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Global Credit Research - 04 Feb 2011
Approximately BRL100 million of debt securities affected
Sao Paulo, February 04, 2011 -- Moody's America Latina (Moody's) affirmed the Ba3 local currency
rating on the global scale and A3.br on the Brazilian National
Scale rating for the existing BRL100 million unsecured debentures due
2012 issued by Companhia de Saneamento do Paraná - Sanepar
and changed the outlook to stable from negative.
Sanepar's Ba3 rating largely reflects its monopoly rights to operate water
and sewage services in an attractive concession area as well as its strong
credit metrics for the rating category, which have been historically
characterized by relatively low leverage and strong operating margins.
A track record of political interference by the state government constrains
the rating, as does the lack of a well established regulatory framework
for water utilities in Brazil and the increasing business risk resulting
from the tariff freeze initiated in 2005. Uncertainties about the
designation of certain advances from the major shareholder totaling BRL866
million further constrain the rating.
The change to stable outlook reflects Moody's decreasing concern
over the potential impact of the existing BRL866 million in liabilities
on the company's cash flow and liquidity position in the near term.
On January 4, 2011, Sanepar's shareholders replaced
six members of its Board of Directors and announced nine new executive
officers, including Mr. Fernando Ghignone as the new CEO
appointed by the new state governor and Mr. Dirceu Wichnieski as
the new CFO suggested by the minority shareholder, Dominó
Holdings S.A (Dominó). These changes in Sanepar's
management team made after a new administration took office in the State
of Parana contributed to lessen Moody's apprehension. Going
forward, we expect the new state government to be more supportive
of Sanepar's operations and more willing to mitigate some of the key challenges
mentioned above, including the ongoing tariff freeze and the ongoing
dispute with the minority shareholders. We also expect to see positive
steps towards improvement in the quality of corporate governance and board
Until 2007, the company had posted a stable capital structure that
featured relatively low leverage and a healthy debt maturity profile that
were very strong for its rating category. At the end of 2008,
however, Sanepar's debt profile deteriorated sharply after the board
of directors decided to convert into debt around BRL775 million of advances
that were originally intended for future increases in capital.
In Moody's opinion, this decision was a response by the major shareholder,
the State of Parana, which was not allowed to convert these resources
into capital as a result of a long judicial dispute with the minority
shareholder, the Dominó, regarding a shareholders'
agreement to control Sanepar that dates back to 2003. As a result,
the leverage ratio measured by Debt to Capitalization reached 51.6%
on September 30, 2010 compared to 35.4% on December
31, 2007, while the FFO to Net Debt ratio decreased to 14.9%
from around 24.8%. Nevertheless, Sanepar's
current credit metrics remain well positioned for its Ba3 rating category.
The tariff freeze in place since 2005 remains a concern as it impairs
the company's ability to generate adequate cash flow in face of a relatively
sizeable capital expansion program and an expected scenario of rising
inflation. The EBITDA margin has consistently decreased over the
last five years as a result of the tariff freeze. Previous management
had focused on improving operating efficiency, which has partly
offset the unchanged tariffs and allowed the EBITDA margin to stabilized
at around 40%. New management has stated its intention is
to reduce operating expenses by 15%. Our projections indicate
that Sanepar should still post adequate operating margins in 2010,
but going forward the margin trend will largely depend on whether the
state government grants some tariff relief. An additional risk
is the reduced cushion in one of the financial covenants embedded in the
outstanding debentures that requires a minimum EBTIDA margin at 35%.
Moody's has not received updated cash flow projections from Sanepar as
the new management team is currently reviewing the budget plan for 2011-2013.
Approval of a revised plan is expected in March. Our preliminary
projections indicate that Sanepar will remain committed through a large
investment program to maintaining high coverage of water services,
to reducing current water losses and to expanding its current installed
sewage capacity. At the end of 2010, the company announced
a BRL1.7 billion investment program in public services from 2011
through 2013 that includes investments to expand the coverage of sewage
services from 62% to 70% of the population in its concession
area by 2014. Historically, the execution of Sanepar's investment
programs have been subject to the availability of adequate funding which
has usually translated into effective cash outlays below the budget plan.
