EPM’s ratings reflect strong ownership and control by its owner, the City of Medellin (‘BB+’/Stable), which was downgraded to ‘BB+’/Stable from ‘BBB-‘/Negative. The company’s business risk is low resulting from its diversification and characteristics as a utility service provider. The company’s ratings also reflect its somewhat aggressive growth strategy and solid credit protection measures supported by moderate projected leverage, healthy interest coverage and an adequate liquidity position.

This article is edited from Fitch’s press release regarding its downgrade of EPM

EPM’s Negative Watch reflects continued uncertainty regarding the closure of Ituango’s blocked Auxiliary Diversion System since April 28, 2018, and final cost over-runs of its Ituango project. The possibility of major flooding downstream from the project exists until the diversion tunnel is closed. While the likelihood of this is remote, the environmental, financial and reputational damage to the company could be significant. Fitch’s expectation is that 300MW of the project will be online by mid-2022. The resolution of the Rating Watch may extend longer than six months given these uncertainties.

Key Rating Drivers

Strong Linkage with Parent:

EPM consistently contributes significant cash flows in the form of dividends to its parent, the City of Medellin (BB+/Stable). These distributions comprised over 22% of the city’s total revenues in 2020 and have exceeded government revenues by 20% four out of the last five years. Under Fitch’s criteria, a government-related entity (GRE) that sustainably generates more than 10% of the government’s revenues is considered a strong linkage factor that would lead to an equalization of the ratings.

Ituango Progress:

Fitch continues to maintain the Rating Watch Negative until further confirmation that the diversion and auxiliary tunnels are appropriately plugged. The tunnels are expected to be secured between December 2021 and March 2022, just prior to the entry of the first 300MW unit. As of March 2021, the company reported 92.5% progress on pre-plug 2 of the right deviation tunnel. Despite an additional delay announced in June 2020 due to the coronavirus, Fitch’s base case is that two 300MW units will come online per year between 2022-2025. Fitch expects that once complete, Ituango will add over $800 million USD to the company’s generation revenue and become part of the country’s base load installed capacity.

Insurance Payments Support Capex:

Fitch’s base case assumes that EPM will receive insurance payments of over USD800 million between 2021-2024 for its Ituango project at a rate of roughly USD200 million per year. Insurance payments will be made in instalments as both entities review damages and costs. The payments are a credit positive and relieve pressure of EPM selling assets to offset the estimated incremental project cost of USD1.6 billion. EPM received the first payment of USD150 million from Mapfre Seguros Generales de Colombia S.A. in 2019 and USD200 million in 2020. Payments are contingent on a suspension of the arbitration process against the insurers, which was temporarily suspended in June 2021.

Deleveraging Expected:

Fitch estimates EPM’s consolidated gross leverage, defined as total debt to EBITDA, will average 3.3x between 2021-2024. Leveraged peaked at 4.7x in 2020 as poor demand affected the company’s distribution businesses, low hydrology impacted generation and Ituango incurred additional cost overruns. Fitch expects leverage to fall to 3.8x in 2021 as conditions normalize and to drop to 2.8x by 2024 due to tariff increases at the company’s distribution businesses and a number of Ituango’s generation units coming online, the first of which is expected in mid-2022.

Moderate Regulatory Risk Exposure:

Fitch believes EPM’s exposure to regulatory risk is low. The bulk of EPM’s consolidated revenues is generated by regulated tariffs or medium-term contracts. The latter exposes the company to potentially sustained low electricity prices. Historically, Colombian regulatory entities have ruled independently from the central government and have provided a fair and balanced framework for both companies and consumers. EPM’s diversified business profile further mitigates the company’s regulatory risk, as a simultaneous tariff decrease across all businesses is unlikely.

Assumption of CaribeMar Assets:

Fitch views EPM’s assumption in September 2020 of CaribeMar, a coastal electricity distribution company renamed to Afinia, as positive for the business and credit neutral. Fitch estimates that once the Afinia business is stabilized in 2023, it will add approximately USD1.2 billion in revenue and USD165 million in EBITDA. Fitch estimates capital expenditures of COP4 trillion, or USD1 billion between 2021-2024. This investment will be necessary to lower high energy losses, which stood at an estimated 27.6% in 2020 with the goal to lower this amount to below 22% by 2024.

