OREANDA-NEWS. Fitch Ratings has upgraded Telefonica Celular del Paraguay S.A.'s (Telecel) long-term foreign currency Issuer Default Rating (IDR) and its USD300 million senior unsecured notes to 'BB+' from 'BB'. The Rating Outlook is Stable.

The upgrade reflects Fitch's upgrade of Paraguay's sovereign rating in 2015, which resulted in an upgrade of its country ceiling to 'BB+' from 'BB'. Fitch also believes that the company's credit profile is in line with a 'BB+' rating based on its solid financial profile, market-leading position, and a strong linkage with its parent, Millicom International Cellular S.A. (MIC, also rated by Fitch at 'BB+'/Outlook Stable).

KEY RATING DRIVERS

Telecel's ratings reflect its leading market positions in Paraguay, supported by its extensive network and distribution coverage, diverse service offering, and the strong brand recognition of Tigo. The company's competitive strengths have enabled stable operational cash flow generation and high margins, despite recent deterioration, resulting in the company's solid financial profile, with leverage that is considered moderately low for the rating category. Negatively, the company's ratings are tempered by its continued EBITDA deterioration amid intense competition, and persistent negative free cash flow (FCF) generation.

Telecel's ratings also reflect a strong linkage between the company and its parent, MIC. Fitch reflects the implicit support from MIC despite weak legal linkage in Telecel's ratings given its strategic and financial importance to the parent's operation in Latin America. The company also benefits from synergies related to MIC's larger scale and management expertise.

Leading Market Position:

Telecel is the largest telecom operator in Paraguay, with around 65% revenue market shares in mobile and fixed-line services. As the first mobile operator in the country in 1992, the company has established an entrenched position with the most extensive network and distribution channel coverage under its strong 'Tigo' brand, shared among MIC's group companies globally. Telecel strengthened its competitive position by the acquisition of Cablevision in 2012, which helped expand its service portfolio into pay-TV and fixed-broadband and achieve operational synergies. These competitive advantages should allow the company to maintain its market leadership over the medium term despite increasing competitive pressures.

Positive Revenue Diversification:

Fitch expects Telecel's fixed-line segments to continue double-digit revenue growth, as demand remains strong given low penetration of these services, which would help mitigate suppressed growth in the mobile business. The subscriber base for these services continued to grow strongly during the first half of 2015 (1H15), with revenue generating units growing by 11% in six months to 228,900 compared to 206,700 at the year-end 2014. Based on this segment's growth, Fitch believes the company will be able to achieve low-single-digit revenue growth in the short- to medium -term. The penetration rates for broadband and pay-TV were 13% and 36%, respectively, as of the year-end 2014.

Margin Recovery:

Fitch projects the company's EBITDA margin will recover to close to 45% from 2016 on due to the termination of the technical service fees paid MIC during 2Q15, which used to be 10% of its revenues. Telecel paid PYG321 billion of this fee during 2014, compared to just PYG48 billion a year earlier, which led to a material decline in its EBITDA margin to 38% from 51% during the same period. Negatively, the company's profitability could resume a downward trend toward 40% over the long term, given competitive pressures and an increasing revenue contribution from lower-margin pay-TV and broadband services.

Negative FCF:

Telecel's on-going negative free cash flow (FCF) generation is unlikely to reverse in the medium term largely due to its high capex plan and dividends. Fitch expects the company's annual capex to be around PYG1,000 billion in 2016, which compares to just PYG510 million in 2014. The investments will be mainly concentrated on the expansion of network coverage and spectrum acquisitions. This level of capex would consume most of the company's CFFO generation, which is estimated to be around PYG1.0 trillion-PYG1.1 trillion during the period. Although the shareholder distribution could be tapered from 2016 given the high investment needs, this would still pressure the company's FCF generation into negative territory.

Low Leverage:

Fitch forecasts Telecel's solid financial profile to remain intact over the medium term backed by its stable operational cash flow generation, which is, however, weakening. Despite the expected continued negative FCF, the company's net leverage should remain at around 1.7x-1.8x over the medium term, which is considered moderately low for the rating category. The company's net leverage ratio was 1.3x as of June 30, 2015, which compares unfavorably to 1.0x and 0.6x at end-2014 and end-2013, respectively. The company has a high exposure to foreign exchange risk as its debt is largely denominated in U.S. dollars, while its EBITDA generation is mostly in local currency. Positively, the risk is manageable, as the company does not face any U.S. dollar debt maturity until 2022 when its USD300 million senior unsecured notes become due.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Telecel include:
--Low-single-digit revenue growth from 2016 on, mainly driven by continued strong growth in the fixed-line operation;
--EBITDA margin to recover toward 45% in 2016 in the absence of a technical service fee to MIC;
--Capex-to-sales ratio to increase to close to 30% in 2016 due to network coverage expansion and 4G spectrum acquisition, but to fall to below 20% over the long term ;
--Negative FCF generation to remain in the short- to medium term;
--Net leverage to increase to 1.7x-1.8x over the medium term.

RATING SENSITIVITIES
A negative rating action would be considered in case of :

--Continued deterioration in the company's EBITDA generation along with weak revenue growth due to competitive pressures, including material loss in mobile market share, ARPU erosion, and substantial increase in marketing expenses;
--Persistent negative FCF generation due to aggressive shareholder distributions and/or higher-than-expected capex;
--Telecel's adjusted net leverage increasing to above 2.5x in conjunction with a weak liquidity profile on a sustained basis;
--A negative rating action on Millicom's ratings could also negatively affect Telecel's ratings.

Conversely, Fitch does not foresee any positive rating action as the ratings are constrained by the Paraguayan country ceiling of 'BB+', and its close linkage to its parent, also rated 'BB+' by Fitch.

LIQUIDITY

Telecel has a good liquidity position underpinned by its stable cash flow generation, and its cash balance of PYG200 billion, which fully covered its short-term debt of PYG101 billion as of June 30, 2015. Fitch does not foresee any liquidity problem for Telecel in the short- to medium-term as the company does not face sizable debt maturities until 2022.