Fitch Ratings has assigned AES Panama Generation Holdings, S.R.L. (AES Panama Generation) ‘BBB-‘ Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) and a ‘AA+(pan)’ Long-Term National scale rating. The Outlook on all ratings is Stable. In addition, Fitch has assigned ‘BBB-‘ and ‘AA+(pan)’ ratings the company’s senior secured notes.

AES Panama Generation will issue a total of approximately USD1.489 billion in debt, including an USD830 million bond due 2030, a USD553 million bond due 2027 and a USD104 million loan. The proceeds will refinance the outstanding debt of AES Panama S.R.L., AES Changuinola S.R.L. and AES Colon, which is a 381MW liquid natural gas (LNG)-fired power plant, Gas Natural Atlantico S.R.L., and an LNG storage facility, Costa Norte LNG Terminal S.R.L., combined. Changuinola’s amortizing bond Tranche A, which totaled USD110 million as of March 31, 2020, will remain outstanding and be repaid according to its amortization schedule. The transaction will also repay a USD62 million loan to build a transmission line from AES Colon’s power plant to the country’s electric grid and finance the construction of 52MW of solar panels at AES Panama.

Following the transaction, intercompany loans (ICLs) will be made to each operating company to refinance its respective debts and AES Corporation’s (BBB-/Stable) shares in the operating companies will be held in a trust as collateral for the notes. Although the notes are not directly secured by any tangible assets in the operating companies, they are secured by the ICLs, AES Corporation’s equity pledge and the collateral trust accounts. The issuer will also enter into a USD50 million committed credit liquidity facility from a consortium of global banks, which will make payments on the notes should one of the ICLs default. The issuer would repay the credit facility with dividends drawn from AES Corporation’s shares in the trust and no dividends could be upstreamed to AES Corporation until the credit facility is fully repaid.

AES Panama Generation’s ratings reflect the consolidated credit profiles of its operating companies. Fitch expects AES Panama Generation to deleverage to 3.6x gross leverage by 2023 from 6.5x in 2019 due to scheduled debt amortizations, increased storage fees at its Costa Norte LNG terminal and contracted price step-ups on its hydro power purchase agreements (PPAs) with distribution companies. The company’s portfolio diversification, which includes hydro, LNG and renewables, and its strong market position with approximately 37% of Panama’s electricity generation add stability to its expected robust cash flows. Fitch considers that a parent and subsidiary relationship exists between AES Panama Generation and AES Corporation due to the latter’s pledge of shares but Fitch rates AES Panama Generation on a standalone basis as it does not assume any implicit support from the parent company.

 

KEY RATING DRIVERS

Medium-Term Leverage to Moderate: The companies’ 2019 combined pro forma leverage was 6.5x, which Fitch expects to moderate to 5.1x in 2020 and 4.8x in 2021 as hydrology conditions are assumed to return to their long-term average levels. Further deleveraging is anticipated in 2022 to 4.3x due to a 5.5% step-up in contracted energy prices with distribution companies in that year. Fitch expects 3.6x gross and 3.4x net leverage in 2023 due to increased LNG storage terminal fees along with the amortization of the newly issued bond and the Changuinola Series A bond. Fitch expects FFO interest coverage to rise to 4.7x in 2023 from 3.9x in 2020.

Diversification Mitigates Hydrology Risk: The addition of AES Colon’s 381MW LNG plant, along with a 55MW wind acquisition in May 2020 and 52MW of solar in 2021, is expected to provide efficient hydrology risk management. In 2019, the Colon power plant’s first full year of operation and an extremely dry year, AES Colon had net generation of 2,700 GWh, or roughly 27% of the country’s supply. The 107MW of wind and solar capacity will provide a cost-effective hedge against lower hydrology as these assets perform better during the dry season from December to April and during dry years. The company will also keep its 72MW fuel oil barge as back-up capacity. However, its operating cost will likely be above the system marginal cost.

Strong Market Position: AES Panama Generation Holdings is expected to represent 29% of Panama’s installed capacity and 37% of the country generation, giving it a dominant position in the market. With the exception of a 72MW fuel oil barge, the company’s generation portfolio is highly cost competitive in the Panamanian market with 705MW of hydroelectricity. Among the company’s assets is AES Colon, a 381MW LNG plant, which debuted in August 2018 and is the country’s first gas-fired plant. LNG-fueled electricity is a strategic initiative for the new government and having built the first LNG tank, AES Colon is positioned to sell tank storage to other currently planned LNG plants, such as the 441MW Martano plant.

Strong Cash Flow Generation: Fitch expects the company to generate strong cash flows over the life of the bond with EBITDA margins between 50% and 60%, net of AES Changuinola’s revenue received from AES Panama. This can be attributed to the profitability of the company’s hydro assets during periods of historically normal hydrology conditions as well as capacity payments from distribution companies to AES Colon until mid-2028. Fitch estimates Colon’s capacity payments to be USD163 million, or slightly more than half of expected 2020 EBITDA. These payments along with distribution company PPAs through 2030 are well matched with the anticipated term of the company’s financing.

Moderate Off-Taker Risk: AES Panama Generation Holdings faces moderate counterparty risk by virtue of its approximately 90% contracted position. Fitch estimates that approximately 28% of the combined companies’ capacity is contracted with Elektra Noreste S.A. (‘BBB’/Stable); 62% with EDEMET and EDECHI, which are both majority owned and operated by Naturgy Energy Group S.A. (‘BBB’/Stable); with the remaining 10% contracted directly with large commercial users. Large commercial users are a growing portion of the companies’ client portfolio and diversify counterparty risk as they include a total of 43 companies.

