Rio Paranapanema Energia S.A.

Transcription

1 CREDIT OPINION Rio Paranapanema Energia S.A. Update Following Outlook Change to Negative Update Summary Rating Rationale RATINGS Rio Paranapanema Energia S.A. Domicile Brazil Long Term Rating 2 Type LT Corporate Family Ratings Outlook Negative Please see the ratings section at the end of this report for more information. The ratings and outlook shown reflect information as of the publication date. The 2 and Aa1.br corporate family ratings reflect Rio Paranapanema Energia S.A. (Rio Paranapanema)'s strong credit metrics, which benefit by medium-term generation supply contracts in the unregulated market, where prices are set freely between the energy suppliers and final consumers. The rating also incorporates better hydrology conditions and relatively lower spot prices in , which consequently reflect in more predictable cash flow generation for the company. Conversely, Rio Paranapanema has a track record of high dividend distributions and exposure to the spot market that has negatively impacted the credit metrics in The rating is currently constrained by Brazil s 2 sovereign bond rating and an ongoing dispute with the State of Sao Paulo around a stated obligation to expand capacity by 15%. Exhibit 1 Credit Metrics (CFO Pre-W/C) / Debt (left axis) (CFO Pre-W/C + Interest) / Interest Expense (right axis) 9.0x 70% 8.0x 60% Contacts 7.0x 50% 6.0x Cristiane Spercel VP-Senior Analyst cristiane.spercel@moodys.com 40% 5.0x 30% 4.0x Alejandro Olivo Associate Managing Director alejandro.olivo@moodys.com 10% Camila Yochikawa Associate Analyst camila.yochikawa@moodys.com 3.0x 20% 2.0x 1.0x 0.0x 0% E Source: Moody's Financial Metrics, Moody's Projections for Credit Strengths Strong credit metrics for the rating category Competitive costs and relatively predictable cash flows based on medium-term energy supply contracts

2 Credit Challenges Hydrological Risk High dividend pay-out ratio and capital splits Risks associated with the contractual obligation to increase installed generation capacity by 15% Potential liability associated with a legal injunction on the exposure to the spot market Rating Outlook The negative outlook for Rio Paranapanema considers Moody's views on the sovereign given that the company's creditworthiness is closely linked to Brazil s credit quality, as their revenues are derived from economic activity within Brazil and subject to government policies. Factors that Could Lead to an Upgrade The company's ratings are currently constrained by Brazil's sovereign rating, therefore a rating upgrade would be considered if the sovereign rating is upgraded. A rating upgrade or outlook stabilization would also consider the relevant credit metrics, the liquidity profile and the regulatory environment where Rio Paranapanema operates. Factors that Could Lead to a Downgrade Downward rating pressure could also result from higher than expected capital expenditures, an inability to secure adequate and timely funding or an unexpected penalty related to the contractual obligation to increase capacity by 15%, and/or dividend payments, such that the company's CFO pre-wc minus the dividends-to-debt ratio falls below 15% and cash interest coverage drops below 3.5x for an extended period.a weakened support of the regulatory framework could also prompt a downward action as well as deterioration in the sovereign s credit quality. Key Indicators Exhibit 2 Key Indicators [1] Rio Paranapanema Energia S.A (CFO Pre-W/C + Interest) / Interest (CFO Pre-W/C) / Debt RCF / Debt 12/31/ x 39.1% 17.3% 12/31/ x 28.2% 15.6% 12/31/ x 46.3% 6.6% 12/31/ x 60.6% 28.4% 12/31/ x 62.2% 19.7% [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. Source: Moody's Financial Metrics Detailed Rating Considerations RELATIVE STABILITY OF MEDIUM TERM ENERGY SUPPLY CONTRACTS Rio Paranapanema relies on medium-term energy supply contracts to the unregulated market. These contracts should generate predictable and stable cash flows for the next three to four years given their relatively stable nature. Unregulated energy contracts, however, expose Rio Paranapanema to potentially lower energy prices and revenues in a scenario in which future prices decline. Conversely, revenue streams in the regulated energy business segment tend to be more predictable and allow for more stable operating margins and cash flow. Rio Paranapanema's increasing exposure to the unregulated energy market is mitigated by the fact that the bulk of the company's client portfolio is made up of large industrial consumers with solid credit profiles. Nevertheless, we consider that free market brings a number credit risks, including a more concentrated customer portfolio, shorter contract duration, that ultimately bring additional cash flow volatility. 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. 2

