Fitch Affirms Empresas Publicas de Medellin E. S.P. IDRs at 'BBB+'; Outlook Negative
A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
EPM's ratings reflect the company's low business risk resulting from its diversification and characteristics as a utility service provider. EPM provides electricity distribution and transmission, water and sewage water, garbage collection and disposal, natural gas distribution services, and is the largest electric generator in Colombia. The company's ratings also reflect its solid credit protection measures supported by moderate historical leverage, healthy interest coverage and an adequate liquidity position. EPM's ratings also reflect the company's somewhat aggressive growth strategy as well as its exposure to regulatory risk, which is considered moderate.
Low Business Risk
EPM's low business risk profile stems from its natural monopoly position as the main supplier of electric power, water and natural gas services to Medellin's metropolitan area. The company is one of the largest generators of electricity within Colombia, with nearly 23% of the country's installed capacity. EPM's electricity distribution assets reach a network of approximately 5.9 million customers in six states in Colombia and four other countries. The company provides water services to approximately one million users. This diversification provides EPM with a stable and predictable cash flow stream, primarily derived from regulated utilities; thereby, offsetting some of the company's hydrology risk.
Strong Credit Metrics
EPM's financial profile is strong, characterized by healthy cash flow generation, moderate leverage and healthy interest coverage and liquidity. As of the last-12-months (LTM) ended June 30, 2016, EPM reported a consolidated EBITDA of approximately USD1 billion and total consolidated financial debt of approximately USD5.0 billion and gross leverage ratio of 4.8x. The company's capital structure was temporarily affected over the past year; half by low hydrology, an unplanned outage of one if its largest generation plants, and the depreciation of the Colombian peso. Fitch expects EPM's credit metrics to recover in line with the rating category to historical levels in the short to medium term as hydrology conditions normalize and ongoing expansion projects commence operations.
Aggressive Growth Strategy
EPM's growth strategy is considered somewhat aggressive and is aimed at increasing consolidated revenues and EBITDA by investing in related businesses both within Colombia and abroad. The company's goals are to reach an EBITDA of COP12.6 billion by 2025. This implies that the company's size will more than double over the next decade. Consequently, free cash flow is expected to be negative as the company funds its currently ongoing capital investment program of more than COP28 trillion.
Fitch expects EPM's debt to increase moderately through 2019 as the company finances a portion of its investments with debt, and for the company's consolidated leverage ratios to trend below 3.5x in the medium term. These credit metrics would still be considered consistent with the company's assigned ratings.
EPM's 10-year capital investment program is largely earmarked towards electricity business while the balance will be directed towards the water segment. Approximately 80% of the company's investment plan will go towards generation, distribution, transmission and gas distribution and the balance will go mostly to water segment. Among the largest investment projects is the development of the hydroelectric generation plant 'Ituango', a 2,400 MW of installed capacity project with an estimated cost of COP11.4 trillion, of which approximately 50% of funds remains to be invested. This project will be developed under a 50-year build, operate, own, maintain and transfer (BOOMT) agreement. This project is advancing on time and on budget and the first phase is expected for the end of 2018 and the second phase for 2022.
Moderate Regulatory Risk Exposure
EPM is exposed to some regulatory risk, but it is considered low. The bulk of EPM's consolidated revenues are generated either by regulated tariffs or medium-term contracts. The latter exposes the company to potentially sustained low electricity prices. Historically, all regulatory entities in Colombia have been independent from the central government and have provided a fair and balanced framework for both companies and consumers. Expected regulatory changes over the coming months are assumed to have a neutral impact for the company's cash flow generation and financial profile. Future regulatory changes are expected to be aimed at adding transparency to the market and the regulatory framework overall. EPM's diversified business profile further mitigates the company's regulatory risk as a simultaneous tariff decrease across all businesses is unlikely.
Neutral Regulatory Changes: EPM's ratings assume that the currently proposed regulatory changes do not materially impact the company's cash flow generation going forward, nor will it significantly increase capital investment requirements on its regulated businesses.
Stable Dividends to Medellin: Dividends to the City of Medellin continue to range between 45% and 55%.
Ituango's First Phase Online in 2018: Ituango's first phase come on line at the end of 2018 with half of its capacity that is 1,200 MW, which lowers electricity prices in the country by at least 10%.
No Major Acquisition in the Short Term: EPM's ratings do not assume additional major acquisitions in the short term. The company's credit metrics could deteriorate beyond its rating triggers depending on how additional acquisitions are financed.
A negative rating action could result for any combination of the following factors; a steep decrease in electricity prices, coupled with low generation and poor electricity demand; increasing leverage on a sustained basis to above 3.5x as a result of overly aggressive investment and/or acquisition strategy; and increasing intervention from the municipality of Medellin, EPM's owner.
An upgrade is not likely in the short to medium term given the company's current credit metrics and aggressive growth strategy.
The company's adequate liquidity position is characterized by a manageable maturity schedule and satisfactory cash on hand of approximately USD467 million as of June 2016. EPM's short-term debt as of June 30, 2016 amounted to USD785 million, which are satisfactorily covered with cash on hand and FFO of USD744 million as of LTM June 2016. The company dividend policy has been moderate and is currently not considered a credit constraint. EPM has transferred on average between 45% and 55% of its net income to the city of Medellin in the form of dividends. EPM's transfers to Medellin have historically represented approximately one third of the city's revenues. Although not considered likely in the near term, an increase in the company's dividend distribution policy could pressure its free cash flow generation, which is already expected to continue being negative over the short to medium term due the company's investment plans.
FULL LIST OF RATING ACTIONS
Fitch has affirmed Empresas Publicas de Medellin E. S.P.'s ratings as follows:
--Long-Term Foreign Currency IDR at 'BBB+'; Negative Outlook;
--Long-Term Local Currency IDR at 'BBB+'; Stable Outlook
--Senior Unsecure Debt Rating at 'BBB+';
--National Scale Long-term Rating at 'AAA(col)'; Stable Outlook
--National Scale Senior Unsecure Debt Rating at 'AAA(col)'.
Fitch has affirmed EPM Inversiones S. A., a wholly owned subsidiary of EPM that consolidates most of the company's investments, as follows:
--National Scale Long-Term Rating at 'AAA(col)';
--National Scale Short-Term Rating at 'F1+(col)'.
The Rating Outlook is Stable.