Centrais Eletricas de Santa Catarina S.A. - Firb...

INFRASTRUCTURE AND PROJECT FINANCE

CREDIT OPINION11 December 2017

Update

RATINGS

Centrais Eletricas de Santa Catarina S.A.Domicile Brazil

Long Term Rating Ba3

Type LT Corporate FamilyRatings

Outlook Positive

Please see the ratings section at the end of this reportfor more information. The ratings and outlook shownreflect information as of the publication date.

Contacts

Paco Debonnaire [email protected]

Cristiane Spercel +55.11.3043.7333VP-Senior [email protected]

Alejandro Olivo +1.212.553.3837Associate [email protected]

CLIENT SERVICES

Americas 1-212-553-1653

Asia Pacific 852-3551-3077

Japan 81-3-5408-4100

EMEA 44-20-7772-5454

Centrais Eletricas de Santa Catarina S.A.Update following affirmation to Ba3/A1.br, positive outlook

SummaryThe credit profile of Centrais Elétricas de Santa Catarina S.A (“Celesc ” or “the company”,Ba3/A1.br positive) reflects (i) a lower business risk profile following settlement of dispute onsector fees and extension of power generation concession, (ii) a moderate leverage relative topeers, even considering the additional debt resulting from arrears in sector fee payments (iii)relatively strong credit metrics for the rating category as shown by a Cash from operationsbefore working capital change (CFO pre WC) to debt ratio of 16.2% and CFO pre WC interestcoverage of 2.0x in the last twelve months ended 30 September 2017, and (iv) a supportiveregulatory framework mitigating higher energy costs due to poor hydrology conditions.

Celesc’s credit profile is constrained by (i) stricter quality of service requirements which weexpect will drive higher capex in coming years (ii) record low level of hydropower reservoirsin Brazil that will continue to pressure energy costs and working capital needs (iii) foreignexchange exposure rising from the additional USD denominated debt with multilateral banks.

Exhibit 1

Credit metrics to improve in 2018

0%

5%

10%

15%

20%

25%

30%

35%

40%

0.0x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

2013 2014 2015 2016 2017e 2018e

(CFO Pre-W/C + Interest) / Interest - left axis (CFO Pre-W/C) / Debt - right axis

Source: Moody's Financial Metrics, Mooody's estimates

Credit Strengths

» Gradual recovery in consumption supports improvement in operating performance andcredit metrics

» Moderate leverage despite scheduled payment of arrears in sector fees and additionalmultilateral debt

This report was republished on 11 December 2017 to correct national scale rating displayed on first page

https://www.surveygizmo.com/s3/1133212/Rate-this-research?pubid=PBC_1100576

MOODY'S INVESTORS SERVICE INFRASTRUCTURE AND PROJECT FINANCE

» Relatively supporting regulatory environment

Credit Challenges

» Higher working capital needs due to rise in energy costs

» Higher capex requirements to meet quality indicators and repayment of sector fees arrears will negatively weight on cash flowsduring 2018 and 2019

» Foreign exchange exposure rising from US denominated loans with multilateral banks, although mitigated by long tenor andcontractual hedging options available

Rating OutlookThe positive outlook reflects our expectations that Celesc will strengthen its cash flow from operations (before capex) going forwarddriven by higher consumption on the back of Brazil’s economic recovery, and improvements in regulatory loss rates and quality ofservice indicators.

Factors that Could Lead to an UpgradeAn upgrade of Celesc's ratings could be considered upon sustainable growth in consumption trends, compliance with regulatory targetsand improvements in operating performance leading to CFO pre WC to debt remains above 20% and CFO pre WC interest coverageratio exceeding 3.5x.

Factors that Could Lead to a DowngradeConversely a weakening in consumption trends and/or continued failure to meet regulatory targets leading to a deterioration in thecompany's credit metrics such that CFO pre WC to debt falls below 15% and CFO pre WC interest coverage remains sustainably below2.0x could prompt a rating downgrade.

Key Indicators

Exhibit 2

Centrais Eletricas de Santa Catarina S.A. Column4 Column1 Column2 Column3 Column32 Column5

2012 2013 2014 2015 2016 LTM Sept-17

CFO pre-WC + Interest / Interest 5.7x 4.8x 3.4x 3.1x 1.8x 2.0x

CFO pre-WC / Debt 17.5% 36.9% 22.7% 20.2% 12.9% 16.2%

CFO pre- / Debt 11.9% 36.9% 19.3% 12.7% 11.1% 15.6%

Debt / Capitalization 43.2% 37.8% 40.2% 46.9% 44.2% 69.1%

[1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations.Source: Moody's Financial Metrics™

ProfileHeadquartered in Florianopolis, in the state of Santa Catarina, Brazil, Celesc is an electricity utility company specialized in thegeneration and distribution of electricity. Through its wholly owned subsidiary Celesc Distribuiçao (responsible for 82% of consolidatedEBITDA) the company serves a population of approximately 6 million including 2.8 million consumer units across 264 municipalities inthe state of Santa Catarina and one municipality in the state of Parana. Celesc also owns a hydropower generation unit through smallhydropower plants with a total of around 107MW in installed capacity. Celesc also holds a 51% equity interests in Companhia de Gasde Santa Catarina, a gas distribution company , and minority interests in small hydropower projects, transmission and water sewageassets. Celesc is controlled by the state government of Santa Catarina, which holds 50.2% of the company’s voting capital and 20.2%of its total capital.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 11 December 2017 Centrais Eletricas de Santa Catarina S.A.: Update following affirmation to Ba3/A1.br, positive outlook


In the twelve months ended 30 September 2017 the company reported BRL6.4 billion in net revenues (excluding constructionrevenues) and BRL42 million in net income respectively.

