order to achieve the targeted in-operation date of the first unit by December The completion of three additional units are expected in 2019, with a fifth in 2021 and the last three during 2022 with final completion expected in July We note that EPM's only commitment with the CREG refers to the allocated Firm Energy Obligations (ENFICC) of the first unit of around 4.6TWh which equals around 53.5% of the ENFICCs declared by Ituango to the CREG. As explained below the ENFICCs are allocated based on the plant's expected output under severe hydrology conditions which in Ituango's case implies a plant capacity factor of only 42% which seems manageable, a credit positive. Ituango provided around a US$40 million guarantee in connection with these obligations. Therefore, delays in the other units would not result in any significant financial consequences, another credit positive. On a negative note, we understand that the project is still around 5% delayed compared to the updated plans. However, we understand that EPM is in the process of implementing an accelerated construction strategy to ensure that the plant becomes operational as scheduled. Conclusions of the negotiations with the contractors are expected next year. Embedded in the project's total budget is 18% in contingencies, made up of 6% for higher costs and 12% for unforeseen events. This level of contingencies is comparable to those observed in other regional hydroelectric projects. Several insurance arrangements are in place to limit to some degree the inherent risks associated with the project's development, a credit positive. We also understand that EPM believes these contingent amounts will be sufficient to cover the resulting increase in the project costs due to the anticipated acceleration. Significant critical milestones are expected for 2015 and 2016 which will further help assess the project's development status. EPM s expansion plan further foresees the construction of the 600MW Espiritu Santo hydro-power project. We estimate the associated investments at around US$1.2 billion (based on Ituango s capex). Its completion is planned in 2024 (expected output: 4,098GWh p.a.). EPM expects to benefit from synergies given the close location of this project to the Ituango project.... Will Further Increase EPM's Exposure To The Unregulated Power Generation Sector The successful implementation of Mega 2022 will further increase EPM's exposure to the energy industry, and particularly to the power generation sector upon completion of the Hydro-Ituango project despite the growth also planned in regulated activities. When completed, we calculate that the more volatile power generation segment will account for over 50% and 40% of EPM's EBITDA and debt, respectively. Appendix 2 depicts the breakdown of EPM s installed power generation plants. Its 38 hydro-plants account for around 85% of its installed capacity, while its three thermal facilities (554MW when using natural gas) and a 19.5MW wind-farm represent about 18% and 1%, respectively. All of these facilities 10 SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

11 are located in the Antioquia department, where the bulk of the country's hydro-facilities are located. As depicted in the Appendix 2 EPM s hydro-plants availability ratios are very high, another credit positive. EPM currently ranks among Colombia s top two wholesale power generators in terms of installed capacity and power output with a market share of around 24% and 23%, respectively. The Colombian regulation caps the power generation market share to 30% as measured in terms of ENFICCs with EPM s current market share currently hovering around 22%. Albeit Cash Flow Predictability Enhanced By Commercial Policies, Reliability Payments... Similar to other hydro-electric Colombian generators, EPM sells a substantial portion of its power output under medium-term agreements. EPM discloses that in 2013, its generation unit sold around 14.1TWh under contracts. This included around 8.6TWh load to meet regulated demand (<55MWh) including over 3.5 TWh supplied to its own regulated utility operations and subsidiaries, as well as 5.5GWh to meet unregulated power demand albeit EPM s commercialization unit with almost 4TWh load accounted for the bulk of it. We understand that the Colombian regulation limits for group s with operations in the generation and commercialization business up to 60% for intra-group purchases of power to meet regulated demand. Given the volatility of spot power prices (see Appendix 2) we consider credit positive EPM s historical modest reliance on power procurement in the spot market to meet its contractual obligations. In our opinion, the mid 2009/2010 El Nino phenomena, along with the 2012/1H2013 unexpected drier than usual hydro-conditions tested the adequacy of this issuer's commercial policies as usually its contractual obligations have accounted for less than 95% of its actual