CFE: Counting on Support

Transcription

1 Deutsche Bank Markets Research Emerging Markets Mexico IG Corporate Credit Utilities Company Comision Federal de Electricidad Date 21 September 2016 Xavier Olave Research Analyst (+1) CFE: Counting on Support Eduardo Vieira Research Analyst (+1) Initiating coverage of ( CFE ) with a Stable Outlook The outlook reflects our view of recurring timely and proper support from CFE s parent, the Mexican government, in the face of the company s ongoing cash flow deficit due to a robust capex program, expectations for relatively low industrial/commercial electricity prices, while providing large subsidies to agricultural/residential customers and servicing large (though decreasing) pension obligations. Like sister company, PEMEX, CFE is wholly-owned by the Mexican federal government and fully integrated into Mexico s federal financial budget, with the exception of its PIDIREGAS project finance debt. CFE will remain the dominant electricity generator in the country in the medium term, while maintaining a monopoly position in the strategically key transmission and distribution market segments, and we believe Mexico retains a high incentive to support CFE s debt in case of stress conditions. Even in light of Mexico s energy reforms that are slated to open up the Mexican electricity industry to increasing competition, we believe CFE remains of vital economic/strategic importance for the Republic of Mexico. Recommending a Hold on CFE s 21, 24, 42 and 45 bonds We assign a Hold recommendation to four CFE unsecured USD bonds (Figure 1) totaling USD3.7bn with maturities in 2021, 2024, 2042 and In our view, CFE s bonds are fairly priced, offering among the tightest spreads on a spread to sovereign basis in the LatAm energy quasi-sovereign space. In particular, we believe the company s long-dated notes ( 42 and 45 bonds) offer very tight valuation with a slight pickup of just 100bp over the sovereign (and a 5.4% yield). On the front of the CFE curve, the company s 21 notes look relatively most attractive at a spread to sovereign of 149bp versus 101bp for the 24 bonds, though we are not recommending these notes as we do not see sufficient valuation upside and the notes yield 3.4%. Key risks In our view, the key negative risks to CFE s bonds include continued burdensome subsidies of residential and residential customers that can only be partially counteracted by substantial Mexican government cash infusions, onerous pension liabilities, constrained natural gas supply for its generation plants, large consumer energy losses at the distribution level, and the longterm potential for increased competition from private generation companies following the recently enacted energy reforms. The key positive risk, in our opinion, is that despite the company having a weak credit profile on a standalone basis (BB), CFE remains a key strategic cog for the Mexican state, which has committed to provide the company with large cash injections of MXN30bn (USD1.7bn) in This increased support by the Mexican government should mean that the ratings agencies will not significantly decouple CFE s rating from those of the sovereign in the short to medium term. CFE is rated BBB+/Stable by Fitch, BBB+/Negative by S&P, and Baa1/Negative, with the first two ratings in-line with the sovereign s foreign currency IDR while Moody s rates CFE one notch below the sovereign. In the long-term, entry into the natural gas commercialization and distribution businesses could provide CFE with a new avenue for meaningful cash flow generation. Distributed on: 22/09/ :12:31 GMT DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016.

2 Figure 1: CFE issues rated by Deutsche Bank (pricing indicative as of 9/20/16) Issue Maturity Amount O/S Mdy/S&P/Fitch DB Rec. / Date of Rec.* Mid Price Mid Yield Z-spread Sov spread CFELEC 4.875% Notes '21 26-May-21 USD 1,000m Baa1 / BBB+ / BBB+ Hold / 19-Sep CFELEC 4.875% Notes '24 15-Jan-24 USD 1,250m Baa1 / BBB+ / BBB+ Hold / 19-Sep CFELEC 5.750% Notes '42 14-Feb-42 USD 750m Baa1 / BBB+ / BBB+ Hold / 19-Sep CFELEC 6.125% Notes '45 16-Jun-45 USD 700m Baa1 / BBB+ / BBB+ Hold / 19-Sep Source: Deutsche Bank. * Deutsche Bank recommendation / date of last change or assignment of recommendation. Relative Value Considerations: Fairly priced with long-dated bonds at a premium The CFE bonds that we are rating as Hold (4.875% 21s and 24s, 5.75% 42s, and 6.125% 45s) offer Z-spreads from 222 bps to 374 bps and a slight spread pick-up over the sovereign curve from 93 bps to 149 bps. We see these levels as fairly priced (see Figures 2-11) and slightly rich on the long-end, versus select large cap quasi-sovereign peers on a ratings-adjusted basis. Sister company Pemex corresponding bonds trade wider versus the sovereign than CFE s bonds, despite the fact that Pemex is, in our view, at least as strategic an asset for the Mexican state. CFELEC s 21s trade 43bp tighter than PEMEX s bonds on a spread to sovereign basis, despite 3 EBITDA turns higher leverage. CFE s 24 s trade 66bps tighter than PEMEX s bonds, while CFE s longest-dated bonds ( 42, 45) are 110bps tighter on spread to sovereign basis. CFE s long-dated bond spreads to sovereign are at one year tights, while there may be some more value in the 21 s and 24 s, which are trading 50bs off their 12-month tights. Figure 2: Sov Spread vs. Net Leverage ( 17-22) Figure 3: Sov Spread vs. Net Leverage ( 23+) Source: Deutsche Bank Source: Deutsche Bank Page 2

3 Figure 4: Z-spread/Duration vs. LatAm SOE s ( 17-22) Figure 5: Z-spread/Duration vs. LatAm SOE s ( 23+) Source: Deutsche Bank Source: Deutsche Bank Figure 6: Z-spread/Avg Rating vs. EM Peers (5-years) Figure 7: Sov spread/standalone Ratings (5-years) Source: Deutsche Bank Source: Deutsche Bank Page 3

4 Figure 8: Z-spread/Avg Rating vs. EM Peers (10-years) Figure 9: Sov spread/standalone Ratings (10-years) Source: Deutsche Bank Source: Deutsche Bank Figure 10: Z-spread/Avg Rating vs. EM Peers (30-years) Figure 11: Sov spread/standalone Ratings (30-years) Source: Deutsche Bank Source: Deutsche Bank Page 4

5 Credit Considerations Mexico s dominant electricity company even after energy reforms ( CFE, CFELEC ) is the leading, fully integrated national electricity company of Mexico. CFE is fully owned by the Mexican government making it a sovereign-owned entity (SOE or quasisovereign entity). The company, which is the fourth-largest company in Mexico in terms of revenues, generates over 90% of the electricity consumed in Mexico, and is the monopoly electricity transmission and distribution services provider for the country. CFE was created in 1937 by presidential decree and then converted by the Mexican Congress in 1949 into an organismo decentralizado de la Administracion Publica Federal (decentralized public entity of the Mexican government). As a result of the recently enacted energy reforms in Mexico, the company became a productive state enterprise on October 7, Under this new legal framework, CFE retains the same rights as a decentralized public entity, but it now has increased managerial and budgetary autonomy. The company s credit quality remains strongly linked to its parent, the Mexican government, as it is a key strategic asset for Mexico due to its continuing role as the primary source of electric generation, transmission and distribution. CFE possesses a strong interrelationship with sister company Petroleos Mexicanos (Pemex), Mexico s national oil company, which serves the role as primary provider of thermoelectric generation fuels. Figure 12: Generation by Source 4% 3% 12% 7% 74% Hydroelectric Coal Other Thermal Nuclear NCRE Source: CFE; Deutsche Bank. As of December 31, As of year-end 2015, CFE provided electricity to 39.6 million accounts (98% of Mexico s population), and had total installed generation capacity of 55 Gigawatts (GW), including Independent Power Producers (IPP). The majority of CFE s electric generation activities are provided via thermal and hydroelectric power plants, which made up 81% and 12%, respectively, of the company s 2015 total generation of 253,060 Gigawatt Hours (GWh). A small percentage of CFE s electric generation activities are provided by other energy sources including nuclear and non-conventional renewable (NCRE) sources. Since 1992, IPP s have been permitted under Mexican law to build and operate generation plants (combined cycle thermal plants), selling the energy exclusively to CFE. IPP s generation is included under CFE s operating statistics, and made up 23% of the overall company s installed capacity and 33% of the overall generation in As of the June 2016 LTM period, CFE had total assets, revenue and adjusted EBITDA (EBITDA before non-cash pension expenses and excluding other non-cash items) of USD71.0bn, USD18.1bn, and USD2.6bn, respectively. Figure 13: CFE s Service Areas Divided into 16 Regions Figure 14: CFE is Vertically Integrated Utility Source: CFE. As of December 31, Source: Deutsche Bank, CFE. As of December 31, 2015 Page 5

