OREANDA-NEWS. 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.

KEY RATING DRIVERS

TDP's ratings reflect the company's dominant market positions in the Peruvian telecom industry and robust cash flow generation from its fully integrated fixed-line and mobile operations, which have supported its strong financial profile. The ratings are tempered by intense competition, especially with new entrants' aggressive marketing efforts, and the growing industry maturity, which have led to the company's profitability deterioration. The ratings also reflect its linkage with the parent, Telefonica SA (TEF, IDR 'BBB'/Outlook Stable), in terms of strategic ties and shareholder return policy, which could potentially affect TDP's financial profile.

Strong Market Position:

TDP is the largest telecom operator in Peru and Fitch expects its dominant position in both the fixed and mobile segments to remain intact backed by its well-established network competitiveness and strong brand recognition despite increasing competitive pressures. Competition for market share in the Peruvian mobile industry has materially increased following the entrance of the Chilean telecom operator, Empresa Nacional de Telecomunicaciones S. A. (Entel; rated 'BBB'/Outlook Negative) in 2013, due to its aggressive marketing campaign to quickly achieve a sizable scale. Although a modest market share loss with continued margin erosion could continue for TDP going forward, Fitch believes that the company's financial capacity to support high investment and marketing expenses will enable it to fend off competitive threats to an extent, and help maintain market leadership.

TDP retained its largest market shares across all of its service platforms, with a 50% subscriber market share for mobile operations as of March 2016. The company also held 81% and 67% subscriber market shares for broadband and pay-TV, respectively, according to the regulator, Organismo Supervisor de Inversion Privada en Telecomunicaciones (Osiptel).

Strong Cash Flow Generation:

TDP boasts solid internal cash flow generation, which Fitch expects to continue over the medium term and help support its conservative financial profile. The company continued deleveraging during 2015, as cash flow from operations (CFFO) of PEN2.6 billion comfortably covered its capex of PEN1.8 billion and insignificant dividends of PEN331,000. During 2012-2015, the company's average free cash flow (FCF) margin was a solid 6%, which was mostly used to pay down its debt.

Fitch forecasts the company's FCF generation to temporarily turn negative in 2016 due to high capex, mainly associated with its 700Mhz spectrum acquisition for USD315 million, but it should reverse back to positive in 2017 in the absence of any sizable dividends, or materialization of contingent liabilities with regard to its income tax disputes against the Superintendencia Nacional de Administracion Tributariabeing (SUNAT). Fitch expects TDP's CFFO to consistently be PEN2.1billion-PEN2.2 billion annually in 2016 and 2017, which should fully cover its recurring capex of about PEN1.8 billion, estimated by Fitch, excluding one-off spectrum auctions. This level of pre-dividend FCF generation with its low leverage should provide some headroom for its shareholder distributions or contingent liability, if necessary. The company made provisions of PEN1.6 billion in June 2015 for the pending SUNAT-related legal disputes.

Solid Financial Profile:

Fitch forecasts TDP's net leverage to remain low for the rating category over the medium term. TDP has continued to improve its financial profile backed by its robust positive FCF generation, which has mostly been used to pay off the debt. During the five years from 2011 to 2015, the company reduced its net debt by PEN2.3 billion to PEN837 million at end-2014 from PEN3.1 billion at end-2011. This has led to its net leverage, measured by EBITDAR / adjusted net debt, falling to 0.3x from 1.1x during the same period. Fitch forecasts net leverage to remain well below 1.0x over the medium term given TDP's solid FCF generating ability, following a slight increase in 2016 to 0.6x due to the spectrum acquisition.

Margin Erosion due to Competitive Pressures:

TDP's ongoing profitability deterioration is unlikely to be curbed in the short - to medium-term. Intense competition in the mobile market remains centered on handset subsidies and aggressive tariffs, which makes it difficult to cut subscriber acquisition costs or mitigate negative pressures on the industry-wide ARPU. The trend will continue as operators try to increase the penetration of smartphones to boost mobile data revenues. During the first half of 2016, the company's EBITDA margin fell to 29%, which compares negatively to 32% in 2015 and in 2014.

KEY ASSUMPTIONS

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

--Muted medium-term revenue growth following negative growth in 2016;

--Mobile market share gradually declines towards 45% in the long term due to competition;

--EBITDA margin to remain under 30% over the medium term;

--FCF to turn negative in 2016 due to high capex; but to revert back to positive from 2017;

--Net leverage to remain below 1.0x over the medium term in the absence of any sizable shareholder distribution or contingent liability payments.

RATING SENSITIVITIES

Negative rating action will be considered in case of material deterioration in the company's key operating and financial metrics which are due to competitive/regulatory pressures, higher-than-expected capex and shareholder distributions, or any substantial negative impact from the pending legal dispute with SUNAT over income tax issues - all of which combined result in the company's net leverage increasing to over 2x on a sustained basis.

TDP's ratings are not directly linked to the ratings of its parent, TEF. However, any significant deterioration in the parent's credit profile, to the effect that it results in further rating downgrades or in a material liquidity crunch for the parent, could place pressure on TDP's ratings. TEF is currently rated 'BBB'/Outlook Stable.

Conversely, an upgrade of TDP's ratings, resulting in more than one-notch differential from the parent's 'BBB' rating, would be limited given their strong linkages.

LIQUIDITY

TDP maintains a sound liquidity profile given its high cash balance of PEN1.5 billion fully covering short-term debt of PEN931 million as of June 30, 2016. The company also has well-spread debt maturities. The company's main source of liquidity, in addition to the cash on hand, is its strong internal cash generation and its undrawn committed credit facilities in the amount of PEN780 million, which further bolsters its financial flexibility.