Fitch Ratings has affirmed Alupar Investimento S.A.'s Long-Term Foreign Currency (FC) and Local Currency (LC) Issuer Default Ratings (IDRs) at 'BB' and 'BBB-', respectively.

In addition, Fitch has affirmed Alupar's and its subsidiary Foz do Rio Claro Energia S.A.'s (Foz do Rio Claro) National Scale ratings and outstanding local debentures at 'AAA(bra)'. The Rating Outlook for the IDRs is Negative, and the Outlook for the National Scale ratings is Stable.

Alupar's ratings reflect its low business risk relative to its diversified portfolio of power transmission assets in Brazil, with predictable revenues and high operating margins. The group should continue to reduce leverage and present a positive FCF starting in 2023. The company's FC IDR is constrained by Brazil's country ceiling of 'BB', while Brazil's operating environment limits the LC IDR. The Negative Outlook for the FC IDR reflects Brazil's 'BB-' sovereign Rating Outlook. The Negative Outlook for the LC IDR reflects the potential weaker operating environment for the country.

Key Rating Drivers

Low Business Risk: Alupar's credit profile benefits from the combination of its activities in energy transmission and generation, mainly in Brazil, through a sizeable and diversified asset base that dilutes potential operational and regulatory risks. Groups' concessions will not begin to expire until 2030 in transmission, and 2038 in generation, and will occur on a staggered basis over the following years.

In transmission, concessions' revenue (Annual Permitted Revenues, PAR) is generated through the availability of its assets, without demand risk and annually adjusted for inflation. This segment will remain the company's main business.

In the generation segment, long-term contracts for the sale of a large part of the assets' assured energy and the partial protection for hydrological risk also create an expectation of strong performance. The importance of this segment for the group's EBITDA, estimated at 18% for 2021, should remain at similar levels over the next few years.

Expected Leverage Reduction: Alupar's consolidated leverage should gradually decline and remain consistent with the current IDRs. Alupar should return to historical conservative credit ratios after punctual increase in the group's net leverage during the strong investment cycle in 2019-2021. During the LTM ended Sept. 30, 2021, the adjusted net debt-to-EBITDA ratio was 4.1x, according to Fitch's criteria, and should gradually decrease to 3.3x in 2022 and 2.7x in 2023, after a peak of 4.7x in 2020.

Favorable Tariff Readjustments: High exposure to transmission concessions IGPM-indexed (about 50% of consolidated PAR) will strengthen the groups consolidated results in 2021 and 2022. PAR readjustment of 37% for IGPM-indexed concessions and 8% for IPCA-indexed concessions from July 2021, and the conclusion of new projects will boost EBITDA, calculated through regulatory accounting, to BRL2.0 billion in 2021 from BRL1.5 billion in 2020.

For 2022, the base case scenario for the rating expects an EBITDA of BRL2.3 billion, which also incorporates the benefits of new projects (one in Dec. 21 and one in Feb. 22). EBITDA margins are high, ranging 80%-85%, characteristic of transmission companies in Brazil.

Manageable Negative FCF: Alupar should have negative consolidated FCFs of BRL247 million in 2021 and BRL94 million in 2022, pressured by disbursements of the capex program of approximately BRL2.2 billion in the period, and dividend distribution corresponding to 50% of net income. Dividend paid should reach BRL570 million in 2022 after BRL757 million in 2021. The forecast consolidated annual cash flow from operations (CFFO) of around BRL1.6 billion during the 2021-2022 period, represents growth from BRL1.2 billion in 2020.

The additional PAR of BRL244 million from the conclusion of two projects until Feb. 22 should boost Alupar's CFFO to BRL1.7 billion in 2023, which in combination with the reduction in the capex level to around BRL400 million, will allow a positive FCF of BRL776 million.

Manageable Construction Risk: Alupar's positive track record of developing and obtaining long-term financing for its new transmission and generation projects mitigates the risks associated with the construction phase. Pending the project finance structure of two transmission lines and of the generation projects is not a major concern. The group needs to raise BRL750 million long-term debt in 2022.

Alupar has three transmission projects and three energy generation plants under construction. Transmission lines will add 476 km and require BRL980 million capex in 2022 and 2023, while the conclusion of the generation plants in 2022 will add an installed capacity of 125 MW and require capex of BRL653 million. Licensing is pending only in the project located in Colombia and is scheduled for the first half of 2022.

TNE Should Not Affect Ratings: The base case scenario for the rating does not include the development of Alupar's largest pre-operational project, the transmission line Transnorte Energia S.A. (TNE), as it is under negotiation with regulators regarding indigenous compensation. Alupar has 51% of the project, but does not consolidate it.