6 Post-energy reform, CFE s generation monopoly to ebb away slowly The energy reforms put in place by the Mexican government seek to create a competitive electricity market, but this will be a drawn-out process. Given its monopolistic position, CFE should remain the dominant electrical market player in the short to medium term, with no meaningful market share losses at least during the next five years. Since its inception, CFE has been the sole electricity provider in the country with a monopoly in all three electricity market segments: generation, transmission and distribution. Post-reform, CFE will maintain its monopoly in the transmission and distribution segments, but it will face new competition in the generation segment from new generation plants, which by law are allowed to be interconnected into the CFE transmission and distribution networks. Given the lead-time required to build new independent power plants, we do not expect significant operational generation market share losses in the next five years from new players. The major projects that should be built in the short to medium term are nonconventional renewable energy projects (solar, wind, etc.), which in the longrun could end up making up 5% of Mexico s overall energy matrix. In the generation segment, the more immediate competitive threat to CFE would hypothetically come from IPP s that have assets currently in service; this is unlikely to move the needle for the next five years. The Mexican government has allowed IPP s to build-out generation plants, though all the energy produced has been historically sold directly to CFE under 25 year contracts. Once these contracts end, now that the country is in a post-reform era these IPP s could have the ability to sell energy directly to customers and bypass CFE. However, this is more of a long-term risk as the average maturity of IPP contracts is currently approximately 17 years. Pricing declines pose a more immediate risk; Reform impact not yet felt One of the main goals of the energy reform is to reduce electricity prices in the country, particularly in the business sectors, in order to make Mexican industry more efficient and competitive globally; CFE s energy prices are beginning to reflect this, but not yet due to new competition. Pre-reform electricity prices, for all customers, were previously determined annually by the Mexican government, reflecting anticipated production and long-term marginal costs as well as other variables (customer category, time of day, etc.). In the case of industrial/commercial tariffs, these were adjusted on a monthly basis by fuel costs and inflation. The reforms created a wholesale electricity market for Mexico, that will conceivably create a competitive dynamic in the industrial market segment (i.e., move from a regulated pricing model to a competitive pricing model). We estimate that this segment makes up approximately 70% of CFE s revenues, and above 100% of the company s consolidated EBITDA (the company generates negative EBITDA in the agriculture and low-income residential segments). Going forward, independent generation companies will compete with CFE for bilateral contracts with industrial customers as new power plants come into service. For this purpose, CFE must become a leaner, more efficient company, while at the same time continuing to face the burden of subsidizing negative margin agricultural and residential customers. Page 6

7 USD/kwh YoY % Change 21 September 2016 Figure 15: Mexico/CFE Prices vs. Other Markets Figure 16: Steady Sales with Declining Prices Average Electricity Prices Sales Volume vs. Pricing Mexico US Brazil Argentina Chile Peru 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% E Residential Industrial Energy Sales Energy Prices Industrial Prices Source: Deutsche Bank, CFE, ANEEL, EIA, Pampa Energia. As of December 31, 2015 Source: Deutsche Bank, CFE. As of December 31, 2015 Price declines are evident in 2015, mainly driven by the economic slowdown (lower demand) and fuel cost declines (though we note that fuel cost declines are passed onto the end-customer for three-fourths of CFE s sales volumes, which is an EBITDA-neutral event). In the period, CFE s energy sales volumes (GWh) grew by an average of 2.5%/year, while at the same time its overall unit prices increased by 5.4% per year (largely driven by an increase in industrial prices of 6.7%/year). In 2015, sales volumes grew by 2%, but CFE s prices declined by 12% with industrial prices declining by 20% for the same period. This price decline, as noted previously, can be explained by the fall of hydrocarbon prices (75% of CFE s revenue base comprises industrial/high-use residential tariffs that are adjusted on a monthly basis for the price of fuel) and also lower demand due to the economy. In 2015, energy sales revenues declined by -12% YoY (on a peso basis), which partially explains the adjusted EBITDA decline of -27% for the year. The delta in the underperformance is explained by robust pension expenses, subsidies that continued to weight down the company s results, and the lack of available natural gas in the southeast region where the company has been forced to generate using more expensive fuel oil. There has been a partial recovery in prices starting with 2Q16. As of July 2016, prices had recovered slightly as the company was able to increase industrial and commercial tariffs to account for a corresponding increase in fuel prices. July 2016 overall energy unit prices (price per Kw sold) declined by 4% YTD, however industrial prices increased by 4%. We expect this trend to continue in the second half of the year if hydrocarbon prices hold steady, as domestic gas prices increased by 11% (versus July) and fuel oil increased by 15%. To try to match these fuel price increases, in late August 2016 the company announced it expects for industrial/commercial tariffs to increase by 6.5%-8.4% and 8.6%- 9.4%, respectively, starting in September. Concurrently, the company is keeping low-use residential tariffs flat, which likely means that subsidy outflows will increase in the second half of the year (i.e., the fuel price increases will not be passed onto low-use residential/agricultural customers). Page 7

8 Figure 17: Fuel Oil and Natural Gas Prices had been rising until 2015 Source: Deutsche Bank, CFE. As of December 31, Subsidies are a substantial overhang; Direct cash injections from government needed The rates charged to residential and agricultural customers will continue to be determined and regulated by the Mexican government; we expect for CFE to continue to heavily subsidize these customers (combined with a cross-subsidy from industrial/commercial/high-use residential users that will decline as tariffs charged to these customers become more competitive). In the new postreform era, the formula for determining tariff rates for these customers is expected to allow CFE to recover its operating and maintenance (O&M) costs and receive a profit in an amount determined by the Mexican government. This would be a significant step-up from the current situation where substantial cash injections from the Mexican government are needed in order to somewhat counteract these losses, but the devil is in the details. In the past, nebulous non-cash charges cancelled most of the subsidies in the Income Statement, while the overall effect represented significant cash flow drainage. We believe agricultural and residential customers will continue to generate negative margins going forward as tariffs are unlikely to be adjusted upwards. This is best evidenced by the fact that subsidized residential tariffs actually decreased by 2% so far in 2016, while industrial/commercial tariffs will have increased by double-digits to reflect increased fuel prices. Prior to 2015, CFE received non-cash transfers in the form of tax credits from the Mexican government to compensate for negative margin agricultural/residential tariff losses that couldn t be compensated by charging higher rates to industrial/commercial/high-use residential users. CFE would calculate the rate shortfall from providing services to agricultural/low-use residential consumers, which could then be offset by a non-cash credit given to CFE by the Mexican government in lieu of paying the Public Use Tax (if paid, this tax would have been 9% of CFE s fixed assets). This credit had historically not been sufficient to cover the entire subsidy shortfall, so the balance would then be written off by the company in CFE s Income Statement and Equity accounts. For example, as shown in Figure 18, in 2014 the gross subsidy was calculated to be USD 6.5bn (MXN86.2bn), which was then cancelled by a noncash tax credit of USD4.4bn (MXN58.8bn), making the net subsidy total nearly USD2.1bn (MXN27.4bn). The net subsidy would be written off by CFE in its Income Statement and Equity accounts, but is the amount that we consider to be CFE s net cash subsidy loss. Page 8