Stable Cash Flow Profile:

EPM has a stable and predictable cash flow profile supported by regulated businesses in investment grade markets. Fitch estimates 79% of EPM’s 1Q21 EBITDA was derived from its energy business, where its generation segment comprised 34%; 38% was distribution; and the gas and transmission segments combined for 7%. EPM’s distribution business operates in highly regulated markets, mostly concentrated in Colombia, where it is the largest distributor in the country, with a market share of 25%. Fitch estimates that 21% of the company’s EBITDA comes from its water and waste management services.

Interference Weakens Corporate Governance:

Fitch views EPM’s corporate governance as weak due to the strong influence exerted by the company’s owner, the City of Medellin. This follows a lawsuit against the Ituango project insurers and contractors and the contemplated change of the company’s social objective in 2020, which prompted the resignation of all eight independent board members. EPM has an ESG Relevance Score of ‘4’, which reflects the company’s recent instability in board membership and indicates that the score has a negative impact on the company’s credit profile.

Derivation Summary

EPM’s ratings are linked to those of its owner, the Municipality of Medellin (BB+/Stable), due to the latter’s strong ownership and control over the company. The company’s low business-risk profile is commensurate with that of Grupo Energia Bogota S.A. E.S.P.’s (GEB, BBB/Stable), Enel Americas S.A. (A-/Stable), AES Gener (BBB-/Stable) and Promigas (BBB-/Stable).

Fitch projects EPM’s total leverage to average 3.3x over the rating horizon and 3.0x on a net basis. This is slightly above AES Gener’s expected average gross and net leverage of 3.1x and 2.3x and below Promigas’, which is expected to be 3.6x and 3.3x, respectively. In 2024, Fitch expects gross and net leverage to be 2.8x and 2.5x, respectively, reflecting advances in the Ituango project, a recovery in EPM’s electricity distribution businesses and the normalization of operations at newly-acquired Afinia.

Key Assumptions

• Ituango units come online at a rate of two per year from 2022-2025;
• Total Ituango cost of USD3.9 billion, a USD1.8 billion increase from original budget;
• Ituango’s medium-term commercial obligations are covered with electricity purchases, existing hydroelectric asset base and thermal generation;
• No Dividends from UNE expected over the rating horizon;
• Dividend payout of 55% of previous year’s net income;
• No divestments in 2021 or the rating horizon;
• Total Insurance payments in excess of USD800 million from 2021 through 2024;
• Capex for Electricarbe to be financed predominately through debt up to USD800 million;
• Medium-term electricity spot prices of COP155/KWh.

Rating Sensitivities

Factors that could, individually or collectively, lead to positive rating action/upgrade:

• Although unlikely in the near term, Fitch may consider a positive rating action if there is a positive rating action on the company’s owner, the City of Medellin;
• Fitch may consider a resolution of the Rating Watch Negative once the company has secured the second deviation tunnel at its Ituango project, which Fitch expects by early 2022. In such a case, the rating Outlook for the City of Medellin would likely apply.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

• A negative rating action on the City of Medellin’s ratings;
• The materialization of significant cost overruns and contingencies at the Ituango project that weaken the company’s liquidity.

Best & Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity & Debt Structure

Strong Liquidity: Fitch expects the company’s USD750 million 2020 bond issuance to provide the near-term liquidity for general corporate purposes and to fund the company’s capex program in 2021. Approximately 66% of the company’s EBITDA is from regulated businesses with highly stable cash flow generation. EPM held approximately COP5.3 trillion of cash and equivalents as of 1Q 2021. Fitch expects the company will have COP2.3 trillion of cash on hand at the end of 2021 as it continues work on the Ituango project and makes network improvements at its newly-acquired distribution business, Afinia. Fitch estimates the company has in excess of USD500 million in available committed credit lines.

