October 11, 2017 / 9:09 PM / 9 days ago

Fitch Affirms Telefonica del Peru at 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, October 11 (Fitch) Fitch Ratings has affirmed Telefonica del Peru S.A.A.'s (TDP) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at 'BBB+' with a Stable Outlook. TDP's ratings reflect the company's leading market positions in the Peruvian telecom industry with its fully integrated fixed-line and mobile operations, network competitiveness and brand recognition, and solid financial profile for the rating category. Negatively, the ratings are tempered by its falling mobile market shares due to intense competition, which has resulted in revenue contraction and profitability deterioration. TDP's failure to turn around its ongoing market share erosion and increasing leverage in coming quarters could result in a negative rating action. TDP's ratings are based on its stand-alone credit profile. Although a parent-subsidiary relationship exists between TDP and its parent, Telefonica SA (TEF,BBB/Stable), given the latter's management control and strategic ties, Fitch believes that the linkage is weak due to a lack of legal linkage, such as guarantees or cross-default clauses. TEF has allowed TDP to keep most of its internally generated cash flow in order to strengthen its financial profile in recent years. TDP has a stronger capital structure than its parent, which allows its ratings to be rated one-notch higher than TEF's IDRs. KEY RATING DRIVERS Leading Market Position: TDP is the largest telecom operator in Peru and Fitch expects its leading position, particularly in the fixed-line segment, to remain intact in the short- to medium-term, backed by its well-established network despite increasing competitive pressures. TDP retained its largest market share across all of its service platforms, with a 41% subscriber market share for mobile operations as of June, 30, 2017. The company also held 76% and 73% subscriber market shares for broadband and pay-TV, respectively, during the same period, according to the regulator, Organismo Supervisor de Inversion Privada en Telecomunicaciones (Osiptel). TDP has a balanced revenue mix, with its mobile service revenues representing 40% of its total sales, and broadband and pay-TV accounting for 16% and 13%, respectively, during the first half of 2017 (1H17). Negative Mobile Trend: Heated competition for mobile market share in Peru has remained uncurbed, and Fitch expects the trend to continue at least for the short term driven by aggressive handset subsidies and tariffs. The intense competitive landscape, driven by new entrants, led to a rapid market share erosion for TDP to 41% as of June 30, 2017 from 52% at end-2015. The company's mobile service revenues, excluding handsets, fell by 11% in 2016 on a y-o-y basis, and by 17% during 1H17 compared to the same period in 2016. Any signs of competition easing up have yet to be seen as the number of subscribers switching operators through number portability remains high in 2017, with TDP losing the most subscribers in the industry. Fitch does not expect any material recovery in TDP's mobile revenues in the short term given pressured average revenue per user (ARPU) prospects. Stable Fixed-Line Operation: Performance in TDP's non-voice fixed line operation has remained relatively stable compared to mobile operation, and Fitch expects the company's broadband and pay-TV operation to undergo stable growth over the medium term. The demand outlook for non-voice fixed line services remains solid given low penetration rates of broadband and pay-TV, estimated to be below 30% and 40%, respectively at end-2016. TDP's investment plans to increase its fiber coverage to ensure service competitiveness also bodes well for the segment growth over the medium term. During 1H17, the company's broadband and pay-TV subscribers increased by 2% and 5%, respectively. Fixed voice will continue to contract due to waning demand and will dilute growth from non-voice segments to a degree. TDP's fixed voice revenues declined by 19% during 1H17, representing 8% of the total sales. Weak Performance: TDP's revenue contraction and profitability deterioration is likely to continue in the short term. Intense competition in the mobile market impedes any substantial cut in subscriber acquisition costs or the industry-wide ARPU recovery. Fitch forecasts TDP's consolidated revenues to fall by 8% in 2017, continuing from a 4% drop in 2016, with its EBITDA margin falling to 24% from 29% during the same period. Under such a negative sector trend, Fitch believes that material recovery in EBITDA would be challenging