9 $/MWh 21 September 2016 Figure 18: Large subsidies now partially offset by Mexican sovereign cash injections Source: CFE; Deutsche Bank. (USD millions) Cash Net Year Subsidy Tax Credit Injection Subsidy ,806 (4,604) 0 2, ,856 (3,404) 0 2, ,722 (3,606) 0 3, ,476 (4,415) 0 2, , , E 3,818 0 (1,633) 2,185 Starting January 1, 2015, under the new regulatory regime the company is now considered a productive state enterprise and is not eligible to receive the public use tax credit. For this reason, the company reported a gross/net subsidy of MXN60.3bn (USD3.8bn) without a corresponding tax credit. This total subsidy was written off from the income statement in its entirety, but there is still some uncertainty as to the government s plans for this subsidy deficit. Positively, in 2016 the government has committed to make direct cash injections to partially cover the subsidy. The Mexican Ministry of Finance has committed to inject MXN30bn (USD1.7bn), which will partially backstop CFE s subsidy deficit. As of the second quarter of 2016, the company has received MXN12bn of these budgeted funds. Long-term, the solution will be for either tariff increases, which we find unlikely, or additional more substantial cash injections by the Mexican government (our base case), otherwise CFE s cash flow generation and credit profile will be pressured. Our analysis of the credit assumes the company will be receiving annual cash injections from the Mexican government in the amount of MXN40bn/year, as we believe given CFE s strategic importance to the state that the government will continue to financially support the company, and the subsidy regime will remain in place. In the preliminary 2017 federal budget, the state has approved a MXN43bn subsidy reimbursement for CFE for that year, though these figures aren t final. We may be too optimistic in assuming the same level of payments from the government during all of , but do believe that in the end supporting CFE will be imperative from the sovereign s perspective. Figure 19: Subsidies take large toll Figure 20: Tariffs do not come close to covering costs Subsidies Weighing Down Results (USD mn) Revenues vs. Cost (Residential/Agricultural Users) 6, , , (2,000) (4,000) E E EBITDA w/subsidies Net Subsidy Loss Revenue/MWh Total Cost/MWh Source: Deutsche Bank, CFE. As of December 31, Source: Deutsche Bank, CFE. As of December 31, 2015 Energy losses on a declining trend, but still substantial From a peak of 16% in energy losses in 2010, the company has steadily reduced transmission and distribution energy losses to the ~13% level. This is still a significantly high level, with the company looking to reduce its non- Page 9

10 September 2016 technical losses (electricity generated/used and not paid for by consumers) via a modernization of its metering systems, strengthening its infrastructure and optimizing its operations. The company s goal is to reduce non-technical losses to sub-10% by 2019, which would allow the company to recover a cumulative 37,000 GWh in electricity losses during the period. Just to give an idea of the potential financial savings, the average residential customer paid USD0.074/kwh, so this would mean a potential USD2.7bn in incremental revenues (USD550mn/year). In our view, this estimate may prove overly ambitious and is not included in our base case, but if the company is able to increase to cut non-technical losses to 11.5%, this could mean incremental EBITDA generation of approximately USD275mn. Figure 21: Energy losses declining, but still very high 17 Energy Losses (%) Source: SENER, CFE. As of December 31, Natural gas supply is critical; gas commercialization a long-term opportunity The main beneficial impact to the company during the next five years from the energy reforms and CFE s foray into the natural gas business will come in the form of incremental gas supply via an expanded gas pipeline system. Due to diminishing Mexican gas production and lacking gas transportation/distribution infrastructure, CFE has suffered from frequent shortages of natural gas which has forced the company to rely on more expensive fuel oil for its generation needs (fuel oil generation costs are typically 3x natural gas costs). CFE main supplier is PEMEX from whom it buys fuel oil on a long-term (10 year) supply contract. In terms of natural gas, the company s suppliers are PEMEX and other providers including Gas de Litoral, S. de R.L. de C.V., IEnova LNG, S. de R.L. de C.V., Grupo Iberdrola, CIC Corporativo Industrial Coahuila y Fuerza y Energía de Tuxpan based on indexed prices under long-term contracts. In 2015, 65% of the company s fuel costs were comprised of fuel oil and natural gas, while approximately 75% of the company s revenues (Industrial/Commercial/High Use Residential segments) are indexed to the price of these fuels and adjusted on a monthly basis. The Energy Reform s goals, if successfully implemented, would be positive from CFE s perspective if it results in a natural gas supply increase driven by incremental private-sector investment. CFE currently purchases a majority of its natural gas from PEMEX, which has, at times, limited the amount of natural gas available to the company as, in large part driven by lower global hydrocarbon prices and underinvestment, its natural gas production has declined. From an energy supply perspective, a substantial natural gas pipeline infrastructure buildout is critical for CFE as it would increase the availability of Page 10

11 YoY % Change Thousands of BOE/day 21 September 2016 critical domestic natural gas supplies and would also allow the company to import high quality, inexpensive gas from the United States. Figure 22: CFE s Gas Demand Outstripping Pemex Gas Production Figure 23: Mexico s Expanded Pipeline Network Should Help Meet Growing CFE Demand CFE Gas Purchases vs. Pemex Production CFE Gas Purchases Pemex Production CFE Gas Purchases CFE Gas Purchases Source: Deutsche Bank, Pemex. As of December 31, Source: CFE. As of December 31, As part of the energy reform, CFE s mandate has been expanded from being solely an electricity company to becoming an energy company involved in natural gas commercialization; we think this new line of business s impact will be minimal during next five years. CFE currently buys upwards of 40% of the natural gas that is commercialized in Mexico, which is a trend we expect to continue with volumes increasing. In the long-run, the company expects to be able to sell excess natural gas to power generation/other commercial projects. Among the new services that CFE will be entering, are the ability to commercialize, import, export, transport and store natural gas in Mexico and the United States. As the pipeline buildout in Mexico is expected to take place during the next five years, we do not expect a meaningful positive impact in the short-to-medium term from this new potential revenue stream, though our forecast assumes moderation of fuel costs as more natural gas is available and the company converts existing fuel oil plants into natural gas powered power plants. The company believes it will be able to commercialize 25% of its installed pipeline capacity by 2019, but we believe this will take more time, but could provide upside versus our forecast. Page 11

12 USD billions USD billions 21 September 2016 Figure 24: Gas Pipeline Project List and Timeline Estimated Original Investment Investment (USD mn) Estimate Tender (USD mn) Process Project Length (km) Year Tendered Tuxpan-Tula La Laguna-Aguascalientes 600 1,000 1, Lazaro Cardenas-Acapulco Webb County-Escobedo- Monterrey 300 2, Tula-Villa de Reyes Villa de Reyes-Aguascalientes- Guadalajar , San Isidro-Samalayuca Samalayuca-Sasabe , Jatipan-Salina Cruz Salina Cruz-Tapachula Sur de Texas-Tuxpan 800 3,100 3, Los Ramones-Cempoala 855 1,980 1, El Cabrito Compression Plant N/A Source: Deutsche Bank, CFE; CENACE. As of December 31, 2015 Year in Operation Pensions pose a significant burden, but actions to rectify undertaken When adding the company s USD36bn in unfunded pension liabilities to CFE s total debt, 2015 gross leverage (on a dollar basis) is nearly 20x. Similar to its sister company, Pemex, this is one of the largest overhangs on CFE s capital structure, as its unfunded pension liabilities (as of YE2015) were equivalent to 1.7x its total financial debt and nearly 12x its annual adjusted EBITDA (in USD). In , the company registered approximately USD4bn in pension expenses on an annual basis, with about half of these expenses representing cash outflows. The depreciation of the MXN has reduced the pension liability balance the last two years, but on an MXN basis the company s unfunded pension liabilities have increased by 9%/year in , with growth accelerating to 11% in Figure 25: Pensions Represent Largest Financial Liabilities Financial Liabilities (including Pensions) Financial Liabilities Financial Leases Unfunded Pension Liabilities Figure 26: EBITDA more than doubles w/o Pensions/Subsidies Pension and Subsidy Expense Reduce Cash Generation Adjusted EBITDA Cash Pension Expense Cash Subsidy Expense Source: Deutsche Bank, CFE. As of December 31, Source: CFE. As of December 31, CFE was the first Mexican SOE to take steps to rectify its pension overhang when it implemented a defined pension contribution retirement plan in In that year it was established that the pension plans for employees hired starting in August 19, 2008 were to be funded by contributions made by CFE Page 12