Currently, the company’s dividend policy is expected to remain in place despite the cash flow impact derived from Ituango’s delay. Historically, 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 20% to 30% of the city’s investment budget. Although not likely in the near term, an increase in the company’s dividend distribution policy could pressure its FCF generation, which is already expected to continue to be negative in the near term as the company continues to execute its investment plan.

Issuer Profile

EPM is a leading electricity generator in Colombia and exhibits a diversified international portfolio of utility businesses that include electric generation, transmission and distribution, water and sewage services, natural gas distribution, and garbage collection and disposal services.

• Ecopetrol S.A. (NYSE: EC) — Colombia’s largest petroleum company, majority owned by the government
• Grupo de Inversiones Suramericana S.A. (Grupo Sura) — Colombia’s largest Insurance conglomerate
• ISAGEN, S.A. E.S.P. — A Colombian Energy and infrastructure provider controlled by Canada’s Brookfield Asset Management
• Oleoducto Central, S.A. (OCENSA).— Oil pipeline operator affiliated with Ecopetrol

Although the following two entities have ratings above that on Colombia’s sovereign rating, S&P downgraded them to ‘BBB-‘ from ‘BBB’ while assigning a stable outlook:

• Enel Americas S.A. — Electrical utility subsidiary of European utility conglomerate Enel.S.p.A.
• Emgesa S.A. E.S.P.— Wholesale electricity provider, also a subsidiary of Enel.

The ratings on both entities are higher than on Colombia’s sovereign rating, primarily because of the potential support they would receive in case of financial distress from their parent companies — Enel SpA (BBB+/Stable/A-2) in the case of Enel Americas, and Enel Americas for Emgesa.

S&P also lowered the issue-level ratings on OCENSA parent A.I. Candelaria Spain to ‘B+’ from ‘BB-‘. The ratings firm says that this is because they still see a notch differential due to its total reliance on subordinated dividend payments from its sole investment, OCENSA, which distributes them after funding its operating and financial needs.

S&P also affirmed the ‘AA’ rating on toll highway developer Sociedad Concesionaria Vial Montes de María S.A.S. (Puerta de Hierro). The outlook remains stable.

The latter rating action follows the failure of the government’s fiscal reform proposal amid high spending pressures, resulting in a sharply lower likelihood of Colombia improving its fiscal position following a recent and marked deterioration. Given high external vulnerability, comparably weak economic profile–balanced by adequate institutions and monetary credibility–Colombia’s debt will stabilize at around 60% of GDP during 2021-2024 and will post relatively wide fiscal deficits. These factors are no longer consistent with an investment-grade foreign currency rating (readers may refer to S&P’s “Colombia Long-Term Foreign Currency Rating Lowered To ‘BB+’ On Persistent Fiscal Weakness; Outlook Stable“, published on May 19, 2021, for further details).

This is because according to Standard & Poor, these firms continue to be exposed to Colombia’s sovereign risk given that they operate in what S&P deems highly regulated sectors (dependent on rate adjustments approved by government regulators) and that demand for their services is in some cases correlated to the country’s GDP growth pace. Consequently, S&P believes the entities could suffer from heavier regulation in a sovereign stress scenario, and wouldn’t be able to generate or maintain sufficient cash to honor their financial obligations under a sovereign default scenario.

Ecopetrol

This is the case for Ecopetrol, of which Colombia’s government is a controlling shareholder. Therefore, ratings on the company and its subsidiaries move in tandem with those on the sovereign. In S&P’s view, the final rating on Ecopetrol is capped at the level of the ‘BB+’ foreign currency rating on Colombia, given the ratings firm’s expectation that the government could have a tendency to increase taxes or dividends if it faces fiscal or external stress, which could restrict Ecopetrol’s financial flexibility. Additionally, S&P’s assessment that the company has a very strong link with the government also limits the rating. As a result of the downgrade of Ecopetrol, S&P took a similar rating action on its subsidiary, OCENSA, because the ratings agency doesn’t believe there are meaningful regulatory mechanisms or other structural barriers that restrict the parent from accessing the subsidiaries’ cash flows in a scenario of distress. In addition, Ecopetrol is OCENSA’s main client, representing more than 80% of its revenue in 2020.

