TEXT-Moody's on Union Fenosa SA, Union Fenosa Finance BV

(The following statement was released by the ratings agency)

June 9 - Moody's Investors Service has today upgraded to A3 from Baa1 the senior unsecured issuer and debt ratings of Union Fenosa SA (UNF.MC: Quote, Profile, Research) and its guaranteed subsidiary Union Fenosa Finance BV. The outlook is stable. The Prime-2 short-term rating is affirmed.

The rating upgrade recognises the company's steady progress in improving and stabilising its business and financial risk profile and Moody's view that the company will continue to maintain a credit profile commensurate with an A3 rating over the medium term.

According to Moody's, Union Fenosa has demonstrated a strong track record on delivering against its strategic plan and its improvement in business risk has been achieved through timely execution of its capex plans and the strategic alliances it has formed, whilst its financial profile has improved and stabilised via asset divestments and cash flow growth. The company today maintains a sound position within the Spanish electricity sector with a market share of around 13%, benefiting from its vertically integrated position and a well-hedged thermal generation portfolio with favourable gas contracts. Moody's also believes that the recent acquisition of a stake in the Kangra mine in South Africa should help Union Fenosa in hedging its coal-fired assets.

The company has an efficient generation portfolio, but is nonetheless exposed to greater commodity price risk than its larger Iberian peers given its greater thermal generation bias and mid-market gas position. Moody's cautions that a degree of overcapacity in the Spanish electricity sector - particularly if some competitors make further large investments in generation - could lead to greater pricing volatility, which might have an adverse impact on the company's margins. Around 25-30% of Union Fenosa's EBITDA comes from higher-risk international business, although Moody's does not expect this to substantially increase in the intermediate term.

Union Fenosa's financial profile is expected to gradually improve over the life of the strategic plan to 2011 based on its current EUR6.1 billion investment programme. Moody's would expect Union Fenosa to continue to demonstrate financial discipline with regard to further investments or acquisitions outside of the plan. As a result, the company should be able to maintain the following credit metrics: RCF/adjusted debt in the mid-teens, FFO/debt in the high teens/low twenties and FFO/interest of 4x, assuming a similar business risk profile, for the current A3 category. These guidelines could shift higher or lower in the event that the company makes riskier or less risky investments, respectively, outside its current strategic plan.

Moody's notes that Union Fenosa's controlling shareholder ACS, with 45%, also owns a direct 7.8% stake in Iberdrola (and an additional 5.2% via equity swaps) and has commented that it would envisage Union Fenosa playing a role in any further consolidation of the Spanish utility sector. Should such a development occur involving further asset acquisition, Moody's would expect that a larger market share and a more diversified generation portfolio could benefit Union Fenosa's business risk profile. Moody's further expects that in such circumstances the company would ensure that an appropriate financial profile is achieved commensurate with the current rating.

The rating agency adds that the proportionate amount of debt with third parties at entities below the holding company level remains rather high at approximately 30-35% of total consolidated adjusted debt. Moody's would expect the company to manage subsidiary debt such that this does not create a structural subordination issue, whilst recognising that most of this debt is designed to reduce political and currency risk at the level of international subsidiaries or is funded at the joint venture level where it has entered into partnerships. Moody's understands that: (i) these structures have no, or very limited, recourse to assets or cash flows outside the immediate project, and (ii) the holding company debt is directly supported by a good proportion of lower-risk and largely unencumbered cash flows from Iberian distribution, generation and gas supply, which still provides reasonable cover for the parental debt.

The stable outlook envisages that Union Fenosa will maintain the group's financial and business risk profile as indicated above and that there will be no deterioration to debt protection at the parental level.