Potential Sale of Bayano: In October 2019, it was announced that AES Panama and the Panamanian government had signed a memorandum of understanding to negotiate the possible sale of the company’s largest hydro asset, Bayano, which is a 260MW reservoir hydro plant located 80km from Panama City. Bayano has historically produced 35%-40% of AES Panama’s net generation and is an important contributor to its profitability. The government’s interest in Bayano would be to control the lake and use it to regulate the water levels of the Panama Canal, which experienced very low levels in 1H19. Fitch assumes AES Panama Generation would maintain its capital structure if Bayano were to be sold to the government.

Regulatory Risk: The company’s ratings also reflect its exposure to regulatory risk. Historically, power generation companies in Panama were competitive, unregulated businesses free to implement their own commercial strategies. However, in the past several years higher electricity prices have resulted in increased government intervention to curb the effect on end users. Efforts to diversify the country’s energy matrix will help to reduce prices over the medium term, limiting the need for regulatory interference.

 

DERIVATION SUMMARY

Fitch expects AES Panama Generation Holdings’ leverage to be between 4.3x and 5.1x between 2020 and 2022 before falling to below 4.0x in 2023 and thereafter. This proposed capital structure is in line with that of Kallpa Generacion S.A. (‘BBB-‘/Negative), which is expected to have leverage of 4.0x-4.5x over the medium term. Like AES Panama Generation, Kallpa also features a diversified asset base of both natural gas and hydro production. AES Panama Generation Holdings’ capital structure is also comparable with that of AES Gener S.A. (‘BBB-‘/Stable), which had 2019 leverage of 4.4x, although Fitch expects it to fall below 4.0x in 2020.

AES Panama Generation’s capital structure is more aggressive than those of higher rated Colombian peers, such as Isagen S.A. ESP (‘BBB’/Negative) and Emgesa S.A. E.S.P. (‘BBB’/Negative), which are expected to have medium-term leverage of 2.5x-3.0x and 1.5x-1.2x, respectively. Both companies have significant hydroelectric capacity and mitigate El Nino risk with back-up thermal capacity. Despite comparable market shares, Isagen and Emgesa each have installed capacity in excess of 3,000MW while AES Panama Generation’s would be 1,157MW. The company compares favorably with Orazul Energy Peru (‘BB’/Stable) with expected 2020 leverage of 5.0x.

The company’s national scale rating of ‘AA+(pan)’/Stable is comparable with that of Empresa de Transmision Electrica S.A. (ETESA; ‘AAA[pan]’/Stable). ETESA is more highly levered, with expected 2021 gross leverage of 5.6x, but it operates in the electricity transmission subsector, which is highly regulated and considerably less volatile than electricity generation. AESP’s sister company, AES Changuinola (‘A+[pan]’), had higher 2019 leverage of 24.0x due to a nine-month tunnel repair. After returning to full operation in 2020, leverage will fall to 4.0x.

 

KEY ASSUMPTIONS

— USD1.489 billion of new debt, including two bonds and a loan, is issued to refinance all outstanding debt at the three operating companies, except for the Changuinola Series A bond; The new bonds are assumed to carry an interest rate of approximately 4.5-5%. The USD553 million bond has amortizations between 2023 and 2026 with a balloon repayment in 2027. The USD830 million bond has a single balloon payment at maturity in 2030. The USD104 million loan has amortizations between 2020 and 2023.

— Hydrology conditions will return to their long-term historical averages in 2020 and beyond;

— AES Panama S.R.L. adds 55MW of new wind asset revenue in 2H2020 and 52MW of solar assets in 1H21;

— Spot prices will be USD50/MWh in 2020 due to improved hydrology and lower electricity demand and USD60/MWh thereafter due to normalized hydrology and demand conditions;

— AES Panama S.R.L.’s barge will be used minimally after its PPA expires in mid-2020 and retired after 2023;

— Combined cash in excess of USD75 million will be paid out as dividends;

— A new gas plant contracts storage capacity with AES Colon’s LNG terminal in 2023;

— No significant asset sales take place during the rating horizon;

— Expiring large user hydro PPAs are renewed with similar terms.

 

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:

— Sustained gross leverage below 3.0x over the medium term;

— A conservative contracting strategy that promotes cash flow stability and the ability to withstand hydrological shocks to the system;

— Continued evidence of sustainable spot price stabilization as a result of asset diversification in Panamanian electricity matrix.

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:

— Sustained gross leverage above 4.0x and net leverage above 3.5x over the medium term;

— Increased government intervention in the sector, coupled with a weakening regulatory framework;

— Deterioration in the company’s ability to mitigate spot-market risk;

— Payment of dividends coupled with high leverage levels;

— Significant asset sales causing an adverse change in financial structure.

 

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

Adequate Liquidity: Fitch believes the combined company will generate strong cash flow from operations (CFO) of USD150 million-USD250 million between 2020 and 2023 with amortizations of USD20 million per year from 2020 to 2022 and USD50 million in 2023 arising from the Changuinola Series A bond. The new loan and 2027 amortizing bond have combined maturities of USD12 million, USD30 million, USD35 million, USD39 million, USD47 million, USD20 million and USD21 million in 2020 through 2026, respectively. The remainder and majority of the companies’ debt would be long term due in 2027 and 2030. The companies’ strong operating cash flow and favorable debt maturity profile are partially offset by expected future dividends. Fitch assumes a combined minimum cash balance of USD75 million with any residual amounts expected to be paid as dividends. As of March 31, 2020, the combined companies held USD106 million in readily available cash and equivalents.

 

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.