13 and its employees to individual employee retirement accounts. Notably, though, the new pension plan was not applied retroactively to the company s existing labor force. For this reason the company s unfunded pension liabilities had continued to grow, increasing from USD32bn in 2011 to USD36bn in An opportunity to resolve this large problem came in the form of collective bargaining negotiations with CFE s powerful union, which took place in May Eighty-percent of the company s employees are members of the SUTERM labor union, and the collective bargaining agreements are negotiated every two years. The company and the unions agreed to raise retirement age to 65 years. Before these changes, workers were able to retire after 25 years of service at an age of 55 or after 30 years of service, irrespective of age. Now it ll be 30 years of service at an age of 65 or 40 years of service. As a result of these changes, the company s pension liabilities were immediately reduced by approximately MXN150bn (~8bn). Assuming an average cost of debt of 11%, this notable move will lead to annual expense savings of approximately USD1bn (half of that in annual pension cash expenses). Further assistance from the federal government is coming. This assistance was dependent upon successful negotiations with the unions as in August 2014 the Mexican Congress approved legislation that would allow the federal government to assume a portion of CFE and PEMEX s pension liabilities in the event that both companies reform their employee retirement mechanisms in order to reduce their pension liabilities. We are projecting that the Mexican government will absorb an incremental MXN160bn of CFE s pension liabilities, which would reduce annual cash pension expenses by about USD500mn (total cash savings of approximately USD1bn/year when combined with new labor agreement). The timing of the absorption of CFE s pension liabilities is uncertain. We are projecting this event will fully take place in 2017, but would not be surprised if, depending on the state of the sovereign s finances, this process takes place in installments beyond Before the federal government engages in the financial operation, it will await an independent report on the state of CFE s pension liabilities. In the federal government s 2017 budget, the central government is assuming it will assume MXN160bn of CFE s pension liabilities (with an associated financial cost of MXN9bn or approximately USD500mn). We expect the Mexican government to absorb CFE s pension liabilities utilizing a similar mechanism to that used for PEMEX. The Mexican government will probably transfer promissory notes to CFE in multiple installments. At the time of its choosing, the government will then exchange tradable government bonds with CFE for the promissory notes, which CFE will then sell to government development banks. Proceeds from each sale, will then be used to cancel the company s pension liabilities. Large capex program in place; expect negative FCF We expect for the company to spend approximately USD3.0bn/year in capex, which is consistent with recent trends. During , the company averaged capex of approximately USD3bn/year, or approximately 13% of net revenues. The company s plan guided for total capex of approximately USD18bn (USD3.5bn/year), with 80% expected to go towards the improvement and expansion of the company s generation and distribution segments. We would expect the majority of the generation capex will be outsourced to IPPs, so CFE will only directly fund its transmission/distribution investments. CFE s business plan calls for an expansion of its generation capacity by 15.5GW by 2019, with renewable energy sources accounting for approximately 18-20% of total generation. This would mean generation capacity would increase from 55GW currently to 70GW, or a nearly 30% Page 13

14 increase in generation capacity. We are projecting for a lower capacity increase to 60GW, based on current approved/budgeted generation projects. Long-term, the reforms should have a positive effect on CFE s capital investment requirements and FCF trends, as CFE will be permitted to enter into joint ventures with private-sector companies for electricity generation, transmission and distribution ventures, as well as for the distribution and commercialization of natural gas to industrial customers. CFE s incumbent role will place it in the position to be the natural strategic partner. We are projecting CFE will return to a negative FCF position, with average negative FCF of upwards of USD900mn per year during the period, however this should moderate in the outer years as the company benefits from higher natural gas availability. In , the company generated cumulative positive FCF of approximately USD2.4bn, we believe partially due to the decline of fuel prices, lower capex outlays, and increased generation using more inexpensive natural gas plants at the expense of fuel oil generation. The company generated FFO of USD8bn during , versus capex of USD6bn. Negative FCF must be plugged by government cash injections and new debt Given our expectations for negative FCF generation during the next five years, we believe the funding gap will be filled by an equal combination of debt issuances and our key assumption that the Mexican government will inject enough cash flow to plug any liquidity holes. Our base case assumptions are looking for a net debt increase of USD5 billion between YE2015 and YE2020, though this is of course contingent on USD10 billion in cash injections from the Mexican Finance Ministry in order to partially pay for CFE s large energy subsidies. We are assuming that post-reform, the company s industrial/commercial prices will remain low going forward, as the industry becomes competitive. The main risk for our base case is if the cash injections seen in 2016 and that are in the preliminary budget for 2017 do not materialize going forward. However, we believe given the strategic role of CFE for the Mexican state, that the government will continue to support the company financially. There is upside to our base case assumptions if the Mexican government injects incremental cash flow into the company and/or if CFE s foray into new lines of business (e.g., gas commercialization) proves successful sooner than we anticipate. Furthermore, if the company is able to significantly reduce nontechnical losses and subsidy payouts, our base case could also have significant upside. As shown in Figure 27, the company s credit profile is very sensitive to future government cash infusions to partially pay for CFE s subsidies of agricultural/residential users. In the most extreme stress case, with no further cash infusions starting with 2017, the company s average adjusted gross leverage would balloon to nearly 13x. Page 14

15 Subsidy Reimbursement 21 September 2016 Figure 27: Credit profile is sensitive to government cash infusions; Base case assumes MXN40bn per year Gross Leverage MXN mn Avg 40, x 6.1x 6.2x 6.1x 6.4x 35, x 6.5x 6.6x 6.4x 6.8x 30, x 6.9x 7.1x 6.8x 7.3x 25, x 7.4x 7.6x 7.3x 7.8x 20, x 8.0x 8.1x 7.8x 8.5x 15, x 8.7x 8.8x 8.4x 9.2x 10, x 9.5x 9.6x 9.1x 10.2x 5, x 10.5x 10.5x 9.9x 11.3x x 11.7x 11.7x 10.9x 12.8x Source: Deutsche Bank Levered (though improving) capital structure for an investment grade credit Given the company s large capital investment program while at the same time heavily subsidizing the residential and agricultural sectors, CFE s leverage metrics are, and we expect to remain, significantly higher than other investment grade integrated power generation companies in Latin America. For the purposes of our analysis, total debt calculation includes all the company s long-term financial debt (bank loans and bonds/notes), direct Proyectos de Infraestructura Productiva de Largo Plazo (PIDIREGAS) debt, and IPP capital leases. On a reported EBITDA basis, in 2015 CFE s total leverage was approximately 35x. Adjusting for the company s sizable pension obligations (adding non-cash pension expenses to calculate adjusted EBITDA), the company s Total Debt: Adjusted EBITDA ratio was 7.8x (7.1x on a Net Debt basis), which would place the company on the high-end for investment grade integrated utilities (Figure 32). If you add the company s pension liabilities to the calculation of leverage, then the gross leverage ratio is nearly 20x. In our view, this puts the company s leverage metrics closer to non-investment grade Eletrobras than any other Latin American investment grade integrated utility company, however with a much stronger parent (the Mexican sovereign, which is rated A3/BBB+/BBB+ at Moody s/s&p/fitch versus Brazil rated at Ba2/BB/BB). Given the company s funding needs over the next five years, we believe that CFE will be levered closer to 6x on an adjusted gross debt basis, while in the 12x level when adding pension liabilities to the equation. Adequate liquidity with strong access to capital markets CFE is the fourth-largest company in Mexico in terms of revenues, and has 4 USD-denominated bond issues totaling USD3.7 billion with maturities in 2021, 2024, 2042 and The company s total debt was approximately USD23.6 billion as of June 2016, with the debt principally comprised of local MXN bonds and loans, some foreign loans denominated in EUR, CHF, and JPY, and USD11.9bn of debt under the PIDIREGAS program. Approximately USD5.2bn (22% of total debt) of the PIDIREGAS debt are categorized as for Direct Investment (Pidiregas Direct). In this case, the projects are built out by external parties, and CFE takes possession of the assets at the end of the construction period. The company s transmission and distribution projects are typically constructed under this pidirega category, under the Obra Publica Financiada (OPF) program. USD6.7bn (28%) of the company s financial debt was made up of PIDIREGAS-IPPs, which are the capital leases of combined cycle power plants that are owned by IPP s where CFE pays rent for the term of the Figure 28: Total Debt by Type Pidiregas - IPP's 28% Pidiregas - Direct 22% USD Bonds 16% Source: Deutsche Bank; Company reports. Other Financial Debt 34% Page 15