output. However, in 2011, EPM s commercial policy was affected by the restrictions to inject power output into the system due to terrorist attacks that continued in These events affected Porce III's output and required the company to procure around 2% of its power requirements to meet its contractual obligations. We note that under Colombian regulation these types of circumstances are not considered Force Majeure which would exempt power generators from meeting their supply obligations, a credit negative. EPM s thermal fired facility, La Sierrra, further helps the company to manage its commercial policy, another credit positive. We note that during 2013, EPM's contracted obligations decreased after this facility had access only to diesel fuel to back-up EPM's ENFICCs (before natural gas). EPM's generation segment's cash flows are further underpinned by the reliability charges received subject to its ENFICCs, which amounts to over US$200 million (2012: US$210 million; 2011: US$160 million). As explained in the Appendix 2 the ENFICCs are allocated under tenders that are scheduled to take place at least four years before the date on which the ENFICCs are due. These tenders consider the annual projected energy demand, and are based on the maximum power output that a plant is able to deliver on a continual basis during a year under extreme hydrology conditions. In addition to the additional revenue base we consider these auctions and the authority s involvement in the development of the generation system credit positive because it somewhat reduces the risk of oversupply if too many plants are built and the related sunk costs for the generation companies. 11 SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

12 ...And Regulated Operations In our assessment we consider that EPM's regulated operations further enhance its cash flow predictability, a credit positive that is considered in the hedging and contractual sub-factor of the methodology grid (see Appendix). In our opinion, the Colombian regulatory framework compares well to others prevailing in other Latin American countries in terms of stability and transparency. This opinion is underpinned by its predictable track-record since the enactment in 1994 of Law 142 (Household Public Utilities Services Law; LSPD), associated Decree 1524, as well as other pieces of legislation, including the Electricity Law (Law 143) and other regulation that has further developed the framework over the last fifteen years. However, our opinion of the regulatory framework is somewhat tempered by the composition and election of the CREG's board members which does not fully insulate it from possible political interference, albeit we have seen no evidence of this to date. That being said, we also note that certain aspects continue to evolve. For example, EPM also expects that the CRA will implement this year a new framework that regulates its water, sewage and waste management services. We also understand that the Colombian authorities have been making progress in introducing certain changes within the natural gas sector in the aftermath of the challenges faced by the country during the 2009/2010 El Niño phenomena. Their goal is to foster new investments and higher system reliability. In 2013, the CREG published the methodology for the tariff review of natural gas tariffs; however, the new charges are still pending. EPM expects them during the first quarter of 2015 but does not expect it will result in significant changes. EPM's regulated water and distribution electricity operations (next tariff review scheduled also for 2015) are still rendered under rates that were set during their last tariff reviews. We understand that the tariff review processes are progressing overall smoothly with the involvement of all stakeholders. This underpins our opinion about the constructive relationship between EPM and the regulatory authorities, another credit positive. CREG s publication of the new methodology applicable on the electric distribution operations is expected before year-end (last updated in 2008). The CREG s methodologies recognize the system s units and their reposition costs, the capital costs, the percentage of administration operational and maintenance requirements as well as the quality requirements. EPM expects that the new methodology could introduce changes in the recovery by its commercialization unit of the power procurements costs from the regulated end-users. Under the 2008 tariff regime these are based on the average tariff for the immediately preceding month. To limit the possible losses and impact on the liquidity profile of its commercialization operations, EPM s current policy consists of contracting the bulk of its power procurement requirements for regulated and unregulated customers under bilateral agreements and limiting its exposure to 10% to the more volatile spot power market. We view positively the fact that charge