A.I. Candelaria Spain

S&P also lowered the issue-level rating on Candelaria’s notes, given 100% of its equity interests in OCENSA and its total reliance on subordinated dividend payments from the latter entity, which distributes them after funding its operating and financial needs. In addition, given that OCENSA is not publicly traded, it might be difficult for Candelaria to liquidate its investment if needed, and for S&P to forecast asset valuations relative to debt with certainty. The rating on Candelaria’s notes also captures the existing governance principles contained in the shareholders’ agreement whereby Candelaria holds veto powers over OCENSA’s material decisions such as business plans, large investments, and changes to the dividends policy.

Isagen

Isagen sells about 35% of its energy to distributors, which have their rates set by the regulator. Therefore, S&P says that it believes payments to Isagen–in case of a regulatory interference in distributors’ rates–could deteriorate. In addition, Isagen sells a portion of its output on the spot market, which could also be at its regulatory floor amid recession. Therefore, the sovereign rating caps the rating on Isagen, in S&P’s view.

Grupo Sura

S&P believes that Grupo Sura wouldn’t pass a Colombian sovereign default stress test scenario. The sovereign rating cap and risk to Grupo Sura in a sovereign default scenario reflect the high correlation between the company’s assets and dividends, and the country’s economy, because around 40% of assets operate mostly inside Colombia. The company is exposed to Colombia’s financial system because Grupo Sura has a stake in Bancolombia, which represents approximately 25% of the dividend stream. S&P says this limits the rating on Grupo Sura to the sovereign level because it is highly likely that a sovereign default would entail a significant shock to the country’s financial system.

Enel Americas

S&P predicts around 35% of Enel Americas’ EBITDA to come from Colombia in 2021, followed by Brazil (about 45%), Peru (15%), and Argentina (5%). Although Enel Americas’ debt repayment capacity remains stronger than those of the sovereigns where it operates, mainly because of the potential support it would receive from its parent company Enel in case of financial distress, the company’s downgrade reflects its sensitivity to deteriorating country risks.

The rating action on Emgesa follows the one on Enel Americas, given that the former plays an important role in the latter’s strategy in Latin America. Therefore, S&P expects the latter to support Emgesa under any foreseeable circumstance, including a hypothetical sovereign default of Colombia.

Puerta de Hierro –  Sociedad Concesionaria Vial Montes de María S.A.S.

S&P affirmed the rating on Puerta de Hierro as it reflects the guarantor’s creditworthiness. This is because Puerta de Hierro’s notes benefit from an irrevocable financial guarantee for interest and make-whole premium payment, in respect to the maximum guaranteed principal amount and for up to $350 million on principal from the US Government’s Development Finance Corp. (DFC). However, S&P revised downwards the project’s operations phase stand-alone credit profile to ‘bb+’ from ‘bbb-‘ because they consider the creditworthiness of the project’s main offtaker (Agencia Nacional de Infrastructura) to be one notch below its ‘BBB-‘ local currency rating on Colombia for the following reasons:

• There are no cross-default clauses linking these obligations with sovereign debt;
• S&P views the reporting of ‘Vigencias Futuras’ and other contingent liabilities as transparent because the government explicitly recognizes payment obligations and contingent liabilities that arise from this transaction. However, the government doesn’t report these 4G Highway-related obligations as sovereign debt.

Outlook

The stable outlook on these entities mirrors that on Colombia. The ratings on the latter pose a limitation on credit quality of corporate and infrastructure entities, given their exposure to sovereign risk. Therefore, S&P expects the ratings on these entities to move in tandem with the sovereign ratings in the next 12 to 18 months.

The stable outlook on Enel Americas mirrors that on Brazil and Colombia, its two main markets. Ratings on Emgesa are the same as on the parent and would move in tandem with the latter.

