News Column

Fitch Affirms Comision Federal de Electricidad's Ratings; Outlook Stable

May 14, 2014

MONTERREY, Mexico & CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has affirmed Comision Federal de Electricidad's (CFE) ratings as follows:

--Long-term Issuer Default Rating (IDR) at 'BBB+';

--Local currency long-term IDR at 'A-';

--USD1.750 billion senior unsecured notes at 'BBB+';

--National scale long-term rating at 'AAA(mex)';

--MXN90,489 million unsecured Certificados Bursatiles Issuances at 'AAA(mex)';

--National scale short-term rating at 'F1+(mex)';

--Short-term Certificados Bursatiles Program at 'F1+(mex)'.

The Rating Outlook is Stable.

KEY RATING DRIVERS

The rating action reflects CFE's existing structure as the state owned monopoly to provide electric services and strong linkage with the Mexican government. The proposed energy reform, which is in the process of discussion and approval of the secondary laws, could materially change CFE's structure. While credit impact is still uncertain and a negative impact cannot be ruled out, Fitch will review CFE's ratings once the secondary laws and additional regulation are in place to assess the impact to credit quality. Fitch will focus its review on the resulting capital structure, business profile and the degree of linkage with the Mexican government as the energy reform is ready to be enforced.

Among the main topics included in the initiative of the secondary laws sent by the president to congress is a change in CFE's legal structure to a productive state company owned by the government. This new structure is expected to have linkage with the government; however, the degree of linkage will be assessed once all laws and regulations are approved. CFE is proposed to have budgetary independence from the congress, with the board of directors led by the Ministry of Energy and will include the Ministry of Finance, three government counselors as well as four independent members, plus one member appointed by the workers. Positively, the current 9% tax on fixed assets is proposed to be eliminated and distributions to the government will be in the form of dividends, however, the initiative on secondary laws does not address what will happen with the subsidies to agricultural and residential customers, a topic that is likely to be addressed once additional regulation is set which will also include the rates.

An open electric market is likely to attract new entrants to serve the industrial customers and absent of a change in the subsidies to agricultural and residential customers can have a material impact to CFE's finances. As per the initiative, CFE's distribution and transmission network will remain state owned and the Centro Nacional de Control de Energia (CENACE), a decentralized public agency, will be in charge of the planning and control of the national electric system, including the wholesale market. Fitch views that after the secondary laws are approved, additional regulation need to be in place to give more detail of which assets and liabilities are transferred to CENACE. Fitch expects that additional regulation will give more detail on the subsidies.

CFE's ratings incorporate the company's position as the largest electricity generator in Mexico. Also reflected are CFE's strong linkage with, and strategic importance, to the Mexican government, and the government's implicit support. CFE's foreign and local currency IDR ratings are at the same level as Mexico's sovereign rating. CFE is a decentralized public entity of the Mexican federal government. The company also has exclusive rights for the transmission and distribution of electricity, which makes it strategically important for the country. CFE's ratings also incorporate the significant adjusted debt levels after taking into consideration unfunded pension liabilities, negative free cash flow (FCF) during the cycle, and risk of political interference.

Current Strong Linkage With Government

The actual relationship between CFE and the government is strong and extends beyond its ownership. CFE's budget and financing plan must be submitted to and approved by the Minister of Energy and the Minister of Finance. In addition, as a decentralized public entity of the Mexican government, the financing and investment plans of CFE are included in the overall public sector financing plans and expenditure budget, which require the approval of the Mexican Congress. The Minister of Energy acts as chairman of the company's board, and CFE's rates are set annually by the Mexican government.

Strategically Important For The Country

The company operates as a virtual monopoly and has exclusive rights to provide electric services throughout Mexico. In the past, the company's monopoly status has been embedded in the Mexican Constitution and is defined by the Electric Energy Public Service Law. CFE generates approximately 91% of the electricity in Mexico and owns a 100% of transmission and distribution infrastructure. While CFE's monopoly position decreases competitive risks and other risks related to business operations, the company's financial performance is highly correlated with the decisions of the Mexican federal government, which does not provide an explicit debt guarantee.

Risk Of Political Interference

The way rates are set today by the government exposes the company to regulatory risk and political interference. However, in addition to material subsidies to agricultural and residential sectors, CFE's tariff structure also includes monthly fuel cost adjustments for approximately 75% of revenues, which allows CFE to partially offset costs increases. CFE is partially exposed to fuel prices, fluctuations in production costs and unfavorable tariffs, which at times could be set below operating costs for a specific class of customer.

Energy Reform

Although CFE's linkage with the government will likely continue to be considered strong and may increase as a key factor for its credit ratings after the energy reform, this last one would likely give the company financial flexibility through budgetary and financing independence. Also, the company would benefit by being able to associate with private investors to increase and develop the transmission and distribution infrastructure by implementing sharing costs models. Fitch still sees regulatory risk and political interference on the future regulated rates, and considers the open to competition in the industrial customers, a big challenge for CFE, due to the need to manage competitive rates and seek improvement in its cost structure.

High Leverage With Manageable Debt-Maturity Profile

As of March 31, 2014, total on-balance sheet debt was MXN348.4 billion. Adjusted for unfunded pension liabilities, total adjusted debt increases to MXN883.2 billion. Debt maturity profile is manageable, with MXN86.9 billion maturing within the next two years, of which MXN59.1 billion is short-term, compared to MXN66.8 billion in cash. FCF has been negative during the last five years, mainly due to subsidies in the tariffs and high capital expenditures.

RATING SENSITIVITIES

An upgrade of CFE could result from an upgrade of the sovereign, increased financial support from the government, significant improvement in credit profile, and/or a sharp and extended generation of positive FCF. Negative rating actions could be triggered by a downgrade of the sovereign's rating, the perception of a lower degree of linkage between CFE and the sovereign due to the Energy Reform in conjunction with a levered capital structure, and failure to offset declining profit margins resulting from the loss of industrial customers.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 5, 2013);

--'National Scale Ratings Criteria' (Oct. 30, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

National Scale Ratings Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=720082

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=830177

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Alberto De Los Santos, +52-81-8399-9100

Associate Director

Fitch Mexico S.A. de C.V.

Prol. Alfonso Reyes 2612

Monterrey, N.L., Mexico

or

Secondary Analyst

Lucas Aristizabal, +1-312-368-3260

Director

or

Committee Chairperson

Alberto Moreno, +52-81-8399-9100

Senior Director

or

Media Relations

Elizabeth Fogerty, +1-212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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