16 agreement and then has the option to purchase the asset or renew the lease agreement. Prior to IFRS adoption in 2012, external PIDIREGAS were considered operating leases. In terms of liquidity, CFE retains solid access to domestic and international banks and multilateral financial institutions. As of June 2016, CFE had USD2.8bn of cash versus short-term debt of USD3.6bn (USD2bn coming due in 2H16), which is adequate, though given our expectations of a return to FCF burn we expect the company to need to raise additional debt in the form of loans and/or capital markets issuances. To this purpose, in May 2016 the company raised approximately USD800 million in local bonds. We do not expect for the company to issue cross border bond issuances in the rest of 2016, but could see incremental international issuances in Figure 29: Debt by currency Figure 30: Debt maturity profile (USDm) 9,563 Foreign currency 34% Local currency 66% 2,798 2,046 1,369 2, Cash & equivalents Source: Deutsche Bank. Company Data Note: Financial Debt plus Direct PIDIREGAS (excludes financial leases) Source: Deutsche Bank. Company Data Ratings continue to be tied to sovereign; could see some decoupling, but not dramatically so The ratings agencies are consistently rating CFE based on a direct linkage between CFE and the sovereign, with Moody s being the most conservative as the company s issuer default rating is one notch lower than the sovereign based on a relatively weak stand-alone credit profile. All three agencies have recently affirmed the credit, so we do not expect any further rating actions for the next twelve months. Given Moody s ratings downgrade of Pemex to Baa3, which is three notches below the sovereign, we could see the agency further decoupling CFE s rating from the sovereign within the next twelve months if further cash support from the sovereign does not come in 2017 to partially mitigate for continuing agricultural/residential subsidies; though this latter scenario seems unlikely now that the government approved 2017 subsidy support. On April 6, 2016, Moody s affirmed the company s Baa1 rating (stand-alone rating of ba1), but revised the Outlook to Negative from Stable in line with the ratings agency s view that the credit is linked to the sovereign, which it rates one notch higher. This move followed the ratings agency s revision of the sovereign rating outlook to Negative from Stable, though Moody s did affirm the A3 rating of the Mexican government. The negative rating triggers for Moody s include: 1) the downgrade of the sovereign rating; 2) evidence of lower implied government support; 3) the deterioration of CFE s stand-alone credit profile. On the third point, Moody s mentioned CFE s ratings could face downwards pressure if FFO/Total Debt and FFO/Interest coverage were below 10% and 2.0x on a sustained basis. Considering that the company s FFO leverage metric has been below 10% since 2012 and that FFO interest Page 16

17 coverage has been at 2.1x the last three years, the company could face a possible ratings downgrade during the next twelve months if its financial performance deteriorates, but a downgrade does not seem imminent at this time. For their part, both S&P and Fitch rate CFE at par with the sovereign at BBB+ with a Stable Outlook. S&P did lower its stand-alone rating to b+ from bbgiven elevated leverage metrics. Both ratings agencies see a very high likelihood that the government of Mexico would provide extraordinary support to the company if its situation becomes stressed, acknowledging that the company s ratings are receiving a sovereign uplift. In terms of downgrade scenarios, S&P noted that it could move the rating down by one notch if it revises its view of government support from almost certain to extremely high. Fitch for its part noted that a ratings downgrade, outside of a sovereign downgrade, would come from the perception of a lower degree of linkage between CFE and the sovereign as a result of the energy reform combined with a weakening credit profile. Fitch s stand-alone rating for the company is BB-. Page 17

18 Figure 31: CFE Financial Model D e u t s c h e B a n Eduardo Vieira (212) Xavier Olave (212) Company Description: CFE generates, transmits and distributes electricity. It acts as a state-owned electricity company with activities that include planning and carrying out of the instalations and works required by the national electric system. generates power by hydropower plants, thermalpower plants, coal fired plants, geotherminal power plants, nuclear power plants and wind-driven plants. The company operates 177 generating plants with a 47,925 km transfer network. The company was founded in 1937 and is headquartered in Mexico City. Income Statement (USDm) 2Q15 3Q15 4Q15 1Q16 2Q16 qoq yoy LTM Total Revenues 4, , , , , % -4.6% 25, , ,086.3 COGS (3,461.4) (3,644.8) (3,351.4) (2,860.5) (3,107.6) 8.6% -10.2% (17,576.8) (13,884.0) (12,964.3) Gross Profit 1, , , , , % 9.7% 7, , ,122.0 Gross Margin 28.1% 24.4% 29.0% 27.6% 32.3% % 28.2% 28.3% Gross interest expense (395.6) (359.7) (453.7) (267.8) (491.7) 83.6% 24.3% (1,651.4) (1,569.8) (1,572.9) SG&A (1,105.6) (1,055.4) (1,449.9) (1,228.7) 7, % % (4,749.6) (4,811.7) 4,179.2 Cash Flow (USDm) 2Q15 3Q15 4Q15 1Q16 2Q16 qoq yoy LTM EBIT (502.7) (554.5) (823.3) (774.0) 8,483.1 NM NM (409.1) (2,196.7) 6,331.3 Adjusted EBITDA , % 26.7% 4, , ,623.0 Adj. EBITDA Margin 16.6% 11.7% 13.3% 10.5% 22.1% 1, % 15.2% 14.5% Net change in debt (697.0) (1,118.1) (141.4) NM NM (1,300.5) (437.2) (1,323.8) Balance Sheet (USDm) 2Q15 3Q15 4Q15 1Q16 2Q16 qoq yoy LTM S-T Debt 2, , , , , % 19.5% 1, , ,538.8 L-T Debt 10, , , , , % -9.2% 9, , ,145.8 Total Debt ex-pidiregas 12, , , , , % -4.2% 10, , ,684.6 Cash and cash equivalents 4, , , , , % -40.8% 2, , ,797.9 Net Debt ex-pidiregas 7, , , , , % 19.0% 7, , ,886.7 Credit Ratios 2Q15 3Q15 4Q15 1Q16 2Q16 qoq bps yoy bps LTM Interest Coverage 2.02x 1.56x 1.39x 1.56x 2.06x x 1.88x 1.67x Adj. EBITDA-Capex/Interest 0.73x 0.05x 0.09x 0.41x 0.96x x 0.28x 0.41x S-T Debt/Tot Debt 17.4% 18.8% 10.2% 18.9% 21.7% % 10.2% 21.7% Cash/S-T Debt 2.22x 1.77x 1.88x 1.30x 1.10x x 1.88x 1.10x Total debt/adjusted EBITDA (x) 7.78x 10.77x 9.17x 14.23x 5.81x x 7.84x 8.99x Total debt/ltm Adjusted EBITDA (x) 3.96x 3.54x 7.84x 9.85x 8.99x x 7.84x 8.99x Net dnet debt/adjusted EBITDA (x) 6.30x 9.02x 8.35x 12.49x 5.12x x 7.14x 7.93x Net debt/ltm Adjusted EBITDA (x) 3.21x 2.96x 7.14x 8.65x 7.93x x 7.14x 7.93x LTM OCF/Total Debt (%) 16.0% 11.6% 4.0% -0.1% 38.1% % 14.0% 9.8% Working Capital turnover (days) CAPEX (%) Revenues 10.7% 11.3% 12.5% 7.8% 11.9% % 12.9% 11.0% Capital Structure 2Q16 (USDm) Liquidity CFE 2Q16 revenue breakdown amount as % total Documented debt 11, % Cash 2,797.9 Pidiregas debt 11, % Commited credit lines 0.0 Other % Total 2,797.9 Total Debt 23, % S-T Debt 2,538.8 Shareholders' Equity 13, % Surplus/(Deficit) Total Capitalization 36, % Debt profile, USDm as of 2Q16 8,000 6,000 4,000 2,000 0 Cash & Equiv Equity Value Market Cap. as on 04/12/ Net Debt 20,792.0 Minority Interest (BV) 0.0 Enterprise Value 20,792.0 EV/LTM EBITDA 7.93x Other programs 14% Industrial services 46% Agriculture services 3% Domestic services 18% Business services 12% Street lightining 7% Source: Company reports; Deutsche Bank Page 18