The stable outlook on Puerta de Hierro’s notes reflects S&P’s expectation of full coverage for the debt repayment given DFC’s financial guarantee. Therefore, the outlook on project’s notes reflects that on the US rather than Colombia. Moreover, the stable outlook reflects the guarantee coverage of over 60% stemming from the appreciation of the Colombian peso.

Downside scenario

In the next 12-18 months, S&P says it may downgrade these companies in case of a similar rating action on Colombia. The firm could lower the sovereign ratings if the potential long-term damage caused by the pandemic, other domestic developments, or new external shocks, prevent the Colombian economy from recovering in 2021 and results in lower-than-expected GDP growth in subsequent years. A perceived deterioration in Colombia’s institutional effectiveness, such as the inability to find political and social consensus to sustain growth and the country’s fiscal profile, could also translate into a downgrade.

S&P might also downgrade Enel Americas in case of a negative rating action on Brazil or if it believes that the company has become a less integral subsidiary for Enel. In such a case, they say they would also downgrade Emgesa.

S&P could lower the rating on Puerta del on Hierro in the next 12-24 months if DFC’s credit quality weakens, which could happen if S&P lowers the rating on the US or the relationship between the US government and DFC weakens.

Upside scenario

In the next 12-18 months, S&P indicates it could upgrade these companies if it takes a similar action on the sovereign rating on Colombia, while everything else remains equal. This can occur if there is faster-than-expected economic growth, coupled with structural fiscal measures, which reduce Colombia’s fiscal financing gap, lower the debt burden, and strengthen public finances. A larger and more diverse export sector, helping to reduce external vulnerability and strengthen economic resilience, could also result in the upgrade over the middle to long term.

In the next 18 months, S&P also says it could raise the rating on Puerta de Hierro’s notes if it either raises the rating on the US or if S&P believes the relationship between the US government and DFC strengthens.

See also: Colombians Take To The Streets To Protest, Lambast President Duque’s Fiscal Reform Package

At closing the issuance amount of the 8.375% senior notes payable in Colombian pesos will be converted into an initial equivalent Colombian peso amount based on the then current exchange rate. The Colombian peso amounts payable in respect of principal and interest will be converted to U.S. dollars based on the Colombian peso exchange rate prevailing at that moment. Payment of the notes is therefore exposed to exchange rate fluctuations, and payment of principal and interest can decrease in USD terms if the Colombian peso depreciates.

EPM’s ratings reflect the company’s low business risk resulting from its diversification and characteristics as a utility service provider. EPM is a leading electricity generator in Colombia and exhibits a diversified portfolio of utility businesses that include electric generation, transmission and distribution, water and sewage services, natural gas distribution, and garbage collection and disposal services. The company’s ratings also reflect its solid credit protection measures supported by moderate historical and projected 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 low.

EPM’s Negative Watch reflects continued uncertainty regarding the closure of Ituango’s blocked Auxiliary Diversion System since April 28, 2018, and final cost over-runs of its Ituango project. In June 2020, the company announced an additional delay due to the coronavirus pandemic. Fitch’s expectation is that 300MW of the project will be online by early 2022. Additional technical and infrastructure complications are possible and could further delay the project’s Commercial Operation Date (COD). Additional unforeseen contingencies have been partially mitigated after the insurers announced the damages qualified under the insurance policy, but there is no clarity as to when and what damages will be covered. The resolution of the Rating Watch may extend longer than six months given these uncertainties.

KEY RATING DRIVERS

Minor Delay at Ituango: Fitch continues to maintain the Rating Watch Negative until further confirmation that the diversion and auxiliary tunnels are appropriately plugged. In June 2020, the company announced an additional delay because of the coronavirus pandemic. Fitch believes that the financial impact of the Ituango project is mitigated after the announcement that its insurer, Mapfre, determined that the causes of damage at the Ituango project is covered by the insurance policy. EPM received $150 million USD in insurance proceeds in 2019 and expects to receive between $100 and $200 million USD in 2020.