components are adjusted to reflect changes in inflation while also noting differences in the indexation applied among the electricity, natural gas, and water and sewage segments. Around 60% of the charges and fees in the electricity segment, namely transmission and distribution charges, are adjusted to reflect changes in the Colombian Producer Price Index (IPP) with the commercialization charges (additional 20%) subject to adjustments to the Producer Price Consumer (IPC). This applies also to the prices underlying the PPAs. The adjustments to the natural gas tariff components are linked either to the IPP (distribution) or to the IPC (commercialization) but only after the applicable index is above 3%. However, on a negative note, none of the charges are periodically adjusted to reflect 12 SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

13 changes in the foreign exchange rates (such as Col Ps/USD), as is the case in other Latin American regulatory frameworks. As part of the tariff review CREG will also define the weighted average cost of capital (WACC) used in calculating the annual revenues. We understand that the WACC could be reviewed downward (currently ranges between 13% and 13.9% on a real pre-tax basis) to reflect the drop in interest rates associated with the lower country risk. Another change could result in the requirement for commercialization companies to also start sharing the financial burden associated with the electricity losses. The latter would be a credit positive for EPM since these losses are currently born exclusively by the distribution companies, and despite the downward trend recorded in recent years they still exceed 10% (2013: 10.8% versus 2011: 12.2%). Following a change in the CRA s calculation method of the water unit losses, EPM s unit registered losses of almost 34.4% at year-end 2013, a credit negative. To alleviate the financial burden EPM is also pursuing loss reduction initiatives in its water infrastructure. We also consider the benefits of EPM's international diversification and the increased exposure to regulated operations associated with EPM's acquisition of the Central American subsidiaries mentioned earlier. That said, we believe that most of these jurisdictions and regulatory frameworks are less transparent and somewhat less predictable than the Colombian regulatory framework. Credit Metrics Expected To Score Within The Rating Category The increase in leverage undertaken to fund its expansion plans have contributed to the deterioration of EPM's historical credit metrics. In 2013, EPM's cash flows were enhanced by the material distributions received from its subsidiaries as mentioned earlier. In this regard, we note that EPM's CFO pre-w/c to debt, interest coverage and RCF to debt averaged around 35%, 6.7x and 20%, respectively, a significant drop from the average RCF to debt and CFO pre-w/c interest coverage of 40.2% and 12x, respectively. EPM's BCA incorporates our expectation that these credit metrics will further deteriorate amid the expected increase in leverage to fund the investments planned with Mega 2022, particularly the Ituango project. Until the 2H 2014, EPM had funded the capex associated with this project with internally generated cash flows, a credit positive; however, we understand that it will start incurring debt this year to aid in the financing of the project. Given EPM's long-term target capital structure of 60% debt and 40% equity for this project the increase in leverage will be substantial, while its contribution to EPM's EBITDA will only start in 2019 (first unit becomes operational in December 2018) and peak in 2022 (with the last of 8 units). That said, Moody's expects that EPM will nevertheless be able to record credit metrics that are commensurate with the lower end of the Baa-rating category according to the guidelines provided under our Unregulated Power Companies ratings methodology. Specifically, EPM's CFO pre-w/c to debt and Retained Cash Flow (RCF) to debt will remain above 20% and 15%, respectively. This expectation is based on EPM's cash-flow generation ability, the 3.5x consolidated debt to EBITDA cap mentioned earlier, as well as no material changes in its dividend payout ratio going forward coupled with expected prudent financing of any new organic or external expansion opportunities carried out under its Mega 2022 Strategic Plan. 13 SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