19 Figure 32: CFE Forecast (Base Case MXN) COMISION FEDERAL DE ELECTRICIDAD (CFE) E 2017E 2018E 2019E 2020E E 2017E 2018E 2019E 2020E Income Statement (MXN millions) Domestic 59,383 62,949 64,658 69,021 76,294 81,603 84,892 88, % 2.7% 6.7% 10.5% 7.0% 4.0% 4.0% Commercial 39,286 40,710 38,827 41,914 46,771 50,508 52,543 54, % -4.6% 8.0% 11.6% 8.0% 4.0% 4.0% Services 18,586 19,892 21,234 21,923 21,694 21,642 22,515 23, % 6.7% 3.2% -1.0% -0.2% 4.0% 4.0% Agricultural 5,466 4,703 4,874 6,165 7,068 7,557 7,784 8, % 3.6% 26.5% 14.7% 6.9% 3.0% 3.0% Industrial 186, , , , , , , , % -19.3% -2.2% 4.8% 3.8% 3.0% 3.0% Other Programs 9,505 10,320 20,131 43,421 53,421 53,421 53,421 53, % 95.1% 115.7% 23.0% 0.0% 0.0% 0.0% Net Revenues 318, , , , , , , , % -8.0% 9.5% 9.0% 4.3% 3.0% 3.0% COGS (243,673) (234,037) (220,403) (232,868) (254,402) (262,606) (269,987) (276,282) -4.0% -5.8% 5.7% 9.2% 3.2% 2.8% 2.3% Gross Income 74,737 99,360 86, , , , , , % -13.0% 19.4% 8.4% 6.7% 3.4% 4.5% Gross Margin (%) 23.5% 29.8% 28.2% 30.7% 30.5% 31.2% 31.4% 31.8% G&A (8,540) (8,151) (7,999) (15,370) (16,751) (17,467) (17,990) (18,532) -4.6% -1.9% 92.2% 9.0% 4.3% 3.0% 3.0% D&A (36,236) (41,565) (45,252) (60,979) (60,979) (62,836) (64,728) (66,620) 14.7% 8.9% 34.8% 0.0% 3.0% 3.0% 2.9% Pension Expenses (48,689) (55,090) (68,564) 98,878 (56,055) (40,137) (41,341) (42,581) 13.1% 24.5% % % -28.4% 3.0% 3.0% EBIT (18,728) (5,446) (35,354) 125,725 (21,916) (1,119) (680) 1, % 549.1% % % -94.9% -39.2% % Plus D&A 36,236 41,565 45,252 60,979 60,979 62,836 64,728 66, % 8.9% 34.8% 0.0% 3.0% 3.0% 2.9% Rep. EBITDA 17,508 36,119 9, ,704 39,063 61,717 64,048 67, % -72.6% % -79.1% 58.0% 3.8% 5.9% Rep. EBITDA Margin 5.5% 10.8% 3.2% 55.6% 10.7% 16.2% 16.3% 16.7% Pension Adjustment 25,310 26,897 36,436 (126,812) 29,788 21,329 21,969 22,628 Other Adjustment 1, Adj EBITDA 44,454 63,016 46,334 59,892 68,852 83,046 86,017 90, % -26.5% 29.3% 15.0% 20.6% 3.6% 5.1% EBITDA Margin 14.0% 18.9% 15.1% 17.8% 18.8% 21.7% 21.9% 22.3% Cash Flow (MXN millions) FFO 28,836 42,066 78,198 56,308 66,030 67,604 69,441 72, % 85.9% -28.0% 17.3% 2.4% 2.7% 5.0% CFO 17,839 54,739 69,238 35,799 31,742 31,310 44,654 43, % 26.5% -48.3% -11.3% -1.4% 42.6% -3.1% Capex (37,370) (46,622) (39,790) (47,131) (57,450) (58,500) (58,500) (58,500) 24.8% -14.7% 18.5% 21.9% 1.8% 0.0% 0.0% % of revenues 11.7% 14.0% 13.0% 14.0% 15.7% 15.3% 14.9% 14.4% FCF (19,531) 8,116 29,448 (11,332) (25,708) (27,190) (13,846) (15,237) % 262.8% % 126.9% 5.8% -49.1% 10.0% FCF Margin -6.1% 2.4% 9.6% -3.4% -7.0% -7.1% -3.5% -3.8% Net Change in Cash (453) 795 (714) (9,367) 5,526 (7,826) 17,335 (3,995) Check 0 0 (0) Balance Sheet (MXN millions) Cash & Equivalents 35,516 36,311 35,597 26,230 31,756 23,929 41,264 37, % -2.0% -26.3% 21.1% -24.6% 72.4% -9.7% Change in Cash (453) 795 (714) (9,367) 5,526 (7,826) 17,335 (3,995) Short-term Debt 48,484 30,816 41,725 68,321 70,865 70,865 70,865 70, % 35.4% 63.7% 3.7% 0.0% 0.0% 0.0% Long-term Debt 276, , , , , , , , % 12.4% 3.9% 12.3% 4.7% 7.2% 2.4% Total Debt 325, , , , , , , , % 14.5% 10.2% 11.0% 4.0% 6.2% 2.1% Change in Debt 24,697 21,831 50,281 40,457 48,110 19,364 31,181 11,242 Net Debt 289, , , , , , , , % 16.4% 13.8% 10.3% 6.0% 2.9% 3.1% Unfunded Pension Liabilities 527, , , , , , , , % 10.8% -18.5% -28.4% 3.0% 3.0% 3.0% Total Debt (incl. Pensions) 852, ,240 1,022, , , , , , % 12.2% -7.3% -10.2% 3.6% 4.8% 2.5% Net Debt (incl. Pensions) 817, , , , , , , , % 12.8% -6.7% -11.1% 4.7% 2.9% 3.0% Total Debt:Adj. EBITDA Net Debt:Adj. EBITDA Total Debt+Pens.:Adj. EBITDA Net Debt+Pens.:Adj. EBITDA Adj. EBITDA:Interest Expense EV:Adj. EBITDA Operating Stats Installed Gen. Capacity (MW) 51,780 52,906 54,952 56,768 57,546 59,550 60,328 60, % 3.9% 3.3% 1.4% 3.5% 1.3% 0.8% Users (000's users) Total Users 37,434 38,434 39,601 40,576 40,584 40,593 40,605 40,618 Electric Generation (GWh) 254, , , , , , , , % 1.2% 8.5% 4.9% 7.1% 2.6% 1.7% GWh/GW Capacity 4,918 4,726 4,605 4,936 5,004 5,178 5,246 5, % -2.5% 7.2% 1.4% 3.5% 1.3% 0.8% Fossil Fuel Gen. Volumes (GWh) 210, , , , , , , , % 4.2% 7.6% 4.1% 7.1% 2.6% 1.7% % of Generation 82.7% 80.9% 83.3% 82.6% 82.0% 82.0% 82.0% 82.0% Fossil Fuel Cost/MWh (MXN) % -15.5% -13.8% -0.6% -4.5% 0.0% 0.0% Fossil Fuel Cost/MWh (USD) % -29.1% -25.5% -4.6% -6.3% 0.0% 0.0% Electric Sales (GWh) Domestic 52,370 53,914 55,986 59,041 61,993 64,472 66,407 68, % 3.8% 5.5% 5.0% 4.0% 3.0% 3.0% Commercial 13,743 13,960 14,810 15,816 16,765 17,603 18,131 18, % 6.1% 6.8% 6.0% 5.0% 3.0% 3.0% Services 9,261 8,984 8,969 8,365 7,863 7,627 7,856 8, % -0.2% -6.7% -6.0% -3.0% 3.0% 3.0% Agricultural 10,282 10,028 10,059 12,354 13,589 14,269 14,697 15, % 0.3% 22.8% 10.0% 5.0% 3.0% 3.0% Medium Enterprise 76,378 78,226 81,188 84,799 88,191 90,837 93,562 96, % 3.8% 4.4% 4.0% 3.0% 3.0% 3.0% Large Enterprise 44,095 42,904 41,188 41,054 42,285 43,554 44,860 46, % -4.0% -0.3% 3.0% 3.0% 3.0% 3.0% Total Sales 206, , , , , , , , % 2.0% 4.3% 4.2% 3.3% 3.0% 3.0% Rev/MWh Total Rev/MWh 1,499 1,553 1,351 1,322 1,356 1,378 1,385 1, % -13.0% -2.2% 2.6% 1.6% 0.5% 0.5% Rev/User Domestic 1,792 1,849 1,843 1,921 2,122 2,270 2,360 2, % -0.3% 4.2% 10.5% 6.9% 4.0% 4.0% Commercial 10,631 10,805 10,004 10,538 11,757 12,693 13,200 13, % -7.4% 5.3% 11.6% 8.0% 4.0% 4.0% Services 96, , , , , , , , % 3.0% 1.2% -1.1% -0.3% 4.0% 4.0% Agricultural 43,207 36,844 38,200 47,336 54,262 58,003 59,725 61, % 3.7% 23.9% 14.6% 6.9% 3.0% 3.0% Industrial 655, , , , , , , , % -23.1% -5.5% 4.8% 3.8% 3.0% 3.0% Implied /Subsidies Subsidy 85,770 86,227 60,332 73,432 81,686 89,369 92,050 94, % -30.0% 21.7% 11.2% 9.4% 3.0% 3.0% Tax Credit/Cash Inflow (46,013) (58,792) 0 (30,000) (40,000) (40,000) (40,000) (40,000) Balance (39,758) (27,435) (60,332) (43,432) (41,686) (49,369) (52,050) (54,812) Net Subsidy 39,758 27,435 60,332 43,432 41,686 49,369 52,050 54, % 119.9% -28.0% -4.0% 18.4% 5.4% 5.3% Employees 95,594 93,942 93,199 91,815 90,451 89,108 87,784 86, % -0.8% -1.5% -1.5% -1.5% -1.5% -1.5% Rev/Employee (mil.) % -7.2% 11.2% 10.6% 5.8% 4.5% 4.6% Source: Company reports; Deutsche Bank. 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20 Figure 33: CFE Forecast (Base Case USD) COMISION FEDERAL DE ELECTRICIDAD (CFE) E 2017E 2018E 2019E 2020E E 2017E 2018E 2019E 2020E Income Statement (USD millions) Domestic 4,654 4,728 4,065 3,750 3,984 4,185 4,353 4, % -14.0% -7.7% 6.2% 5.0% 4.0% 4.0% Commercial 3,079 3,057 2,446 2,278 2,442 2,590 2,695 2, % -20.0% -6.9% 7.2% 6.1% 4.0% 4.0% Services 1,457 1,494 1,340 1,194 1,133 1,110 1,155 1, % -10.3% -10.9% -5.1% -2.0% 4.0% 4.0% Agricultural % -12.8% 9.2% 9.8% 5.0% 3.0% 3.0% Industrial 14,591 14,632 9,933 8,358 8,408 8,574 8,831 9, % -32.1% -15.9% 0.6% 2.0% 3.0% 3.0% Other Programs ,258 2,359 2,790 2,740 2,740 2, % 62.3% 87.5% 18.3% -1.8% 0.0% 0.0% Net Revenues 24,953 25,039 19,349 18,274 19,126 19,586 20,173 20, % -22.7% -5.6% 4.7% 2.4% 3.0% 3.0% COGS (19,096) (17,577) (13,884) (12,663) (13,285) (13,467) (13,845) (14,168) -8.0% -21.0% -8.8% 4.9% 1.4% 2.8% 2.3% Gross Income 5,857 7,462 5,465 5,610 5,842 6,119 6,327 6, % -26.8% 2.7% 4.1% 4.7% 3.4% 4.5% Gross Margin (%) 23.5% 29.8% 28.2% 30.7% 30.5% 31.2% 31.4% 31.8% G&A (669) (612) (498) (832) (875) (896) (923) (950) -8.5% -18.6% 66.9% 5.1% 2.4% 3.0% 3.0% D&A (2,840) (3,122) (2,850) (3,315) (3,184) (3,222) (3,319) (3,416) 9.9% -8.7% 16.3% -3.9% 1.2% 3.0% 2.9% Pension Expenses (3,816) (4,137) (4,313) 5,502 (2,927) (2,058) (2,120) (2,184) 8.4% 4.3% % % -29.7% 3.0% 3.0% EBIT (1,468) (409) (2,197) 6,966 (1,144) (57) (35) % 437.0% % % -95.0% -39.2% % Plus D&A 2,840 3,122 2,850 3,315 3,184 3,222 3,319 3, % -8.7% 16.3% -3.9% 1.2% 3.0% 2.9% Rep. EBITDA 1,372 2, ,281 2,040 3,165 3,285 3, % -75.9% % -80.2% 55.2% 3.8% 5.9% Rep. EBITDA Margin 5.5% 10.8% 3.4% 56.3% 10.7% 16.2% 16.3% 16.7% Pension Adjustment 1,983 2,020 2,293 (7,027) 1,556 1,094 1,127 1,160 Other Adjustment Adj EBITDA 3,484 4,733 2,946 3,254 3,595 4,259 4,411 4, % -37.7% 10.4% 10.5% 18.5% 3.6% 5.1% EBITDA Margin 14.0% 18.9% 15.2% 17.8% 18.8% 21.7% 21.9% 22.3% Cash Flow (USD millions) FFO 2,260 3,159 4,863 3,066 3,448 3,467 3,561 3, % 53.9% -37.0% 12.5% 0.5% 2.7% 5.0% CFO 1,398 4,111 4,312 1,954 1,658 1,606 2,290 2, % 4.9% -54.7% -15.2% -3.1% 42.6% -3.1% Capex (2,929) (3,501) (2,522) (2,551) (3,000) (3,000) (3,000) (3,000) 19.6% -28.0% 1.1% 17.6% 0.0% 0.0% 0.0% % of revenues -11.7% -14.0% -13.0% 14.0% 15.7% 15.3% 14.9% 14.4% FCF (1,531) 610 1,790 (597) (1,342) (1,394) (710) (781) % 193.6% % 124.9% 3.9% -49.1% 10.0% Net Change in Cash (50) (250) (393) (673) 233 (401) 889 (205) Check Balance Sheet (USD millions) Cash & Equivalents 2,711 2,462 2,069 1,395 1,629 1,227 2,116 1, % -16.0% -32.6% 16.7% -24.6% 72.4% -9.7% Change in Cash (50) (250) (393) (673) 233 (401) 889 (205) Total Debt 24,836 23,536 23,099 23,294 24,925 25,918 27,517 28, % -1.9% 0.8% 7.0% 4.0% 6.2% 2.1% Change in Debt 1,759 (1,300) (437) 195 1, , Net Debt 22,125 21,074 21,030 21,899 23,296 24,691 25,401 26, % -0.2% 4.1% 6.4% 6.0% 2.9% 3.1% Unfunded Pension Liabilities 40,269 38,237 36,326 27,106 18,712 19,273 19,851 20, % -5.0% -25.4% -31.0% 3.0% 3.0% 3.0% Total Debt (incl. Pensions) 62,394 59,311 57,356 49,005 42,008 43,964 45,252 46, % -3.3% -14.6% -14.3% 4.7% 2.9% 3.0% Net Debt (incl. Pensions) 59,683 56,850 55,287 47,609 40,380 42,737 43,136 44, % -2.7% -13.9% -15.2% 5.8% 0.9% 3.7% Total Debt:Adj. EBITDA Net Debt:Adj. EBITDA Total Debt+Pens.:Adj. EBITDA Net Debt+Pens.:Adj. EBITDA Adj. EBITDA:Interest Expense EV:Adj. EBITDA Rev/MWh Total Rev/MWh % -27.1% -15.4% -1.6% -0.2% 0.5% 0.5% Rev/User Domestic % -16.4% -9.9% 6.0% 5.0% 4.0% 4.0% Commercial % -22.4% -8.9% 7.0% 6.0% 4.0% 4.0% Services 7,561 7,595 6,559 5,738 5,446 5,335 5,548 5, % -13.6% -12.5% -5.1% -2.1% 4.0% 4.0% Agricultural 3,386 2,767 2,405 2,576 2,834 2,975 3,063 3, % -13.1% 7.1% 10.0% 5.0% 3.0% 3.0% Industrial 51,406 49,296 31,766 25,962 26,103 26,612 27,402 28, % -35.6% -18.3% 0.5% 1.9% 3.0% 3.0% Implied /Subsidies Subsidy 6,722 6,476 3,778 3,995 4,266 4,583 4,721 4, % -41.7% 5.8% 6.8% 7.4% 3.0% 3.0% Tax Credit/Cash Inflow (3,606) (4,415) 0 (1,627) (2,089) (2,051) (2,051) (2,051) Balance (3,116) (2,060) (3,778) (2,367) (2,177) (2,532) (2,669) (2,811) Net Subsidy 3,116 2,060 3,778 2,367 2,177 2,532 2,669 2, % 83.3% -37.3% -8.0% 16.3% 5.4% 5.3% Rev/Employee (mil.) % -22.2% -3.9% 6.1% 3.9% 4.5% 4.6% Source: Deutsche Bank Page 20

