OREANDA-NEWS. Fitch Ratings has affirmed AES Panama S.R.L.'s (AESP) foreign and local currency Issuer Default Ratings (IDRs) at 'BB+'. Fitch also affirms AESP's outstanding USD300 million notes due in 2016 at 'BB+'. The Rating Outlook is Negative.

AES Panama's ratings are based on the company's strong portfolio of assets with a competitive dispatch position, its multiple power purchase agreements (PPAs) and its adequate historical financial profile. The ratings also reflect the company's exposure to hydrology risk given its elevated contracted capacity, increased volatility in cash flows evidenced during recent years and weakening operating environment due to energy transmission problems in the country.

Fitch expects the company's credit metrics will stabilize in the short-to-medium term as a result of the start of operations of the power barge in the first quarter of 2015 (1Q'15) and compensations for up to USD60 million to be received in the next two years due to restrictions in the country's transmission lines. The lower spot prices and moderate improvements in hydrological conditions observed since the second half of 2014 (2H'14) should lessen the cash outflows for purchases of energy in the coming quarters.

KEY RATING DRIVERS

Weakened Credit Metrics:

AES Panama's financial profile has weakened and its cash flows have exhibited increased volatility in the last two years. The company's credit metrics deteriorated mainly as result of non-planned purchases of energy in the spot market to fulfill obligations derived from its PPAs. The net impact of these transactions on operating cash was approximately USD117 million in 2013 and USD116 million in the first nine months of 2014. EBITDA declined to negative USD1.6 million for latest 12 months (LTM) ended in September 2014. Over the same period, leverage increased as the company funded the acquisition of a 72MW power barge with debt and tapped its working capital facilities to finance purchases of energy. Cash flows could deteriorate further should hydrology remain abnormally low or 'El Nino' effect materializes.

The start of operations of the power barge in the 1Q'15 and the compensation payments for restrictions in country's transmission lines should mitigate the impact of adverse hydrological conditions. The barge will generate a cumulative incremental EBITDA of USD108 million in the next five years, considering capacity payments only. Revenues derived from energy dispatches will depend on future market conditions, including spot prices. AESP expects elevated levels of dispatch in the short to medium term given the low reserve margins in the system. The current variable cost of the plant is approximately USD83/MWh and spot prices for January 2015 were above USD96/MWh. As per agreement with the Ministry of Finance, the company will receive compensation for future purchases in the spot market for up USD30 million in each of the next two years. These actions could help the company to return to its historical levels of leverage by 2016, if current financial policies remain unchanged.

Cash Flow Supported by Contractual Position:

AES Panama's ratings reflect the company's contractual position with low counterparty risk. Generation companies in Panama are permitted to enter into PPAs for up to their firm capacity allocation. The regulations promote the use of PPAs by requiring distribution companies to secure 100% of their peak regulated demand for the following year. AES Panama maintains PPAs for approximately 90%, on average, of available capacity through 2018. The company sells electricity under separate PPAs with the country's three distribution companies, Empresa de Distribucion Electrica Metro-Oeste S.A. (Edemet), Elektra Noreste (Fitch IDR of 'BBB'), and Empresa de Distribucion Electrica Chiriqui (Edechi), with various maturities. Panamanian distribution companies appear to have the sufficient credit quality and financial ability to support their respective obligations under the PPAs with AES Panama.

AES Panama benefits from a competitive portfolio of low-cost hydroelectric generating assets, including dam-based reservoirs and run of the river units. The diverse location of the company's assets somewhat mitigates its exposure to hydrology risk as the plants are located in different hydrology regions. AES Panama is the largest generation company in the country based on installed capacity. The company has four hydroelectric plants throughout the country with a total installed capacity of approximately 482 MW and different dispatch priorities. The Bayano plant (260MW) operates during the peak load hours yet ahead of the more expensive thermal units. La Estrella (48MW) and Los Valles (54MW) are run of the river facilities and the first units to be dispatched in the system. Esti (120MW) is normally dispatched similar to run of the river facilities given the limited size of its reservoir.

Weakening Liquidity:

The company's liquidity position has been affected during recent years as a result of a weaker cash flow generation from operation and the company's continued dividend payment policy. Cash on hand as of Sept. 30, 2014 was approximately USD16 million, additionally the issuer maintained restricted cash for approximately USD10 million in the Debt Service Reserve Account. The company's financial policy is to maintain a minimum cash balance of USD20 million and future dividend payments may follow this policy.

Working capital debt was approximately USD35 million as of September 2014; this compares with cash of USD16 million and a negative LTM EBITDA of USD1.6 million. The company expects to improve its liquidity levels as the barge starts operations and cash outflows from purchase of energy reduces given the lower spot prices and higher hydro production.

Exposure to Regulatory Risk:

The company's ratings also reflect its exposure to regulatory risk. Historically, generation companies in Panama were competitive unregulated businesses free to implement their own commercial strategies. In the past years, the increase in electricity prices has resulted in increased government intervention in the sector in order to curb the impact of high energy prices for end-users.

Exposure to Hydrological Risk:

The company maintains PPAs that represent approximately 91% of its firm capacity for 2014 (93% in 2013). According to the local regulator, firm capacity is calculated based on a 30-year historical average. This elevated level exposes AES Panama to changes in hydrological conditions such as those observed in 2013 and 2014. Generation shortfalls are covered via purchases in the spot market. In 2013 and 1H'14, spot prices were severely impacted by the abnormal hydrology and other factors. Since 2H'14 spot prices has significantly declined given the decline in oil prices and better year-over-year (YoY) hydrological conditions. In December 2014, the average spot price was USD127.5/MWh compared to USD212.61/MWh in December 2013. Prices considered in AESP's PPAs with distribution companies, the company's largest clients, are below USD100/MWh.

Currently, AES Panama's operations are being pressured by delays in the expansion of country's transmission infrastructure. This has further exposed the company to the spot market and triggered the government to compensate the affected generation companies. The Panamanian government has agreed to compensate the issuer for future purchases in the spot market; this agreement synthetically reduces company's contracted capacity in approximately 70MW or to 77% of its firm capacity for 2014. These compensations have a cap of USD40 million in 2014, USD30 million in 2015 and USD30 million in 2016. Transmission bottle necks are expected to be resolved in 2016, when the Chiriqui - Panama line starts operations.

RATING SENSITIVITIES

A downgrade could result from a combination of the following factors: leverage above 4.0x on a sustained basis, increased government intervention in the sector coupled with weakening regulatory framework, inability to reduce exposure to the spot market, and/or payment of dividends coupled with high leverage levels.

Factors that could trigger a positive rating action include: a sustained decrease in leverage below 3.0x coupled with an effective diversification of revenues among different fuels, and reduced exposure to the spot market.