14 Liquidity Profile Given the currently planned material investments under Mega 2022 mentioned earlier, we anticipate that EPM will continue to be free-cash flow negative over the medium to long term, particularly after considering the dividend distributions to the City of Medellin (around 55% dividend payout ratio). As mentioned earlier, EPM completely funded in 2013 and the 1H2014 the investments associated with Ituango (year-end 2013: around US$850 million) with internally generated cash flows. However, starting later this year we anticipate that the company will use proceeds raised in connection with planned debt issuance to continue financing this project. We understand that EPM is currently working in securing additional financing on top of the current Global Notes issuance. EPM's heavy reliance on the capital markets to fund its capital requirements in the absence of any committed credit facilities tempers EPM's ratings from a liquidity perspective; however, EPM's record of keeping robust cash balances somewhat offsets our concerns, albeit cash is fungible. EPM's debt maturity profile is expected to peak during 2014 (over US$200 million) although we believe it remains manageable for the issuer. Other Considerations As of June 2014, around 50% of EPM's debt has been incurred in US$, considering that its % Global Notes represent Colombian Peso obligations for EPM. We acknowledge that over time EPM has significantly reduced its foreign currency risk exposure through the use of derivative instruments and natural hedges associated with its reliability payments and foreign subsidiaries' dividends in US$. As of July 2014, it had for % of its debt service hedged (natural and financial) while its exposure over the following years ranges between 2% (2015) and 32.5% (in 2017). The current Global Notes issuance will further help EPM to manage its foreign exchange risk exposure. As depicted in Appendix 3 Moody's evaluates EPM's BCA mainly relative to Moody's Unregulated Utilities and Power Companies methodology published in August 2009 given the importance of its power generation activities. As depicted in the grid below, the issuer's indicated rating based on both historical and projected (12 to 18 months) credit metrics is equivalent to a Baa3, respectively, one notch above the currently assigned BCA rating of ba1. 14 SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

15 Appendix 1: EPM Corporate Org-Chart The chart below depicts EPM s operations, as well as its subsidiaries operating in Colombia and abroad under it business units, Energy and Water. Source: EPM OM dated September 2014 based on data as of June 30, SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)

16 Appendix 2: EPM s Installed Generation Capacity In Colombia The Colombian electricity sector is organized into a single interconnection system (SIN) which currently has five interconnection points to Venezuela (3) and Ecuador (2). Plans for an interconnection with Panama are still on hold due to environmental challenges on the transmission site or side? With almost 15TW installed capacity the Colombian electricity system depicts a substantial reliance on hydro-electric facilities in terms of capacity (around 64%) and output (including the minor hydroelectric plants output: 72.3% in 2013; 80.2% in 2012). During 2013, power demand in Colombia aggregated 60,890GWh (+2.6% compared 2012). However, the UPME, the Planning authority responsible for the sustainable development of the mining and energy sectors, estimates that Colombia s electricity power demand will grow between 2013 and 2015 at a compound rate of almost 4.5%. The regulated demand (<55MWh/month) accounts for around 70% of the total demand (2013: 68%) while unregulated end-users account for the balance (2013: 32%). UPME is the national special administrative unit, of a technical nature, responsible for sustainable development of the mining and energy sectors in Colombia and the formulation of state policies The country s multi-year generation and transmission expansion plan considers this growing power demand. The vast majority of the added new capacity will be also hydro (over 4.5TW) followed by thermal-fired units (over 500MW). As a result, UPME estimates that Colombia s electricity installed capacity will aggregate around 17.3 TW by 2019 (including EPM s 1,200MW first phase of the Ituango project) and 18,466MW in 2022 (including the 1,200MW second phase of the Ituango project). That said, as mentioned earlier EPM suspended the construction of its 400MW El Porce IV hydro-facility (scheduled completion in 2015). However, we understand that other new projects, delays in the planned interconnection with Panama (initially 300MW) and lower than anticipated power demand are expected to help offset any negative impact that the suspension of this plant may have on the sector, including power prices. The table below depicts EPM s generation fleet at year-end 2013 broken down by type of fuel-source used in their dispatch as well as the aggregate output: EPM's Current Power Generation Capacity By Type Of Facility in MW Output in GWh 2013 % Porce III 660 Guatapé 560 Guatrón 512 (includes Troneras, Guadalupe 3 and Guadalupe 4) Porce II 405 La Tasajera 306 Playas 201 San Francisco 135 Esmeralda small hydro-plants (up to 20MW) 102 Subtotal Hydro 2, % 14,108 15,600 14, SEPTEMBER 3, 2014 PRE-SALE REPORT: EMPRESAS PUBLICAS DE MEDELLIN E.S.P.(EPM)