3 STRONG CREDIT METRICS Rio Paranapanema has historically reported strong and stable cash flows resulting from medium term energy supply contracts primarily in the unregulated market along with very low capital expenditures. Such strong performance has been tempered by the company s high dividend distribution and capital splits over the past 5 years. Poor hydrological conditions in 2014 and 2015 caused deterioration of Rio Paranapanema s credit metrics by forcing the company to acquire energy in the spot market at much higher prices. But better hydrology conditions and relatively lower spot prices in 2016 supported some recovery. Moody's calculates Rio Paranapanema s Cash Flow from Operations before working capital changes (CFO pre-w/c) to Debt ratio at 39.1% and interest coverage ratio of 4.8x for the fiscal year end 2016, compared to 29.5% and 4.0x, respectively, in Those metrics are strongly positioned for its 2 rating category. Since 2014, Rio Paranapanema s cash distributions to shareholders through dividends and capital splits reached BRL1.9 billion, contributing to a gradual leverage increase. The company's outstanding debt balance reached BRL1.6 billion in December 2016 up from BRL1.1 billion in Rio Paranapanema's operating cash flow as measured by CFO is expected to remain strong in 2017, despite some exposure to the hydrological conditions in Brazil and volatile spot prices. The relatively lower costs associated with the company s exposure to the spot market will be partly offset by Moody's expectation of lower prices in new contracts. We expect Rio Paranapanema will renew some supply contracts between 2017 and Added power capacity and lower consumption could drive new prices around 20% lower compared to existing supply contracts. Under such scenario and assuming a 10% contract renewal, Rio Paranapanema s annual revenues may decrease up to 10% during that period. We forecast that CFO-Pre WC over debt ratio to remain in the mid thirties while interest coverage will be around 3.5x to 4.5x in the next months. HYDROLOGICAL RISK MITIGATED BUT LEGAL AND REGULATORY UNCERTAINTIES REMAIN The severe drought faced in Brazil over the past years resulted in higher costs to hydro generators related to energy purchase on the spot market, which led several companies to file legal injunctions against the Federal Government to avoid overcharges. The hydrological risk significantly receded in 2016 from the combination of a more favorable rainy season, additional installed power capacity and lower electricity consumption, but the legal and regulatory uncertainties remain. Since July 2015, Rio Paranapanema has a legal injunction that allows the company to suspend payments of costs associated with its exposure to the spot market. The suit was filed by APINE (Brazilian Association of Independent Producers of Electric Energy), which represents the interests of Rio Paranapanema in the Brazilian Electricity sector. The Brazilian court accepted APINE's argument by granting it a legal injunction that considers a Generating Scaling Factor (GSF) of 100%, however the merit of this action has not been decided yet. As such it is still subject to eventual disputes. Rio Paranapanema has been conservatively accounting for this matter by fully recognizing the costs of this exposure to the spot prices in its financial statements, as if they remained liable with no legal protection. As of December 31, 2016, the company reported BRL209 million in provisions for loss under liabilities with suppliers. Additionally, Rio Paranapanema has been historically maintaining around 7% of its physical energy un-contracted in order to mitigate the risks associated with exposure to the spot market. We estimate that Rio Paranapanema currently has around 9% of its 1,006 MW (100 MW) physical energy available to sell in the spot market, which works as a buffer to reduce its exposure to the spot market in a scenario in which the total generation of hydropower is considerably lower than the allocated physical energy. Management has indicated that the company would maintain between 10 and 15% of its physical energy un-contracted in 2017 to protect against a potential spike in spot prices and considering management s expectation of a GSF at around 83%. CONTRACTUAL COMMITMENT TO EXPAND INSTALLED CAPACITY BY 15% Rio Paranapanema has an outstanding contractual requirement with the State of Sao Paulo to increase its installed generation capacity in the state by 15% or 322,7 MW, as stated in its acquisition contract when the assets were privatized to Duke Energy. This obligation 3

