SAO PAULO (S&P Global Ratings) June 6, 2022--S&P Global Ratings took the rating action described above. The rating affirmation reflects our expectation that IERL will continue generating relatively predictable cash flows thanks to its long-term and dollar-denominated power purchase agreements (PPAs). That, combined with low maintenance capital expenditures (capex), manageable debt servicing needs, and discretionary dividends will allow the company to keep gross debt to EBITDA in the 4.5x-5.0x range and funds from operations (FFO) to gross debt at 12%-15% in the coming years, aligned with our assessment of an aggressive financial risk profile.
We do expect delays from ENEE will result in higher working capital needs in 2022. However, we still view the liquidity position as adequate because of the following factors:
The payment delays from ENEE are attributable to the difficult financial situation of Honduras' energy sector due to high energy losses and delinquency rates, which the government is trying to address with an energy reform in the country, which includes bilateral negotiations of PPAs with private generators. This is still ongoing, and we're monitoring how it will affect IERL's PPAs in Honduras and the company's credit metrics. As a mitigating factor, IERL benefits from insurance that covers breach of contracts and expropriation in Honduras, provided by Multilateral Investment Guarantee Agency (MIGA), which we believe it would use only as a last resort.
IERL's term loan agreement includes maintenance financial covenants measured by gross debt to EBITDA of up to 5.25x in 2022, 5.20x in 2023, 5.15x in 2024, 5.0x in 2025, 4.8x in 2026, and 4.65x in 2027. If IERL breaches them, it would trigger an event of default. We're amending the covenant calculation because in our last report, published on June 18, 2021, we stated that the covenants were calculated on a net debt basis. Although we forecast tight covenant headroom of about 10% in the next couple of years--considering IERL's gradual deleveraging following the scheduled amortization of the term loan, and while the covenant's threshold narrows--we don't expect the company to breach them.
IERL's business risk profile reflects its smaller scale than that of peers and its exposure to high country risk in Central America, especially Guatemala (foreign currency: BB-/Positive/B), Honduras (BB-/Stable/B), Costa Rica (B/Stable/B), and Nicaragua (B-/Stable/B). These factors partly offset the attractive terms of IERL's dollar-denominated contracts, which have an average remaining term of about 13 years. Although there's some concentration among its off-takers, which are some of the largest electricity distributors in Central America, they're required to buy almost all the energy that IERL's assets generate, in line with the PPA terms.
We also consider the company's good diversification by asset type and its favorable location. IERL has 818.5 megawatts (MW) of installed capacity through 11 assets in six jurisdictions, and 40% of its installed capacity is hydro, 39% is wind, and 21% is solar. In our view, this allows for more stable cash flows, because hydro and wind generation typically show historically negative correlation. Also, the location of its assets allows IERL to post net capacity factors of 40%-43%. We view these factors, along with the company's relatively new and efficient asset base, as rating strengths because they allow IERL to post EBITDA margins in the 55%-60% range, which are higher and more stable than the regional peers' margins of 40%-50%.
ESG credit indicators: E-1, S-3, G-3
Environmental factors are a positive consideration in our credit rating analysis of IERL, which operates exclusively in renewable generation. The company plays an essential role in countries that are promoting the transition to unconventional renewables to replace existing carbon-based technologies. We believe that the company is diversified in terms of asset type (40% of EBITDA comes from hydro run-off river dams, 40% from wind assets, and 20% from solar farms), supporting stable cash flows.
Social and governance factors are moderately negative considerations due to IERL's exposure to high-risk jurisdictions, such as Guatemala and Honduras, given their weak institutional frameworks and problems related to income inequality. Nevertheless, these risks are partly offset by IERL's expertise in developing renewable energy in Central America and its ability to deal with several regulatory authorities.
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