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Rating Action:

Moody's assigns first-time B1 rating to Inkia Energy

 The document has been translated in other languages

Global Credit Research - 18 Mar 2011

Approximately US$300 million of debt securities affected

New York, March 18, 2011 -- Moody's Investors Service has assigned a B1 Corporate Family Rating (CFR) and a FC B1 senior unsecured debt rating on the Global Scale to Inkia Energy Ltd's (Inkia) planned issuance of up to US$300 million of senior unsecured notes to be issued under a 144(A) registration. This is the first time Moody's has rated Inkia. The rating outlook is stable.

RATINGS RATIONALE

The B1 CFR and senior unsecured debt rating reflects our assessment of Inkia's historical and projected consolidated credit metrics, which we believe position the company at the upper end of the B-rating category for unregulated power companies. Over the last three years, Moody's calculates that the company's cash flow before working capital changes (CFO pre-W/C) and cash flow coverage of interest expense were below 12% and 3.0x, respectively, while the company experienced negative free cash flow due principally to various capital investment programs. Prospectively, Moody's believes that these financial metrics will trend downward through 2012, as the company completes its multi-year construction program at Kallpa, a Peruvian based generation subsidiary, which is converting its existing open-cycle natural gas facility (consisting of three turbines) to a combined-cycle plant configuration (CC conversion). The company anticipates the CC conversion will be completed during 2012 which should not only improve the plant's operating efficiency but also its competitive position in the Peruvian power market. Over this timeframe of continuing negative free cash flow, we anticipate that the ratio of CFO pre-W/C to debt will average in the mid-to-high single digits with CFO pre-W/C coverage of interest expense of approximately 2.5x. Moody's notes that Inkia has committed subsidiary level financing arrangements at the Kallpa level, which will help fund this negative free cash flow.

While the rating incorporates the importance of the Peruvian subsidiaries including not only the future expected cash flows from Kallpa but also from its 21.1% economic interest in Edegel, the largest generator in Peru, the rating also acknowledges the asset concentration that exists at Kallpa which is somewhat balanced with the geographic diversity of Inkia's cash flow stream from its investments in other Latin American and Caribbean countries. The rating recognizes the predictability of Kallpa's future cash flows, which is underpinned by the existence of Power Purchase Agreements (PPAs) for the bulk of its available energy that include certain cost indexation clauses, which help to mitigate the impact of substantial variations in certain costs such as fuel that the company may experience over the life of the PPAs.

The B1 rating also considers the degree of structural subordination that exists at Inkia as a holding company and its full reliance on its subsidiaries' dividend distributions to service its debt. In particular, the rating points to the fact that Kallpa, the most important Inkia subsidiary, is not anticipated to provide dividends to Inkia while the CC conversion is being completed, and that Inkia's access to cash payouts from its other prominent cash flow contributor, Edegel, is limited until the outstanding bonds of its indirect intermediate parent holding-company subsidiary, Southern Cone Power Peru S.A. (SCPP) become due in 2012. Therefore, Inkia bondholders will further rely over the near to medium term upon dividends for debt service and other holding company obligations from a variety of smaller subsidiaries. While annual holding company needs are expected to be relatively modest and we anticipate internal sources of holding company liquidity to remain adequate, the increased reliance on the smaller and less predictable subisidaries for debt service over this timeframe is a constraining factor in this rating assignment. Beginning in 2013, Moody's anticipates SCPP and Kallpa will be able to provide meaningful cash flow contributions to the parent beginning in 2013, once Kallpa's CC conversion is completed and SCPP's bonds mature.

The B1 rating further considers the company's fairly sizeable growth and development strategies currently centered around the construction of Cerro del Aguila (Cerro), a 402 megawatt (MW) hydro project, planned to be completed in 2015. While the company's future performance may benefit from the construction of this cost-competitive asset, we observe that Inkia's management has limited project development expertise, particularly as it relates to the construction of a multi-year hydro project. Moreover, Moody's has limited insights into other potential investment projects that Inkia's management may pursue outside of the Cerro project.

The rating acknowledges Inkia's parent company Israel Corporation's (IC) sizeable capital commitment to help fund Inkia's growth and development; however, such support is balanced by our understanding of the terms and conditions of the shareholder loans between IC and Inkia, which we consider to be somewhat akin to subordinated debt-like obligations in our rating assessment of Inkia. That being said, we observe that the terms and conditions of the unsecured notes limit, among others things, the incurrence of additional debt and place restrictions on payments to the shareholder (both dividends and payments under the shareholder loans) which enhances Inkia's financing flexibility, particularly through 2012.

Proceeds of this offering are expected to be used for the repurchase of Inkia's outstanding Nuevos-soles 9.25% senior secured bonds due in 2015 (about US$82.8 million), for working capital purposes, to finance its expected equity contribution in Cerro and for other projects and acquisitions that the company may pursue in the future.

Moody's has reviewed preliminary draft legal documentation for the proposed senior unsecured notes and the assigned rating assumes that there will be no material variation from the draft reviewed and that all agreements will be legally valid, binding and enforceable.

The stable rating outlook reflects our opinion that Inkia's rating is likely to remain well positioned within the B-rating category based upon our expectations for future consolidated credit metrics over the next few years, particularly, with the CC conversion project well underway at Kallpa, the related dividend limitations that are expected to persist during this timeframe, and an anticipated increase in consolidated indebtedness associated with the funding of new growth projects such as Cerro.

Inkia's ratings could see some positive momentum after completion of the CC conversion expansion and receipt of some steady dividend distributions from this critical subsidiary.To that end, once the Kallpa CC conversion nears completion, a positive rating action could surface if, as we expect, Inkia's consolidated credit metrics (including any new project finance debt) improve such that cash flow coverage of interest expense, cash flow to debt and retained cash flow (RCF) to achieve levels in excess of 2.5x, 13% and 8%, respectively, on a sustainable basis. Additionally, any improvement in Inkia's consolidated financial performance will be balanced against our assessment of the company's growth and development initiatives underway at that time.

Complications in the completion of Kallpa's combined cycle expansion program, and/or political or operational problems at some of the other key subsidiaries that result in a material deterioration in the anticipated dividend distributions to Inkia and/or in the consolidated credit metrics could put downward pressure on the ratings. Specifically, if Inkia reports consolidated cash flow to debt, and RCF to debt below 7% and 3%, respectively, and cash flow interest coverage of less than 1.5x, on a sustainable basis.

The principal methodology used in rating Inkia was the Unregulated Utilities and Power Companies methodology (August 2009). Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in our website www.moodys.com.

Headquartered in Lima, Peru, Inkia is an international holding company incorporated in Bermuda that holds ownership stakes in power generation companies in Peru (Government bond rating: Baa3, stable), Bolivia (Government bond rating: B1, positive), Dominican Republic (Government bond rating: B1, stable), El Salvador (Government bond rating: Ba1, negative), Jamaica (Government bond rating: B3, stable) and Panama (Government bond rating: Baa3, stable). Inkia has net ownership of 1,191MW (adjusted to account for its proportional ownership interest) of effective generation capacity. At year-end 2010, Inkia reported consolidated assets of around US$1.2 billion and cash flow from operations of around US$104 million.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, confidential and proprietary Moody's Investors Service information, and confidential and proprietary Moody's Analytics information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of assigning a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Natividad Martel
Analyst
Infrastructure Finance Group

New York
A.J. Sabatelle
Senior Vice President
Infrastructure Finance Group
Moody's Investors Service
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Moody's assigns first-time B1 rating to Inkia Energy
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