for the company over the medium term. Negative FCF Generation: Fitch forecasts TDP's FCF generation to remain negative in 2017 amid weak performance and suppressed cash flow from operations (CFFO) generation. Fitch estimates the company's CFFO to fall by close to 40% in 2017 to about PEN1.4 billion, which would be insufficient to cover its capex of about PEN1.8 billion. Fitch does not foresee any sizable dividends due to the negative FCF generation and its contingent liabilities with regard to its income tax disputes with the Superintendencia Nacional de Administracion Tributaria (SUNAT). TDP's FCF turned negative in 2016 due to high capex, mainly associated with its 700Mhz spectrum auction, for which the company paid USD315 million. Narrower Rating Headroom: Rating headroom for TDP at the current rating level of 'BBB+' has been eroded rapidly, and the company's failure to turn around the ongoing mobile subscriber loss trend in coming quarters will pressure the ratings. Fitch forecasts TDP's adjusted net leverage ratio, measured by total adjusted net debt/EBITDAR, to increase to above 1.5x in the short- to medium-term, which is a significant increase from 0.9x at end-2016 and 0.6x at end-2015, driven by EBITDA contraction and negative FCF generation. Weaker-than-expected performance that leads to its net leverage increasing to 2.0x would be negative for the ratings. DERIVATION SUMMARY TDP is well positioned in the 'BBB' rating category relative to its regional peers given its leading market positions in the Peruvian telecom industry and solid financial profile. The company's business and financial profiles are deemed largely in line with those of Telefonica Moviles Chile S.A. which is also rated 'BBB+'. TDP boasts stronger financial profile than 'BBB' rated operators, including Empresa Nacional de Telecomunicaciones S.A in Chile, which has undergone cash flow and leverage deterioration due to its expansion strategy in Peru, and UNE EPM Telecomunicaciones S.A. in Colombia, which has a relatively weaker market position and higher leverage. A weak parent-subsidiary relationship exists between TDP and its parent,TEF, given a lack of legal ties and any sizable dividend contributions to the latter. TDP's ratings are based on its stand-alone credit profile, which is stronger than its parent and enables a one-notch-higher rating. No Country Ceiling constraint and operating environment influence were in effect for these ratings. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Negative revenue growth until 2018; - EBITDA margin to remain at 23%-24% in the short- to medium-term; - Capex of PEN1.7 billion-PEN1.8 billion; - Negative FCF continues over the medium term; - Adjusted net leverage to increase to above 1.5x over the medium term. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -Any positive rating action is unlikely in the short- to medium-term given the company's recent performance deterioration. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Continued mobile subscriber loss and a lack of indications for eased competition -Failure to curb ongoing revenue and EBITDA contraction -Continued negative FCF generation and its adjusted net leverage to increase to over 2.0x on a sustained basis -A material impact from income tax contingent liability LIQUIDITY TDP's liquidity is deemed adequate given its good access to local capital markets and bank loans, backed by its strong market position in Peru, when in need of external financing. As of June 30, 2017, the company held PEN260 million of readily available cash against its short-term debt of PEN1.1 billion. The company also has well-spread debt maturities. The company's debt structure consists mostly of local bonds and bank loans. As of June 30, 2017 the company's local notes represented 64% of its total debt of PEN2.1 billion, with the remainder being loans and commercial paper. The company does not have any international bonds outstanding following the repayment of PEN375 million in notes during 2016. FULL LIST OF RATING ACTIONS Telefonica del Peru, S.A.A. --Long-Term Foreign-Currency IDR affirmed at 'BBB+';Stable Outlook; --Long-Term Local-Currency IDR affirmed at 'BBB+'; Stable Outlook. Contact: Primary Analyst Alvin Lim, CFA Director +1-312-368-3114 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst Francisco Mercadal Associate Director +56 2 2499 3340 Committee Chair Daniel R. Kastholm, CFA Regional Group Head - Latin America Corporates +1-312-368-2070 Media Relations: Benjamin Rippey, New York, Tel: +1 646 582 4588, Email: benjamin.rippey@fitchratings.com. 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