Fitch Affirms Telefonica Del Peru at 'BBB+'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed Telefonica Del Peru S.A.A.'s (TDP) long-term foreign currency and local currency Issuer Default Ratings (IDR) at 'BBB+' with a Stable Outlook. Fitch has also affirmed the company's PEN754 million senior unsecured notes due 2016 at 'BBB+'.

KEY RATING DRIVERS

TDP's ratings reflect its strong financial profile, underpinned by its low leverage and robust operational cash flow generation. The company also benefits from its dominant market position in the Peruvian telecom industry with its diversified revenue streams from the fully integrated fixed-line and mobile operations. The ratings reflect its linkage with the parent, Telefonica SA (Telefonica, IDR 'BBB+'; Outlook Negative), and its impact on the TDP's financial strategy. The ratings are tempered by a high level of competition amid the increasing industry maturity, which have led to the recent deterioration in its operating margins.

Improved Financial Profile:

Fitch forecasts that TDP's net leverage will remain conservative over the medium term with its adjusted net leverage below 1.0x. TDP has continued to improve its financial profile in 2013 driven by its robust free cash flow (FCF) generation, which mostly has been used to pay off the debt, in the absence of any sizable dividends in the recent two years. As a result, the company's adjusted net debt has fallen to PEN1.8 billion at end-2013 from PEN3.6 billion at end-2010. During that period, the company's adjusted net leverage also fell to 0.7x from 1.2x, which comfortably supports its rating level.

Cash Flow Generation to Remain Strong:

TDP's cash flow generation is expected to remain robust in 2014 and 2015 and help maintain its strong financial profile. In 2013, the company generated cash flow from operations (CFFO) of PEN2.3 billion which was sufficient to cover the capex of PEN1.9 billion and insignificant dividends, leading to a positive free cash flow (FCF) of PEN441 million. The company has kept its shareholder return very low in 2012 and 2013, less than PEN1 million per year, due to its efforts to improve the capital structure in line with the Telefonica Group strategy.

Telefonica group has successfully reduced its net debt to EUR44 billion as of Dec. 31, 2013 from EUR56 billion as of Dec. 31, 2011 through non-core asset disposals and cuts to shareholder distribution. Fitch believes that TDP's dividend upstream may potentially increase in the coming years should the parent need it for debt reduction, shareholder return, or any strategic investment, if necessary.

Market Leading Position:

Fitch expects TDP's largest market shares in both the fixed and mobile segments to remain over the medium term, which benefit economies of scale. The company's strong business position benefits from its extensive network coverage, synergies from the integrated service line-up, as well as the strong brand recognition. Fitch believes the competitive landscape will become more intense, especially from Entel, a Chilean telco which recently entered the Peruvian market through the acquisition of Nextel. However, any material market share loss for TDP is unlikely given its entrenched position. During 2013, TDP remained dominant across all of its service platforms, with over 80% market shares in the fixed-telephony and broadband segments, and close to 60% market shares in the mobile and pay-TV segments.

Stable Revenue Growth Ahead:

Fitch forecasts the company's revenue growth to remain stable, in the mid-single-digits, in 2014 and 2015. The increasing subscriber base for the high-ARPU 4G mobile service as well as the bundled offerings of broadband and pay-TV services will enable the company to fully offset the revenue contraction of the fixed-voice service due to the waning demand. Also, the company's strategy to expand its operational footprint into the untapped rural areas should provide some growth potential going forward. In 2013, the company's consolidated revenue increased by 8.5% from a year ago.

Margin Deterioration; Intensifying Competition:

Fitch believes the ongoing margin erosion will continue over the medium term driven by the competitive and regulatory pressures. TDP's cost structure has been increasingly pressured due to a higher subscriber acquisition cost associated with increasing postpaid subscribers who receive handset subsidies. Fitch believes this trend is likely to continue at least for the short term as the company's mobile business strategy will remain centered on mobile data revenue which incentivize customers' uptake of smartphones supported with subsidies. For the fixed-line telephony, the regulatory tariff adjustments, on top of weak demand, have contributed to its revenue and margin suppression. In 2013, the company's EBITDA margin fell to 33.6% from 36.0% in 2012.

RATING SENSITIVITIES

A substantial weakening in TDP's consolidated financial profile, or deterioration in Telefonica's credit profile which leads to a potential ratings downgrade of the parent company, can negatively pressure the company's ratings. In addition, any substantial negative impact from the pending legal dispute with SUNAT over the income tax issues can pressure the ratings should the contingent liability materialize.

Although the ratings of TDP and Telefonica are not directly linked, an upgrade of TDP's ratings remains limited at this time due to Telefonica's current IDR of 'BBB+' with a Negative Outlook.

Additional information is available on www.fitchratings.com

Applicable Criteria and Related Research

-- 'Corporate Rating Methodology' (Aug. 5, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Additional Disclosure

Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=829757

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Alvin Lim, CFA, +1-312-368-3114
Director
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Josseline Jessen, +59-1-2277-4470
Director
or
Committee Chairperson
Mauro Storino, +55-21-4503-2625
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Alvin Lim, CFA, +1-312-368-3114
Director
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Josseline Jessen, +59-1-2277-4470
Director
or
Committee Chairperson
Mauro Storino, +55-21-4503-2625
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com