OREANDA-NEWS. July 28, 2015. Fitch Ratings has affirmed Instituto Costarricense de Electricidad y Subsidiarias' (Grupo ICE) foreign- and local-currency Issuer Default Ratings (FC/LC IDRs) at 'BB+' as well as its National Scale ratings at 'AAA(cri)'. The Rating Outlook remains Negative. A complete list of rating actions follows at the end of this release.

Grupo ICE's ratings are supported by its linkage to the Sovereign rating of Costa Rica (FC and LC IDRs rated 'BB+'/Negative Outlook by Fitch) which stems from the government ownership and government's implicit and explicit support. ICE's Negative Outlook reflects the Negative Rating Outlook on Costa Rica's Sovereign rating. The company has strategic importance for the government given the growing demand for electricity in the country and the government's plans to increase renewable generation and reduce exposure to fluctuations in fossil fuel prices. The ratings also reflect the company's diversified portfolio of assets, adequate financial profile, aggressive capital expenditure program oriented toward increasing renewable generation capacity and maintaining a strong market share position in the telecommunications business.

KEY RATING DRIVERS

DIVERSIFIED ASSET PORTFOLIO
Grupo ICE is a vertically integrated monopoly in the electricity industry and the incumbent player in the telecommunications industry in Costa Rica. ICE's mobile market share in terms of subscribers was approximately 60% at the end of 2014. The ratings reflect the company's low business risk resulting from its business diversification and positive characteristics as a utility service provider.

The company recorded an installed capacity of 2,253 megawatts (MW) as of December 2014, including plants of its subsidiary, the Compania Nacional de Fuerza y Luz (CNFL). ICE is the exclusive owner of the national transmission grid. The National Electric System (SEN) is composed of Grupo ICE, CNFL, two municipal companies, and four rural electrification cooperatives. There are also private generators that sell energy to Grupo ICE. The SEN installed capacity is 2,885MW.

In 2014, the company generated revenues and EBITDA of CRC1,377,151 million and CRC419,282 million, respectively, up from CRC1,322,800 million and CRC357,235 million in 2013. During 2014 the electricity segment accounted for approximately 57.7% of revenue (2013: 59%), while the telecommunications division contributed the rest. For the LTM ended March 2015 the company generated CRC457,687 million in EBITDA. Fitch expects that the electricity segment's contribution will grow, given current projects and future expansion, as well as relatively stable results in the telecommunications segment.

LEVERAGE DRIVEN BY CAPEX

Grupo ICE's ratings reflect the company's leverage, adequate interest coverage and exposure to foreign exchange risk. Grupo ICE's capital expenditures (capex) accounted for CRC2,298,155 million during the past five fiscal years. The capex plan is mainly financed with debt. The funding related to electricity projects represents approximately 91% of total debt and the remaining funds are allocated to projects in the telecommunications sector.

The leverage ratio calculated as adjusted debt / EBITDAR has increased to around 5.5x as a result of the capex program during 2011-2013. The highest indicator, 5.8x, was registered in 2013. ICE's consolidated debt as of March 2015 was CRC1,953,614 million. The debt adjusted for operating leases was CRC2,508,430 million for the same period. Leverage for the last 12 months as of March 2015 was 4.8x.

The company benefit's from a very favorable debt schedule, as approximately 45.8% of its debt matures after five years, 39.6% between two and five years, and 14.6% in less than two years. The government of Costa Rica guarantees approximately 12% of total ICE Group debt. Debt denominated in U.S. dollars is approximately 85%, which exposes Grupo ICE to fluctuations in the exchange rate.

Grupo ICE recorded charges for currency exchange losses of CRC151,577 million during fiscal 2014, to reflect the accounting impact of the foreign exchange differences. The foreign exchange exposure is reflected in debt service payments (principal amortization and interest payments). A further devaluation of the local currency would generate an increase in the disbursement and the debt service coverage ratios could deteriorate. The debt service coverage ratio measured as EBITDA/debt service is 2x as of March 2015 (2014: 1.8x). The current debt service ratio could decrease to 1.8x based on a 10% FX depreciation scenario.