Moody's will continue to assess further changes to Sanepar's financial
strategy and will comment as appropriate.
While the company's stable rating outlook factors in the continued
execution of its expansion plan, Moody's expects that management
will manage its capital structure prudently and finance its capital expenditures
and dividends in a manner that keeps the company's credit metrics compatible
with the Ba3 rating category. The stable outlook is also predicated
on Moody's expectation of a constructive solution over the designation
of the existing BRL866 million in advances for future increase in capital,
which is key to maintaining the company's adequate debt maturity
profile and liquidity position.
Moody's could upgrade the ratings if financial performance improves
such that there is a sustainable ratio of FFO to Net Debt in excess of
20% and interest coverage above 3.5x, which will depend
materially on increased visibility with regard to future tariffs and capital
expenditures. Strong evidence of increased support from the state
government could also positively affect the ratings.
The ratings could be downgraded if financial performance deteriorates
such that FFO to Net Debt falls below 10% and interest coverage
declines to less than 2.5x for an extended period or if the company's
liquidity position deteriorates as a result of inadequate funding for
its capital expenditure program or an inability to materially reduce its
operating expenses. The ratings could also be negatively affected
by a downward revision of the assumed level of support of the state government.
The last rating action on Sanepar was in July 23, 2009 when Moody's
confirmed all ratings but changed the outlook to negative.
The principal methodology used in rating Sanepar was the Global Regulated
Water Utilities rating methodology published in December 2009.
Other methodologies and factors that may have been considered in the process
of rating this issuer can also be found on Moody's website.
Moody's National Scale Ratings (NSRs) are intended as relative measures
of creditworthiness among debt issues and issuers within a country,
enabling market participants to better differentiate relative risks.
NSRs differ from Moody's global scale ratings in that they are not globally
comparable with the full universe of Moody's rated entities, but
only with NSRs for other rated debt issues and issuers within the same
country. NSRs are designated by a ".nn" country modifier
signifying the relevant country, as in ".br" for Brazil.
For further information on Moody's approach to national scale ratings,
please refer to Moody's Rating Implementation Guidance published in August
2010 entitled "Mapping Moody's National Scale Ratings to Global Scale
The State of Parana holds 60% of Sanepar's voting shares and 52.5%
of its total capital. Consequently, Sanepar is considered
a Government-Related Issuer (GRI) in accordance with Moody's rating
methodology entitled "The Application of Joint Default Analysis to Government-Related
Issuers". Moody's methodology for GRIs incorporates the company's
stand-alone credit risk profile or Baseline Credit Assessment (BCA)
as well as the likelihood that a government would provide extraordinary
support for the company's debt obligations. The Ba3 rating of Sanepar
results from the application of joint-default analysis of the company's
BCA and the State of Parana, Moody's view of high dependence (the
likelihood that both entities would default at the same time), and
a moderate probability of extraordinary support from the controlling shareholder.
The BCA of a GRI may be expressed on a 1-21 scale, corresponding
to the 21 ratings ranging from Aaa to C. Sanepar's ratings incorporate
a BCA of 13 (mapping to Ba3) along with an estimated moderate level of
support and high dependence from the State. Please refer to Moody's
report entitled "Government-Related Issuers: Methodology
Update" as of July 22, 2010 available at moodys.com for additional
information on GRIs.
Headquartered in Curitiba, Brazil, Companhia de Saneamento
do Paraná - Sanepar provides water treatment and distribution
to 9.0 million consumers, and sewage service to 5.4
million consumers in 344 municipalities in the state of Paraná
and one municipality in the state of Santa Catarina. In the last
twelve months ending September 30, 2010, Sanepar reported
net earnings of BRL142 million (USD80 million) on BRL1,461 million
(USD821 million) in net revenues.
Corporate Finance Group
Moody's Investors Service
William L. Hess
MD - Utilities
Infrastructure Finance Group
Moody's Investors Service
Moody's America Latina Ltda.
Moody's affirms the rating of Sanepar; changes outlook to stable
Avenida Nacoes Unidas, 12.551
16th Floor, Room 1601
Sao Paulo, SP 04578-903
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