OREANDA-NEWS. China Three Gorges Corporation's (CTG, A+/Stable) recent hydropower concessions acquisition in Brazil (BBB-/Negative) diversifies its operations through meaningfully increasing its overseas generation capacity, Fitch Ratings says. The acquisition increases CTG's financial leverage moderately, but its balance sheet quality still remains very strong. The company's ratings are aligned with the China sovereign (A+/Stable), given the strong strategic and operational linkages between them.

CTG announced on 26 November that its Brazilian subsidiary - China Three Gorges Brasil Energia Ltda - has won the bidding for the 30-year concessions of two hydropower stations in Brazil - Jupia and Ilha Solteira power stations that are currently operated by Brazil's Companhia Energetica de Sao Paulo with a combined capacity of 4.99 gigawatts (GW). The total payment is agreed at BRL13.8bn (USD3.7bn).

CTG's Brazil investment is a milestone in its globalisation drive and is positive for its business profile in the long run. CTG's current core assets are concentrated along China's Yangtze River. After incorporating the two Brazil hydropower stations, CTG's operated power capacity outside China will increase to 11GW (17% of its total capacity) from 6GW (10%). The acquisition strengthens CTG's status as the world's largest hydropower company, while making it Brazil's second largest private power generation company by capacity.

This investment however comes with some operational and financial risks, especially considering Brazil's weakened economic outlook in the near term. According to CTG, 70% of the projected power sales will earn a regulated return based on benchmark operating/maintenance costs plus a predetermined return on investment. The remaining 30% will be affected by water flow and other market conditions. Foreign currency risks are also associated with this investment due to the Brazilian Real (BRL) denominated income and non-BRL denominated debt. The cost of hedging could be high in case the exchange rate fluctuates widely.

However, Fitch expects no material deterioration of CTG's financial profile due to its large scale and strong balance sheet. The BRL13.7bn payment will account for 18% of CTG's net debt at end-September 2015. With the incremental cash flow from the Brazil projects, we expect CTG's FFO-adjusted net leverage to rise slightly to around 4.5x after the payments and its fixed charge coverage to remain at around 4x. In addition, the private placement of an equity issue at CTG's 72% controlled China Yangtze Power Company Limited (CYPC, A+/Stable), if carried out, would also provide CTG with up to CNY24.2bn in cash on a consolidated basis and help to moderate the financial impact (Please refer to Fitch Rating's press release published on 12 November 2015: CYPC'S Acquisition Strengthens Links with CTG, Boosts Profile).

Fitch also expects the Chinese government to support the overseas expansion of CTG, China's flagship hydro power company. According to CTG, investment funds backed by the Chinese government and bank syndicates will provide adequate financing for the acquisition.