Fitch believes the company remains exposed to execution risk even though the company has made progress to remediate the collapse of the project’s tunnels. Fitch expects EPM will plug the diversion tunnels and auxiliary diversion tunnels (ADT) within the next six to 12 months. Fitch’s base case assumes that 300MW will be in operation in 2022, in line with the company’s guidance.

Stable Credit Metrics: Fitch estimates EPM’s consolidated gross leverage, defined as total debt to EBITDA, will average 4.1x between 2020-2023. The elevated leverage is mostly explained by the company’s Ituango project, which Fitch estimates will cost a total of USD3.4 billion by the final completion, an incremental cost of $1.5 billion USD as well as the additional debt incurred from the offering. Net leverage is expected to average 3.5x over the same horizon as the company is expected to increase its cash on hand to combat economic uncertainty.

Fitch’s base case assumes a modest increase in cash flows in 2022 when 300MW of the project comes online, followed by two additional launches of 300MW thereafter. Fitch believes that despite higher leverage in the medium term, EPM has a solid credit profile with FFO interest coverage averaging 3.7x times between 2020-2023 and average net debt to EBITDA of 3.5x over the same time period. Lastly, Fitch believes EPM has strong access to international and local financial markets, and over the rated horizon, will refinance upcoming maturities to preserve liquidity.

Assumption of CaribeMar Assets: EPM’s assumed ownership of CaribeMar is positive for the business and credit neutral. Fitch’s base case for EPM assumes the company will take over CaribeMar’s operations and assets in September 2020, which are just north of its existing concession areas and will commit up to $1.0 billion USD of investment capex by 2024 to reduce energy losses, quality improvements and general collections. CaribeMar’s capex is expected to be 3.3x greater than its projected EBITDA between 2020 through 2024. Fitch expects material increases of EBITDA by 2025, when losses are expected to decrease and tariffs adjustments. Fitch understands that CaribeMar has no financial debt and the government will assume the pension obligations of the company.

Insurance Payments Support Capex: Fitch’s base case assumes that EPM will receive payments up to USD1.1 billion from its insurance policy between 2019 through 2022. The company received the first payment of USD150 million from Mapfre Seguros Generales de Colombia S.A. in Dec. 2019. Fitch believes the insurance payments will be made in instalments as both entities review damages and costs. The payments are a credit positive and relieve pressure of selling EPM assets to further offset the estimated incremental cost of $1.5 billion USD of the project.

Stable Cash Flow Profile: EPM has a stable and predictable cash flow profile supported by regulated businesses in investment grade markets. Fitch estimates 80% of EPM’s 1Q20 EBITDA was derived from its energy business, where its generation segment comprised 32%; 43% was distribution; and the gas and transmission segments combined for 5%. EPM’s distribution business operates in highly regulated markets, mostly concentrated in Colombia, where it is the largest distributor in the country, with a market share of 25%. Further, EPM is a majority shareholder in the second largest distribution company in Panama, Elektra Noreste (BBB/Stable). EPM also has a presence in water and waste management services in Chile, Colombia and Mexico. Fitch estimates that 20% of the company’s EBITDA comes from its water and waste management services.

Moderate Regulatory Risk Exposure: Fitch believes EPM’s exposure to regulatory risk is low. The bulk of EPM’s consolidated revenues is generated by regulated tariffs or medium-term contracts. The latter exposes the company to potentially sustained low electricity prices. Historically, Colombian regulatory entities have ruled independently from the central government and have provided a fair and balanced framework for both companies and consumers. Fitch expects future regulatory changes will have a neutral impact on 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.

Strong Linkage with Parent: EPM consistently contributes significant cash flows in the form of dividends to its parent, the City of Medellin (BBB-/Negative). These distributions comprised 20% of the city’s total revenues in 2019, and have exceeded government revenues by 20% four out of the last five years. Under Fitch’s criteria, a government-related entity (GRE) that sustainably generates more than 10% of the government’s revenues is considered a strong linkage factor that would lead to an equalization of the ratings. Fitch may nevertheless choose to apply notching down from the government if there are concerns regarding the company’s financial structure. Considering EPM’s capital structure is not as strong as its parent’s and uncertainty surrounding the financial impacts of the Ituango project, Fitch maintains a Negative Watch on EPM’s ratings until the company can regain control of the project.