21 Figure 34: Comp Table: LatAm Integrated Utility Companies Comparables Table Instituto Costarricense de Electricidad y Subsidiarias Company Comision Federal de Electricidad Centrais Eletricas Brasileiras S.A. Empresas de Energia de Bogota E.S.P. Country Mexico Brazil Costa Rica Colombia Colombia Type of Utility Integrated Integrated Integrated Integrated Integrated Description Dominant generator in Mexico, with a continuing monopoly in Transmission and Distribution. Latin America's largest diversified utility company. Grupo ICE provides electricity and telecommunications services in Costa Rica, and is fully owned by Costa Rica. Diversified utility company engaged in power generation/distributio n/transmission, gas distribution/transport ation. Empresas Publicas de Medellin E.S.P. Diversified utility company engaged in power generation/distributio n/transmission, gas distribution, and water services. Controlling Owner Republic of Mexico (100%) Republic of Brazil (52%) Republic of Costa Rica (100%) Bogota D.C. (76.3%) City of Medellin (100%) Debt Rating (Moody's/S&P/Fitch) Baa1 / BBB+ / BBB+ Ba3/BB/BB- Ba1/N.A./BB+ Baa2 / BBB- / BBB Baa3 / N.A. / BBB+ FY 2015 Results (USD millions) Generation Installed Capacity (MW) 54,952 45,391 2,139 3,459 3,735 Revenues 19,349 9,757 2,481 1,244 4,297 EBITDA 2, ,313 Total Senior Debt 23,099 13,533 3,810 2,803 4,741 Cash and Equivalents 2,069 2, Senior Debt:EBITDA 7.8x 15.8x 5.1x 3.2x 3.6x Net Senior Debt:EBITDA 7.1x 13.4x 4.4x 2.9x 3.3x 5-Year USD Bond CFELEC ELEBRA COSICE N/A EEPPME Amount Outstanding (millions) 1,000 1, N/A 500 Price N/A 115 Yield N/A 2.33 Z spread N/A 126 Spread over Sovereign N/A Year USD Bond CFELEC N/A N/A EEBCB N/A Amount Outstanding (millions) 1,250 N/A N/A 749 N/A Price 106 N/A N/A 104 N/A Yield 3.90 N/A N/A 5.26 N/A Z spread 254 N/A N/A 400 N/A Spread over Sovereign 101 N/A N/A 261 N/A 30-Year USD Bonds CFELEC N/A COSICE N/A N/A Amount Outstanding (millions) 750 N/A 500 N/A N/A Price 105 N/A 76 N/A N/A Yield 5.39 N/A 8.70 N/A N/A Z spread 362 N/A 699 N/A N/A Spread over Sovereign 93 N/A 223 N/A N/A Source: Deutsche Bank, Company reports. As of December 31, Page 21

