(Moody’s Investors Service, 6.Jan.2017) – Moody’s Investors Service assigned a B3 Corporate Family Rating (CFR) to Pampa Energía S.A. At the same time, Moody’s assigned a B3 rating to the company’s proposed long term senior unsecured notes. Proceeds from the notes will be used to refinance debt and for capital investments as well as other general business purposes. The outlook on the ratings is stable.
This is the first time that Moody’s assigns ratings to Pampa.
RATINGS RATIONALE
Pampa’s B3 ratings assume a successful merger of Petrobras Argentina S.A. into Pampa, expected to be finalized in the first quarter of 2017. From one side, the ratings consider Pampa’s negative free cash flow, although fueled by expansionary capex in natural gas and power projects, which have favorable prospects; low interest coverage and low retained cash flow compared to total debt, pro forma for the proposed notes; as well as exposure to volatile, highly-regulated power and oil and gas industries in Argentina. On the other hand, these factors are mitigated by the company’s strategy to focus on businesses with positive pricing outlooks, namely natural gas production and power generation; the expected stable demand for electricity and strong demand for natural gas in Argentina; as well as low foreign exchange risk.
Pro forma for the acquisition of PESA, Pampa’s free cash flow will be negative for the foreseeable future, given high expansionary capital expenditures, which are little flexible, compared to operating cash generation. Moody’s assumes that Pampa will issue up to $1 billion in new notes, and thus that its debt burden will be high compared to retained cash flow in the next 2 years: retained cash flow/total debt ratio will hover between 20% and 25% in the next two years (Moody’s considers the $300 million owed to Cammesa, Argentina’s wholesale power market administrator, as short-term payable, not financial debt). Likewise, Moody’s forecasts that the company’s Moody’s-adjusted EBITDA/interest expenses will be below 3.5 times in 2017, which is currently low for a volatile business profile, although with prospects of improvement in the medium term.
Pampa operates in the power as well as the oil and gas industries in Argentina, which are highly-regulated and pose high operating risk. But the industry fundamentals in Argentina for the gas industry in particular are favorable since local natural gas production supplies only 75% of the country’s needs, while the 25% difference is imported from Bolivia and Chile, among others, a situation which should prevail for the next 6 to 7 years, at current local natural gas production growth rate. This dependence on imports of gas, which is paid in kind and with scarce US dollars, sustains solid prospects for the gas industry in the country in the medium to long term. While margins in the refining business have been under pressure given low economic growth and demand for oil products, as well as labor pressure for high wages and benefits, this line of business is small on a consolidated basis.
Similarly, Pampa’s electricity distribution assets are well-positioned to benefit from regulatory reforms and tariff increases, which should come over the course of 2017 and 2018. In addition, the company owns a co-controlling interest in Transener, the largest high voltage power transmission company in Argentina, which has with 20,630 km of transmission lines, equivalent to an 85% market share. However, margins at the power industry have been historically low and Moody’s expects that flat demand for power, in line with the country’s weak GDP growth rate, will challenge the company’s ability to transfer inflation and local currency devaluation costs to power tariffs in later years. For instance, Moody’s estimates that, during 2016, inflation in Argentina was around 30%.
Thus, Moody’s believes that Pampa’s credit metrics related to debt burden and interest coverage will remain in line with its B3 rating in the next 24 months or more, even considering a successful resetting of electricity tariffs at profitable levels, which Pampa expects to happen before the end of February.
Foreign exchange risk is low for Pampa. About half of the company’s costs, mainly in the oil and gas business, is linked to the US dollar and, pro forma for the proposed notes, close to 100% of the company’s debt will be in US dollars. However, close to 80% of Pampa’s EBITDA is generated in the gas and power generation businesses, whose sales are US dollar-linked, although dependent on prevailing exchange rate. While the peso/dollar exchange rate had been controlled and kept low by the Argentine government in the past, since the new government took place, in early 2016, the exchange rate has been set by the market, with limited government intervention.
Currently there is a low level of structural subordination between the holding company’s debt and its subsidiaries’. Pro forma for the merger of PESA into Pampa, close to 50% of the consolidated EBITDA, which Moody’s estimates will reach about $810 billion in 2017, will be generated at the holding level (i.e. at Pampa itself) and will be related to exploration and production of oil and gas. In turn, the holding company will hold about 90% of the group’s debt. Most of the cash-generating subsidiaries in the group are controlled by Pampa at around 99%. However, the proposed notes’ indenture provides for no limit to debt increase at the subsidiaries level, although on a consolidated basis Pampa’s debt leverage cannot exceed 3.5 times on an incurrence basis.
As of September 2016 and pro forma for the acquisition of PESA, Pampa’s refinancing risk is high but would decline significantly after the issuance of the proposed new notes, which Moody’s believes will amount to $1 billion. In addition, the company counts with solid relationships with banks, although credit facilities are uncommitted, and is currently working with Export Credit Agencies and other multilateral financial institutions in order to diversify its external funding sources. The company’s liquidity situation depends on a timely refinancing of upcoming debt maturities of about $760 million in 2017, $100 million in 2018 and $33 million in 2019. In addition, as per the company’s financial policies, it would always maintain a minimum of up to $100 million in cash at all times, which would not be available to repay debt. Furthermore, Moody’s believes that Pampa will spend about $720 million in capex in 2017. However, besides the proceeds from the new notes, sources of cash include a sizable $476 million in consolidated cash on hand as of September 2016, pro forma for the merger with PESA, and about $810 million in EBITDA in 2017, as per Moody’s estimates. Convertibility of local currency into US dollars and transferability of foreign currency abroad are risks also considered in Pampa’s ratings.
The stable outlook on Pampa’s ratings reflects Moody’s expectation that the Argentine power companies will be successful in the current negotiations with the government to increase electricity tariffs, to be set for the next 5 years. It also considers that natural gas prices will remain strong in Argentina given lower local supply vis-a-vis demand.
Pampa’s B3 ratings could be downgraded if the company materially increases its leverage, measured as retained cash flow (funds from operations less dividends) to total debt lower than 10%, or if its interest coverage, as per EBITDA to interest expense, declined to below 2 times with limited prospects of a quick turnaround. Also, a deterioration of the company’s liquidity profile could lead to a rating downgrade.
In turn, a rating upgrade could occur is Pampa’s retained cash flow to total debt ratio is higher than 35% and its EBITDA to interest expense rate is above 6 times on a sustainable basis. An upgrade on the ratings of the Government of Argentina would not necessarily translate into an immediate upgrade of Pampa’s ratings.
Pampa is engaged in generation, distribution and transmission of electric power in Argentina as well as on oil and gas production, refining, petrochemicals and hydrocarbon commercialization and transportation in Argentina and, to a lesser extent, in Venezuela. Pro forma for the merger with PESA, as of September 30, 2016, Pampa was the third largest power generator in Argentina, with approximately 10.6% market share. In addition, it was the fourth oil and gas producer in the country, with an equity oil and gas production of over 58.3 thousands of barrels of oil equivalent per day.
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