AGGRESSIVE CAPITAL EXPENDITURE PLAN

Grupo ICE's capital investment plan is considered aggressive and could weaken the company's financial profile, absent increased cash flow generation and adequate tariff adjustments. The company plans to invest approximately USD3.7 billion over the next five years in order to supply electricity to meet demand and maintain its leadership position in telecommunications in Costa Rica. Grupo ICE expects to finance its investments with a combination of internal cash flow, debt, Build Operate and Transfer (BOT) transactions, and project finance vehicles.

In 2014, capital expenditures of CRC217.247 million represented 15.8% of revenues for the year. During the years 2010 through 2013, this ratio was 44.2% per year on average, which indicates that the largest investment phase of the projects has been completed. Fitch forecasts that capex investment for the years 2015-2018 could average 21% of total revenues.

Fitch expects the company will be able to reduce leverage as capex requirements decrease in the medium term (2015-2018), absent large generation projects, and tariff recognition of the debt service of the generation plants that will start operations in the next few years. The 305MW Reventazon project (currently financed through Reventazon Finance Trust) will finalize by the end of 2016. The Reventazon asset and the associated debt will be incorporated in ICE's financial statements at that same date.

Going forward, leverage could increase consistently to over 6x if the company finances its capital investment plan heavily with debt and the revenues associated with these investments are delayed beyond the expected ramp-up timeframe or do not received the tariff adjustments opportunely.

HIGH EXPOSURE TO REGULATORY AND POLITICAL INTERFERENCE

Grupo ICE is exposed to regulatory interference risk given the lack of clear and transparent electricity tariff schedules. The company annually proposes to the regulator electricity tariffs for end-users; in previous years, the regulatory and political interference affected the tariff adjustment process.

Electricity tariffs are set using two mechanisms: through the quarterly adjustment of variable costs of fuel (CVC) in place since 2013, and the ordinary tariff review that considers the operating costs. ICE cash flow benefits from the tariffs adjustments to recognized expenses from previous years related to fuel expenses, exchange rate difference for fuel oil purchases, and energy import expenses, through deferred quarterly adjustments.

The funding requirement of working capital by ICE Group depends on the lag in cost recognition that may arise in both tariff reviews. The telecom regulatory framework considers the price ceiling methodology in tariffs, and grants operators authority to review and adjust rates for some services in order to promote competition.

Despite the regulatory risk, Grupo ICE has managed to maintain a relative stable cash flow generation. Also, the company is exposed to political interference given that the government appoints and removes ICE's directors and executives, sets and approves the company's tariffs, and regulates its budget.

KEY ASSUMPTIONS

--The strong linkage between the Sovereign of Costa Rica and ICE continues.
--Grupo ICE remains important to the government as a strategic asset for the country.
--Fuel variable-cost tariff revision and ordinary tariff adjustments are in place.
--The Reventazon project begins by the end of 2016.
--The 2016 tariff review considers the debt service and revenue from Reventazon hydroelectric project.

RATING SENSITIVITIES

--Grupo ICE's ratings could be negatively affected by any combination of the following: sovereign downgrades; weakening of legal, operational and/or strategic ties with the government; or regulatory intervention that negatively affects the company's financial performance.
--Grupo ICE's ratings could be positively affected by an upgrade of Costa Rica's sovereign rating

Fitch has affirmed the following ratings:

--Long-term FC IDR at 'BB+'; Negative Outlook;
--Long-term LC IDR at 'BB+'; Negative Outlook;
--Senior unsecured debt at 'BB+';
--Long-term national scale (Costa Rica) at 'AAA(cri)'; Stable Outlook;
--Short-term debt at 'F1+(cri)';
--Senior unsecured domestic long-term debt (Costa Rica) at 'AAA(cri)';