Fitch Affirms Eletropaulo's Ratings at 'BB'; Outlook Stable

SAO PAULO--()--Fitch Ratings has affirmed Eletropaulo Metropolitana de Eletricidade de Sao Paulo S.A.'s (Eletropaulo) Foreign and Local Currency Issuer Default Ratings (IDRs) at 'BB' and long-term National Scale Rating at 'AA-(bra)'. The Rating Outlook for the corporate ratings is Stable. A complete list of rating actions is included at the end of this press release.

KEY RATING DRIVERS

Eletropaulo's ratings reflect its moderate leverage, robust liquidity position and lengthened debt maturity profile. Fitch expects that negative pressures on energy consumption, delinquency and energy losses due to the challenging Brazilian macroeconomic environment will have limited impact to the company's credit profile in the coming years.

Fitch estimates Eletropaulo's free cash flow (FCF) to turn positive only after 2018 due to high capital expenditures (capex) and operating expenses (opex) needs in the next two years. The company operational efficiency measured by quality indicators of duration and frequency of supply interruptions is currently worse than regulatory levels what will demand strong investments to bring them to acceptable levels. Also the company's fourth tariff review implemented on July 4, 2015, slightly pressures its EBITDA as the 1.6% readjustment applied to manageable costs was below inflation.

The company benefits from its business risk profile, in view of its exclusive rights to distribute electricity within its concession area in the Metropolitan Region of Greater Sao Paulo. The ratings incorporate a moderate regulatory and hydrological risk for the Brazilian power sector.

Moderate Leverage to Remain

Fitch expects Eletropaulo's net leverage at moderate levels in the range of 2.5x-3.5x in the next three years. For the last 12 months (LTM) ended on June 30, 2016, the company reported total debt-to-EBITDA ratio of 4.1x, while the net debt-to-EBITDA ratio was 2.6x, in comparison with 3.8x and 3.2x, respectively, in 2015. Fitch's calculations does not incorporate BRL1.3 billion on the debt related to pension funds obligations, which also take part on the company's financial covenants, excluding pension fund expenses from EBITDA.

Positive FCF in 2018

FCF should be positive in 2018 based on a more robust cash flow from operations (CFFO) and considering annual capital expenditures around BRL750 million and limited dividends distribution. In the LTM ended on June 30, 2016, CFFO of BRL884 million was strong and benefited from the recovery of BRL1.3 billion in non-manageable costs in the first half of 2016. The CFFO was sufficient to cover capital expenditures of BRL713 million and dividends of BRL18 million, leading to a FCF of BRL172 million.

In the same period, net revenues were BRL12 billion, not considering construction revenues, while EBITDA of BRL802 million remains significantly below the estimated regulated EBITDA of BRL1.2 billion defined during the last tariff review process in 2015. Part of this gap is explained by the costs associated with higher volumes of energy purchases that cannot be passed through tariff. The regulation allows up to 105% of the demand to be incorporated on tariffs, while Eletropaulo is currently at around 114%. Fitch expects the company to manage this situation in order to avoid high losses.

Fitch does not expect non-recurring items, such as the discussion (ANEEL) with the regulator related to a difference on its asset base adopted on the 2nd Tariff Review Cycle and the loan debt involving Centrais Eletricas Brasileiras S.A. (Eletrobras) and Companhia de Transmissao de Energia Eletrica Paulista S.A. (CTEEP) to negatively impact Eletropaulo's cash flow generation. If those items materialize, the agency will review its projections.

Increasing Opex

Fitch does not expect opex to return to historical figures before 2019 due to the company needs to bring quality indicators to regulatory levels. Eletropaulo service quality indicators are above regulatory limits, leading to a strong need of opex and capex to meet the regulatory standards in order to avoid penalties on its concession contract. Personnel costs have grown in line with inflation, but since 2015, other manageable costs, such as third party services, have grown above historical levels.

Capex Funded by BNDES is Positive

Positively, Banco Nacional de Desenvolvimento Economico e Social (BNDES) is partially funding Eletropaulo's capex needs. Fitch believes this will change the funding sources mix, which has been concentrated on capital markets and bank loans for the last years, and reduce average cost of debt. As of June 2016, from Eletropaulo's capex needs of approximately BRL700 million-BRL800 million per year, BNDES has disbursed BRL272 million.

Low Energy Consumption

Fitch expects an energy consumption decline of around 3.0% in Eletropaulo's concession area in 2016, resuming small growths in the following years. High energy tariffs and challenging macroeconomic scenario are negatively impacting consumptions levels since 2015. In the first half of 2016, energy consumption on Eletropaulo's concession area has declined 3.1% compared with the same period of the previous year, with minus 4.4% in 2015.

KEY ASSUMPTIONS

Fitch's main assumptions, in accordance with the base case scenario for this issuer include:

--Consumption decline of 3.1% in 2016, with growths of 0.7% and 1.0% in 2017 and 2018, respectively;

--Annual average capex of BRL700 billion-BRL800 billion from 2016 to 2019;

--Payout dividend ratio of around of 25% after 2016.

RATING SENSITIVITIES

Future developments that may individually or collectively lead to a negative rating action includes:

--Net leverage consistently above 4.0x;

--Cash and equivalents+CFFO/short-term debt ratio below 2.0x;

--Non-expected significant cash outflows due to the litigation with CTEEP and Eletrobras or to unfavourable regulatory decisions.

Future developments that may individually or collectively lead to a positive rating action includes:

--Net leverage consistently below 2.5x;

--Cash and equivalents+CFFO/short-term debt ratio above 3.0x.

LIQUIDITY

Eletropaulo presents a strong liquidity position and a lengthened debt maturity profile, with proven access to capital markets and bank financings. As of June 30, 2016, the company's cash and marketable securities position of BRL1.3 billion covered 1.5x its short-term debt of BRL898 million. Cash plus funds from operations (FFO)-to-short-term debt ratio and cash plus CFFO-to-short-term debt ratio of 3.5x and 2.5x, respectively, are also robust. Total debt of BRL3.7 billion was mainly composed of debentures (79%) and commercial bank loans (CCB) (8%).

FULL LIST OF RATING ACTIONS

Fitch has affirmed Eletropaulo's ratings as follows:

--Foreign and Local Currency IDRs at 'BB';

--Long-term National Scale Rating at 'AA-(bra)';

--9th debenture issue, in the amount of BRL250 million, due 2018, at 'AA-(bra)';

--11th debenture issue, in the amount of BRL200 million, due 2018, at 'AA-(bra)'; and

--15th debenture issue, in the amount of BRL750 million, due 2018, at 'AA-(bra)'.

The Rating Outlook for the corporate ratings is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012414

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Contacts

Fitch Ratings
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Adriane Silva
Associate Director
+55 11 4504 2205
Fitch Ratings do Brasil Ltda.
Alameda Santos, 700 - 7 andar
Sao Paulo, Brazil
or
Secondary Analyst
Wellington Senter
Associate Director
+55 21 4503 2606
or
Committee Chairperson
Ricardo Carvalho
Senior Director
+55 21 4503 2627
or
Media Relations
Elizabeth Fogerty
+1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Adriane Silva
Associate Director
+55 11 4504 2205
Fitch Ratings do Brasil Ltda.
Alameda Santos, 700 - 7 andar
Sao Paulo, Brazil
or
Secondary Analyst
Wellington Senter
Associate Director
+55 21 4503 2606
or
Committee Chairperson
Ricardo Carvalho
Senior Director
+55 21 4503 2627
or
Media Relations
Elizabeth Fogerty
+1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com