4 was due in 2007, however the company has not been able to accomplish it due to limited investment opportunities in the state and other regulatory restrictions. In 2009, the State of Sao Paulo filed a lawsuit to force the company to present an investment plan to meet this contractual requirement, which has been disputed by the company. The matter has not been resolved and it is still under dispute. We estimate that the contingency from the ongoing discussion could reach as much as BRL 1.1 billion over a three-year period without jeopardizing Rio Paranapanema's ability to service its debt. Under that scenario, Rio Paranapanema s debt metrics could see some deterioration although still appropriate for its current rating category, particularly if the current relatively high dividend payout ratio were adjusted downward somewhat to maintain a balance in the capital structure. NEW SHAREHOLDERS WITH SOLID TRACK RECORD IN HYDRO PROJECTS On December 29, 2016 Duke Energy Corporation (1 stable) completed the sale Rio Paranapanema to China Three Gorges Corporation (CTG, A1 stable) for an enterprise value of USD947 million. Rio Paranapanema will benefit from CTG s solid experience in large scale hydro power projects as the world s largest hydropower operator, as well as its ample and lower-cost funding sources. With the acquisition of Rio Paranapanema, CTG would become the second-largest hydropower operator in Brazil with an installed capacity of 8.27 GW, almost 6% of the country s installed capacity. Liquidity Analysis Like other Brazilian companies, Rio Paranapanema does not have committed banking facilities to face any unexpected cash disbursements. In spite of this lack of committed credit facilities, we deem Rio Paranapanema's liquidity position as strong in light of its comfortable cash position of BRL853 million as of December 31, 2016 vis-à-vis BRL516 million of debt maturities in the short term. We forecast that the company's cash flow generation will comfortably meet its cash needs over the next couple of years, which largely consist of the payment of dividends and amortization of current portion of long-term debt. Given the company's good historical access to both banking and capital markets we believe that Rio Paranapanema will be able to comfortably secure long- term debt if needed. Rio Paranapanema continues to comfortably comply with the financial covenants embedded in the company's five debenture series, which represent the bulk of the company's debt. These financial covenants are common for the five series, which restrict leverage to a maximum Net Debt over EBITDA ratio of 3.2x and a minimum interest coverage (EBITDA/ Net Financial Result) of 2.0x. As of December 30, 2016, the company was in compliance with those covenants. Profile Rio Paranapanema is an electricity generation company controlled by China Three Gorges Corporation (Aa3 Negative), which indirectly holds 99.06% of its voting capital. The company has installed capacity of 2,241 MW (1,085.6MW of physical energy) in eight hydroelectric power plants along the Paranapanema River, which represents approximately 1.7% of Brazil's current total installed capacity. In 2016, Rio Paranapanema reported net sales of BRL1.3 billion and net profit of BRL361 million. 4

5 Rating Methodology and Scorecard Factors The grid implied rating from Moody's month forward view of the Unregulated Utilities and Power Companies Industry methodology is 3, which is two notches above Rio Paranapanema's current rating. Exhibit 3 Rating Factors Rio Paranapanema Energia S.A Unregulated Utilities and Unregulated Power Companies Industry Grid [1][2] Factor 1 : Scale (10%) a) Scale (USD Billion) Factor 2 : Business Profile (40%) a) Market Diversification b) Hedging and Integration Impact on Cash Flow Predictability c) Market Framework & Positioning d) Capital Requirements and Operational Performance Factor 3 : Financial Policy (10%) a) Financial Policy Factor 4 : Leverage and Coverage (40%) a) (CFO Pre-W/C + Interest) / Interest (3 Year Avg) b) (CFO Pre-W/C) / Debt (3 Year Avg) c) RCF / Debt (3 Year Avg) Rating: a) Indicated Rating from Grid b) Actual Rating Assigned Current FY 12/31/2016 Moody's Month Forward View As of 5/29/2017 [3] Measure B Score B Measure Score 4.7x 37.4% 13.6% A 3.3x - 4.5x 32% - 35% 5% - 12% [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. [2] As of 12/31/2016(L) [3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures Source: Moody's Financial Metrics Ratings Exhibit 4 Category RIO PARANAPANEMA ENERGIA S.A. Outlook Corporate Family Rating Senior Unsecured -Dom Curr NSR Corporate Family Rating NSR Senior Unsecured Moody's Rating Negative 2 2 Aa1.br Aa1.br PARENT: CHINA THREE GORGES CORPORATION Outlook Issuer Rating Stable A1 Source: Moody's Investors Service 5

6 Recent Developments On May 31, 2017 Moody s changed the outlook on Rio Paranapanema's ratings to negative from stable. Rio Paranapanema's outlook follows the negative outlook of Brazil s 2 rating, given the company's strong links to sovereign credit quality as their revenues are derived from economic activity within Brazil and subject to government policies. 6

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