OREANDA-NEWS. On the effective date of Aug. 1, 2016, Fitch Ratings affirmed the Long-Term National Rating of Aegea Saneamento e Participacoes S. A. (Aegea) at 'AA-(bra)'. The Rating Outlook is Stable.

KEY RATING DRIVERS

The rating action reflects the low business risk of the water/wastewater utility sector, which is characterized by a high predictability of operating cash generation. Aegea has been expanding its activities with a satisfactory financial profile and benefits from its growing assets diversification in the industry. The affirmation of Aegea's rating is also supported by the solid credit quality of its main operating subsidiaries: Aguas Guariroba S. A. (Guariroba) and Prolagos S. A. - Concessionaria de Servicos Publicos de Agua e Esgoto (Prolagos), both rated 'AA(bra)'/Stable Outlook.

Aegea's favorable record benefits the company as it tries to maintain its conservative consolidated and financial profile with net leverage below 3.5x sustainably while expanding its operations. Fitch's assessment of Aegea incorporates the group's strong growth strategy through acquisitions and concession bids, which require management and efficiency improvements on the recent incorporated operations. Fitch expects Aegea to support those subsidiaries in the development stage, and to simultaneously distribute relevant dividends within the next five years.

Aegea's rating takes into consideration its operating subsidiaries' exposure to a developing regulatory environment and political interferences, particularly regarding tariff adjustments. These risks are mitigated by the favorable track record of tariff increases of its companies in recent years, which have maintained the economic-financial balance of the concession contracts. The assessment also includes hydrologic risk, which is inherent to the company's sector, as well as the structural subordination of Aegea's obligations to its subsidiaries obligations, which are mitigated by the expected flow of dividends and the company's financial flexibility demonstrated in accessing external resources.

Satisfactory Leverage

Fitch believes Aegea will maintain its consolidated credit indicators at levels compatible with its rating and successfully manage its net financial leverage ratio up to 3.5x. On a consolidated basis, Aegea's net debt/EBITDA ratio was 3.1x during the 12-month period in March 2016, according to Fitch's methodology. At the same time, its total consolidated debt of BRL1.6 billion consisted mainly of long-term loans with Banco Nacional de Desenvolvimento Economico e Social (BNDES) and Caixa Economica Federal (BRL599 million), Prolagos's and Guariroba's debentures (BRL330 million), bridge loans (BRL320 million) and debts of the holding company (BRL188 million).

Moderate Debt Service Coverage

Fitch expects Aegea's holding leverage to remain below 3.0x, until 2020, measured by net debt over dividends received on a pro forma basis. As per Fitch's projections, this ratio will reach around 1.5x in 2016, supported by the estimate dividends of BRL131 million, and the expected capitalization of BRL125 million from minority shareholders, which should occur by August 2016. The company has financial commitments of cash injection on its subsidiaries under development of around BRL530 million between 2016 and 2020 and has simultaneously presented high levels of dividend payments. In 2015, the company relevant dividends received of BRL252 million was supported by the strong distribution from Guariroba. Fitch estimates the holding company will receive, between 2017 and 2020, on average around BRL170 million of annual dividends.

Manageable Debt Amortization Profile

Aegea's consolidated debt amortization is manageable, although Fitch considers partial debt refinancing of the holding's and its subsidiaries' liabilities within the next years. By the end of March 2016 the consolidated short-term debt was BRL368 million. Out of this amount the BRL124 million at the holding level was refinanced with BRL265 million of long term loan with the Inter-American Development Bank (IDB) issued in the second quarter of 2016. During the same period, Aegea also refinanced BRL50 million of debt linked with operations at Barra do Garcas and Matao and is additionally finalizing the debentures issuance to refinance the bridge-loan at the subsidiary Nascentes do Xingu of BRL140 million. The company's remaining short-term debt was mainly composed of long-term debt installments of the subsidiaries -- mainly Prolagos and Guariroba -- (BRL36 million).

On a pro forma basis, considering refinanced debt, the holding's cash balance was robust at around BRL193 million compared to its reduced short-term debt. On a consolidated basis, the ratio cash balance/short-term rose to 1.9x from 0.6x previously.

High Operating Margins

Aegea's consolidated financial profile will continue to benefit from the high operating margins of its main subsidiaries. Fitch expects the group's EBITDA margin will be 56% until 2020. During the latest-12-month (LTM) period ended on March 31, 2016, the consolidated net revenue of BRL866 million (excluding construction revenues) represented relevant growth of 8.9% as compared with the LTM ended March, 2015. This increase was mostly favored by the expansion of operations, tariff adjustments and development of recently incorporated operations.

Aegea has been managing its costs effectively, which benefited its consolidated EBITDA of BRL444 million during the LTM ended March 31, 2016. This amount corresponds to a favorable consolidated EBITDA margin of 51.3%, above industry peers average. The company's consolidated EBITDA margin has increased as compared with 49% registered in 2014 as a result of the gradual efficiency development on concessions with lower profitability levels.

Capex Pressures Cash Flow

Fitch's expects Aegea's consolidated Free Cash Flow (FCF) to remain negative at around BRL400 million in 2016, with a gradual reduction to approximately BRL150 million until 2020. The company's capex should pressure its FCF due to relevant annual commitment of around BRL380 million on average of subsidiaries during the period, and by the high level of dividends distributed annually estimated at BRL 120 million. The agency estimates that the increase on the volume of water and sewage billed in addition to tariff adjustments and rebalancing will continue to support Aegea's consolidated operating cash flow generation and mitigate the pressure on its FCF.

During the LTM ended March 31, 2016, the CFFO on a consolidated basis totaled BRL157 million, which resulted in a negative FCF of BRL275 million after the investments of BRL315 million and the dividend payment of BRL117 million. In 2016 investments are likely to reach approximately BRL450 million.

Inherent Political Risk

Aegea's water/wastewater operations are based on concession contracts that offer regulatory framework to the group's activities. Despite the diversified concession granting powers of its subsidiaries, none are ring-fenced from political interference from municipal government in the operational and financial performance of the concessionaries. Positively, Aegea's operations are subject to distinct regulatory agencies, which imply risk dilution. The favorable track record concession agreement enforceability of its subsidiaries during the last years and the satisfactory capacity of the group to interact with various public agents and autarchies are important consideration on the analysis. 

KEY ASSUMPTIONS

Fitch's key assumptions within its rating case for the issuer include:

--Water and sewage volume billed growth of 5% and 7% in 2016, respectively; 4% and 8% in 2017; and 2% and 4% to 5% in the following years;

--Average tariff adjustment of 15% for 2016, in line with inflation in the following years;

--Annual capex of around BRL380 million on average from 2016 to 2020;

--Annual dividends distribution of around BRL120 million on average.

RATING SENSITIVITIES

Negative Rating Action: Actions that might lead (individually or collectively) to a negative rating action include:

--Consolidated Net Leverage that is consistently above 3.5x;

--Cash plus CFFO/short-term debt ratio below 1.5x on consolidated basis; and

--Holding company coverage ratio, measured by net debt/ received dividends consistently above 3.0x.

Positive Rating Action:

Developments that might (individually or collectively) lead to positive rating actions include:

--Consolidated Net Leverage below 2.0x on a sustainable basis;

--Maintenance of the net liquidity coverage index, measured by cash plus CFFO/short-term debt higher than 3.0x on a consolidated basis; and

--Holding company coverage ratio, measured by net debt/received dividends below 1.5x on a consistent basis.