Should Alupar obtain the approval to continue with the construction, it will require capex of BRL2.5 billion and at least 36 months to conclude the construction of the 715 km between the States of Amazonas and Roraima. Incorporating equity injections and debt guarantees to Alupar's credit metrics, the adjusted net debt-to-EBITDA ratio should slightly increase to 3.4x in 2022 and 3.0x in 2023 compared with the current base case.

Subsidiary Rating Equalized: Fitch equalizes the National Scale ratings of Foz do Rio Claro and Alupar due to the strong legal, operational and strategic incentives between the subsidiary and the controlling shareholder. Alupar holds 100% of Foz do Rio Claro's shares and is the guarantor of the company's single debt, whose financial covenants are verified based on Alupar's consolidated figures.

Derivation Summary

Alupar's financial profile is stronger than Latin American peers Interconexion Electrica S.A. E.S.P. (FC IDR BBB/Stable) and Consorcio Transmantaro S.A. (FC IDR BBB/Stable), in Colombia, and Transelec S.A. (FC IDR BBB/Stable), in Chile. All these peers have low business risk profiles and predictable cash flow generation, characteristic of transmission electricity companies in a regulated industry. The main differentiation in the IDRs of Alupar and those companies is the country where they generate their main revenues and the location of assets.

While its peers are located in countries with higher IDRs, Alupar's ratings are negatively affected by Brazil's country ceiling of 'BB'. In the case of Transmissora Alianca de Energia Eletrica S.A.'s (FC IDR BB/Stable), also located in Brazil, both have similar credit profile, with diversified portfolio of transmission companies and a robust financial profile, with some expected decrease in leverage metrics due to reduction in investments.

Key Assumptions

Fitch's main assumptions of its base scenario for the issuer include:

RAPs adjusted annually by inflation, with a 50% reduction for transmission assets whose concession agreement contemplates this movement after the 15th year of operation;

Readjustments of 2021/2022 cycle PAR: IGPM-indexed concessions: +37% / IPCA-indexed concessions: +8%;

Generation scaling factor of 0.80 in 2022, 0.85 in 2023 and 0.93 in 2024;

Operating expenses adjusted by inflation;

Distribution of dividends equivalent to 50% of net income;

Total investments of BRL2.7 billion during 2021-2024 period and absence of acquisitions and/or new investments out of the current portfolio.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Positive rating action for the company's FC IDR would be associated to an upgrade on Brazil's sovereign rating;

Positive rating action for the company's LC IDR would be associated to improvements on Brazil's operating environment;

Upgrade not applicable to the National Scale rating as it is at the highest level.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Negative rating action for the LC IDR would be associated to a deterioration in Alupar's consolidated financial profile, with net adjusted leverage above 3.5x and funds from operations net leverage above 4.0x, both on a sustainable basis;

A weaker Brazilian operating environment may result in a downgrade of the LC IDR;

A downgrade on Brazil's sovereign rating would result in a similar rating action on Alupar's FC IDR;

A two-notches downgrade on Alupar's LC IDR would lead to a downgrade on the National Scale rating.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Sound Liquidity Profile: Alupar group should continue to benefit from a high liquidity position and broad access to the banking and capital markets. On a consolidated basis, the group's cash position of BRL1.5 billion at the end of September 2021 covered its short-term debt of BRL1.1 billion by 1.3x. Fitch also expects that the operating cash generation of new transmission lines will be adequate to service their debt. On Sept. 30, 2021, total consolidated adjusted debt of BRL9.4 billion mainly consisted of debentures issuances (BRL6.9 billion, or 73%) and Banco Nacional de Desenvolvimento Economico e Social (BNDES; BRL821 million, or 9% of the total).

The holding company should use its significant cash reserves to supply the needs of its projects, maintaining a debt maturity schedule compatible with its cash flow expectations. As of Sept. 30, 2021, its cash position of BRL611 million (41% of the consolidated amount) was slightly smaller than the total debt of BRL664 million. The dividends inflow is its main source of funds, with BRL671 million received in the LTM ended on Sept. 30, 2021. In the same period, the total debt-to-received dividends ratio was 1.0x. Alupar should be able to maintain the net debt-to-received dividends ratio below 1.0x over the following years.

Issuer Profile

Alupar is a non-operational holding company that operates in the energy transmission and generation segments mainly in Brazil, with small operations in other countries in Latin America. The company's shares are traded at B3 in Brazil.

Summary of Financial Adjustments

Net revenues and EBITDA net of construction revenues and cost.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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