DERIVATION SUMMARY

EPM’s low business-risk profile is commensurate with its investment-grade rating and is comparable with that of Grupo Energia Bogota S.A. E.S.P.’s (GEB, BBB/Stable), Enel Americas S.A. (A-/Stable), AES Gener (BBB-/Stable) and Promigas (BBB-/Stable). EPM’s ratings are two notches below Enel Americas, as the latter has a strong diversified and geographic footprint in South America and a more conservative capital structure. Fitch estimates Enel Americas gross leverage will be 1.6x in 2020 and will remain below that level thereafter, not considering any acquisitions. Fitch projects EPM’s leverage to average 4.1x over the rating horizon, falling to 3.7x in 2024.

EPM and GEB are rated one notch above AES Gener and Promigas. GEB’s operating environment and exposure to regulated business bodes well for its credit quality compared with AES Gener, which operates in a more competitive environment. Also, Fitch projected leverage for GEB is in the range of 3.5x to 4.0x, slightly lower than AES Gener, for which Fitch expects leverage metrics to average 4.0x. Promigas is also rated one notch below GEB in the international scale, given its lower level of business and geographic diversification and its higher leverage levels over the medium term compared to GEB.

KEY ASSUMPTIONS

Fitch’s Key Assumptions Within Its Rating Case for the Issuer:

• EPM issues a senior unsecured USD bond due 2031 and reopens its 2027 peso-denominated bond;
• Ituango project gradually launched into operations with 300MW by early 2022, 600MW later in 2022 and 1,200MW in 2026;
• Total Ituango cost of USD3.4 billion, a USD1.5 billion increase from original budget;
• Ituango’s medium-term commercial obligations are covered with electricity purchases, existing hydroelectric asset base and thermal generation;
• No Dividends from UNE expected over the rated horizon;
• Dividend pay-out of 50% of previous year’s net income;
• Divestment in 2019 of Los Cururos for USD 138 million, 1% overall stake in ISA for USD69 million and 10% stake in GasOriente for USD10 million;
• No Divestment in 2020 or the rating horizon;
• Total Insurance payments of USD1.1 billion from 2019 through 2022;
• Refinancing of all Local & International bonds maturing over the rated horizon;
• Capex for CaribeMar to be financed predominately through debt up to USD800 million.

 RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

• An upgrade is not likely in the short to medium term given the expected delay in Ituango’s operation, the company’s current credit metrics, large capex program and the potential materialization of project relation contingencies.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

• The materialization of significant cost overruns and contingencies that weaken the company’s liquidity;
• Additional delays in Ituango’s COD;
• Sustained leverage above 4.0x;
• An overly aggressive investment and/or acquisition strategy that drives leverage metrics consistently above 4x;
• Increased intervention from the company’s owner, the municipality of Medellin, which negatively affects cash flows.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Fitch expects the company’s July 2020 issuance to bolster liquidity and does not anticipate a material near-term effect on EPM’s liquidity and operating cash flow resulting from the Ituango 2018 landslide. Approximately 66% of the company’s EBITDA is from regulated businesses with highly stable cash flow generation. EPM held approximately COP 2.4 trillion of cash on hand as of March 2020. Fitch expects the company will have 3.1 trillion cash on hand at the end of 2020 following the issuance and cash flow from operations of approximately COP 2.4 trillion for the year. These amounts provide sufficient liquidity to cover short-term financial obligations of COP 1.5 trillion for 2020 and its capex program.

Currently, the company’s dividend policy is expected to remain in place despite the cash flow impact derived from Ituango’s delay. Historically, 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 20% to 30% of the city’s investment budget. Although not likely in the near term, an increase in the company’s dividend distribution policy could pressure its FCF generation, which is already expected to continue to be negative in the medium term as the company continues to execute its investment plan.

Empresas Publicas de Medellin E.S.P.’s (EPM) ratings are linked to the country ceiling of Colombia (‘BBB’).