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Rating Action:

Moody's affirms EPM's Baa3 senior unsecured rating; Outlook Stable

Global Credit Research - 20 Sep 2013

New York, September 20, 2013 -- Moody's Investors Service affirms the Baa3 issuer and senior unsecured ratings of Empresas Publicas de Medellin (EPM); the outlook is stable.

RATINGS RATIONALE

"Today's action to affirm EPM's rating is prompted by EPM's Board of Directors' approval of the strategic funding of Mega 2022 plan" said Natividad Martel, a Moody's Vice President. "Because this gives us some clarity on EPM's plans on how it will fund its material capital expenditure program, we now expect the issuer will be able to report credit metrics that remain commensurate with the rating category."

Moody's notes that during the course of the previous strategic plan, Mega 2015, the issuer's financial metrics declined materially with its standalone Cash Flows from Operations (CFO) before Working Capital (pre-W/C) to debt ratio declining from around 74% at year-end 2008 to 32% at year-end 2012. However, Moody's anticipated this deterioration and incorporated it when Moody's assigned EPM a Baa3 rating in 2009. Furthermore, the year-end 2012 metric still compares well against the financial ratio guidelines of 21% to 35% for Baa-rated power producers outlined in Moody's Unregulated Power Generation Companies ratings methodology.

Moody's considers EPM's new expansion strategy, Mega 2022, to be somewhat more aggressive and not without risk, particularly given the challenges and uncertainty associated with its planned optimization processes to achieve EBITDA improvements. Another challenge will be integrating new acquisitions as it continues to extend its footprint to new regional markets, including Mexico and Chile. Furthermore, EPM is exposed to significant execution risk through the large 2,400MW hydroelectric Ituango project, a major endeavor with total investments estimated at approximately US$4.5 billion (including around 18% contingencies). Nevertheless, Moody's gains comfort from EPM's proven track record of financial discipline in funding its expansions. Investment practices for its growth initiatives typically include the use of a significant amount of internally generated resources. To this end, the rating further acknowledges that EPM's dividend policy is also relatively prudent. With a target dividend payout ratio of around 55%, which includes a 25% extraordinary component, future dividends could potentially benefit from some level of flexibility from the Municipality of Medellin during the heavier construction years.

Moody's expectation is that EPM's credit metrics will further deteriorate amid the expected increase in leverage to fund the investments planned with Mega 2022, particularly Ituango. However, Moody's expects the metrics will be somewhat aided by EPM's long-term target capital structure of 60% debt and 40% equity for this project. Furthermore, given the multi-year nature of this eight-unit plant (the first unit is scheduled for completion before year-end 2018 with the last unit expected before year-end 2021), increased borrowings are expected to occur over several years and peak in 2019 when four units are scheduled to be already operational. Considering EPM's cash-flow generation ability, Moody's expects that despite the additional indebtedness, EPM will be able to record CFO pre-W/C to debt at least in the mid to high teens, Retained Cash Flows (RCF) to debt in the low to mid-teens and an interest coverage ratio of at least 3.0x. These metrics are within the financial ratio guidelines for Ba-rated companies under the Unregulated Power generation ratings methodology and are commensurate with EPM's current ba1 Baseline Credit Assessment (BCA). The BCA is a representation of the group's intrinsic creditworthiness before taking into account possible extraordinary support from the Municipality of Medellin.

The Baa3 rating continues to reflect EPM's ownership structure and linkages with its single owner, the Municipality of Medellin (Baa3 positive). Given it is fully owned by the Municipality of Medellin, EPM falls under the scope of Moody's rating methodology for government-related issuers (GRIs). The Baa3 rating reflects Moody's assessment of a medium-level probability of extraordinary support from the municipality and a high level of dependence, which reflects the degree to which Medellin is exposed to the same risks as those that would affect credit quality at EPM.

The outlook on EPM's ratings is stable, which is based on our belief that EPM will be able to successfully manage its expected increased leverage position and ongoing substantial capex programs, foreign currency risk exposure and liquidity despite its significant dependence on the capital markets in the absence of committed bank credit facilities. It further assumes that EPM will continue its overall prudent dividend policy and that funding of its investments will be done in such a way that the reported credit metrics will continue to be well positioned for its current ba1 BCA rating.

Assuming any new expansion opportunities do not result in the implementation of a more aggressive financial policy, the BCA rating could be upgraded if EPM successfully manages the construction of the multi-year Ituango hydro project; particularly, in terms of cash flows, leverage as well as liquidity, and after evidence that the planned construction advances were expended according to schedule and budget. The BCA could experience further positive momentum upon evidence of a significant improvement in the credit supportiveness of the Colombian regulatory framework that results in a material enhancement of EPM's financial performance. Quantitatively, an upgrade could be triggered if EPM reports RCF to debt higher than 22% and CFO pre-W/C interest coverage higher than 4.5x, both on a sustainable basis. Apart from a change in the standalone fundamental credit quality of EPM, the unsecured debt rating could be upgraded if the rating of the Municipality of Medellin is upgraded, albeit this will also depend on Moody's assessment regarding the Municipality's ability and willingness to provide extraordinary support, particularly given EPM's growing international footprint.

The BCA rating could be downgraded as a result of a deterioration in the credit supportiveness of the Colombian regulatory framework or EPM's inability to recover costs in a timely manner. A rating action could be also triggered if the Ituango hydro project and/or any new expansion targets are poorly executed or result in the implementation of financial policies, such that the indebtedness increases significantly above anticipated levels resulting in a material deterioration of its credit metrics. Quantitatively, a negative rating action would be triggered if the interest coverage falls below 3.0x and the RCF to Debt declines below the mid-teens' level. Apart from a change in the standalone fundamental credit quality of the issuer, the ratings of the notes could be downgraded if EPM decided to incur a material amount of secured debt as a proportion of total debt (currently all debt is unsecured). Moreover, a significant deterioration of the financial strength of the City of Medellin or a downgrade in Colombia's foreign currency ceiling could negatively affect EPM's ratings as well.

The principal methodologies used in rating EPM are the Moody's Unregulated Power Generation Companies rating methodology published in August 2009 and the Government Related Issuers: Methodology Update published in July 2010. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Headquartered in Medellin, Colombia (Baa3 positive), Empresas Publicas de Medellin, E.S.P. (EPM) is a multi-utility vertically integrated public service group. EPM provides directly or indirectly via its subsidiaries natural gas and electric distribution, generation, transmission, and commercialization services (energy business unit) to over three million customers, as well as water and sewage services (water business unit) to around one million customers. EPM's regulated operations in the Colombian natural gas and electricity sector are subject to the purview of the Comision de Regulacion de Energia y Gas (CREG), while its water and sewage activities are under the jurisdiction of the Comision de Regulacion de Agua Potable y Saneamiento Basico (CRA). EPM holds also ownership stakes in regulated utilities in Guatemala, El Salvador and Panama and extended its international footprint during the second quarter of this year to Chile (110MW wind-farm) and Mexico (80% interest in Tecnologia Intercontinental S.A. de C.V., an engineering and operator of water treatment plants). EPM is currently also in the process of combining its subsidiary, EPM Telecomunicaciones S.A. E.S.P. (UNE) with Millicom's controlled Colombia Movil.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Natividad Martel
Vice President - Senior Analyst
Infrastructure Finance Group
Moody's Investors Service, Inc.

JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

William L. Hess
MD - Utilities
Infrastructure Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's affirms EPM's Baa3 senior unsecured rating; Outlook Stable
No Related Data.

 

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