22 Energy Reforms Appendix Vertically and horizontally integrated structure As part of the enacted energy reforms, CFE was converted into a productive state enterprise, now operating under a legal framework which gives the company managerial and budgetary autonomy to generate economic value. CFE moved from being solely an electric company to becoming an energy company involved in additional aspects of the energy value chain of Mexico, including natural gas commercialization for power generation and other purposes. The new electricity laws called for CFE to create subsidiaries and undertake a vertical and horizontal separation of its key electric sector activities: Generation, Transmission, Distribution and Commercialization. In addition, the company s new organization has additional subsidiaries to engage in new lines of business. The company s structure became operational as of January 29, Figure 35: CFE new organizational structure starting in 2016 Source: CFE. As of January 29, Competitive pricing regime for large generation customers As part of the reforms, private industry is now capable of investing and participating in all aspects of generation and the commercialization of electricity. This competitive change, along with a move from a regulated to unregulated pricing structure in the Industrial and Commercial market segments, will have the largest impact on CFE s financial position. The rates charged to CFE s large Industrial and Commercial customers that are categorized as qualified users by registration with the Comision Reguladora de Energia (Energy Regulatory Commission) (provided existing demand exceeds certain thresholds) will no longer be regulated. The rates charged to Page 22

23 Residential and Agricultural customers will continue to be determined and regulated by the Mexican government (historically, these customers have been priced at a loss). Long-term, the Mexican government plans to adjust these tariffs to a cost-plus model whereby CFE would be able to recover operating costs and a reasonable profit margin. The Transmission and Distribution segments are also moving towards a cost-plus model that would allow CFE to obtain a profit the Mexican government determines to be reasonable. Income taxes and dividends will begin when company becomes profitable The previous tax regime that obligated the company to pay a public use tax to the Mexican government based on the value of its net fixed assets has been replaced by a conventional income tax comparable to that paid by the Mexican private sector. In addition, starting in 2016, CFE will be required to pay a dividend to the Mexican government based on net income. The Ministry of Finance will determine the amount of any dividend paid to the Mexican government each year after taking into account CFE s business plan and capital investment needs for the upcoming fiscal year. Given our expectations that the company will remain unprofitable, we do not believe meaningful income taxes or dividends will be paid in the next five years. Greater budgetary authority; CFE remains key cog for Mexican government CFE s move to a productive state enterprise is designed to provide it with greater budgetary autonomy. The Mexican Congress is in charge of approving the company s financial balance and personal services expenditure ceiling, but the Board of Directors is now able to define its five-year business plan, annual budget and approve investment priorities and projects. The Federal Government continues to be solely responsible for the planning and administration of the Mexican Electric System (SEN) and of the transmission and distribution market segments. Corporate governance changes brings CFE closer to private sector CFE adopted a corporate governance framework based on international best practices that is more closely aligned to the governance frameworks of privatesector companies. The company s Board of Directors now consists of five representatives of the Mexican government, including the Minister of Energy and the Minister of Finance, four independent directors and one union representative. The company s internal auditing, control and accountability functions are also now undertaken by three separate and independent bodies rather than a single body. New supervisory oversight The SENER and CRE have technical and administrative authority over some of CFE s operations and the electrical sector as a whole. In addition, the CENACE (Centro Nacional de Control de Energia) was spun-off from CFE and created to oversee the entire electrical system and operate the wholesale electrical market. Page 23

24 Figure 36: Mexico Electrical Industry Structure 2016 Source: CFE. As of January 29, Page 24