Detailed Rating ConsiderationsLower risk profile following settlement of dispute on sector fees and extension of power generation concessionIn July of this year two events have helped to materially reduce some contingency risks that have weighted on Celesc's credit profile.Brazil´s electric sector regulator Aneel renewed for a period of 30 years the concession of Celesc’s main power plant Pery (30MWof installed capacity) responsible for 28% of Celesc´s generation installed capacity. Aneel also approved a compensation in favor ofCelesc from unamortized assets for a value of BRL 107 million that will be paid through the new concession period. Operating underthe regime of quotas, the plant's revenues are set by the regulator to cover operating and capital expenditures, and immune to theadditional thermal power costs triggered by poor hydrology conditions.

Celesc also settled a long standing dispute with Brazil´s power commercialization chamber (CCEE) to repay suspended sector fees thathad been accumulated at energy development account fund (CDE) since April 2015. The settlement of this contingency supports amore predictable cash flow stream for the company, although it will represent large outflows in 2018 and 2019. As per the agreementCelesc will repay the past-due amounts of BRL 1.2 billion over 30 months from July 2017 causing extra costs of around BRL 500 millionin 2018 and 2019 respectively.

These recent developments support the gradual strengthening of Celesc´s credit profile.

Moderate leverage despite scheduled payment of arrears in sector fees and additional multilateral debtCelesc’s leverage has historically been low relative to peers, with a ratio of Debt to Capitalization of around 42% on average in the fiveyears to 2016, compared to around 50-70% on average for other rated electricity distribution companies. As of 30 September 2017that ratio rose to 69%, reflecting the increase in debt due to the inclusion of the accumulated CDE sector payment arrears amountingto BRL 1.05 billion at the end of September.

Celesc is well advanced in securing long-term financing that will enable the company to cover its capex requirements for the period2018 to 2022. The company expects to close a loan of around USD 345 million (BRL 1.1 billion equivalent) from the Inter-AmericanDevelopment Bank (IDB) and from the Agence Française de Developpement (AFD). While significant, the IDB/AFD loans will bedisbursed progressively throughout the next 5 years as the company deploys its capital investment program and therefore will notresult in a significant increase in leverage. In addition, we expect the company will releverage relatively quickly in the next two yearsgiven the short payment schedule on the sector fee arrears, and we anticipate the ratio of Debt to Capitalization will fall back to around50-60% in 2018 and 2019.

The additional debt with IDB/AFD is denominated in foreign currency, exposing Celesc to a risk of currency devaluation given that thecompany's revenues is exclusively denominated in domestic currency. This risk will be mitigated by the long tenor (25 years includinga 5 year grace period) and relatively low interest rates on the loans. In addition we understand that Celesc could mitigate that riskthrough the use of derivatives under a clause of the loan contract.

Due to its state-owned status, Celesc features a higher pension burden related to privately owned peers, reflected by underfundedpension obligations which represent 32% of its debt (as adjusted by Moody’s) as of 30 September 2017.

Credit metrics expected to improve gradually, supported by pick up in consumptionSince 2014 Celesc's credit metrics progressively deteriorated, impacted by the decline in energy consumption on the back of Brazil'seconomic recession, and in 2016 by a BRL 256 million provision following the settlement of a dispute with the regulator ANEEL relatedto energy costs incurred during 2014. This led Moody’s adjusted cash flow from operations before working capital (CFO pre WC) toDebt to fall to 12.9% in 2016 from 22.7% in 2014, and CFO pre WC interest coverage to move to 1.8x in 2016 from 3.4x in 2014.Since 2017 however, in the absence of such provisions cash flow from operations started to recover driven by a gradual recovery inconsumption which grew by 3% year on year during the first nine month of 2017.

Going forward we expect operating cash flows will continue to grow driven by a gradual recovery in consumption levels in line withBrazil's GDP expected to grow between 2% to 3% in 2018. We expect improvements in credit metrics will be gradual however, held



back by higher operating costs during 2018 reflecting the impact of a voluntary personnel dismissal plan announced in September 2017,and by the additional debt formed from the arrears in sector fee payments that the company will have to repay up until March 2020.

Relatively supporting regulatory environmentANEEL has over the last several years consistently applied tariff decisions in what we consider an open and transparent manner,taking into consideration comments from market participants through public hearings and providing the methodological backgroundsupporting each tariff increase.

We expect the regulatory framework will continue to be supportive of distribution companies in Brazil, including Celesc. The NationalElectric Energy Agency (ANEEL), the industry' regulator has for example allowed distributors to reduce the amount of energy theycommit to buying when contracts are renewed (today, this amount is set at 96% of expiring contracted energy), or enabled directnegotiations between distributors that are over-contracted and generators whose power projects are delayed. This has led Celesc toexpect oversupply below the 105% threshold which allows a full pass through the oversupply costs to consumers in 2018.

ANEEL has also used concession contractual agreements to provide support to distribution companies. In March 2015, it approved anexceptional tariff increase of around 23% on average for all operators to account for the impact of a severe drought in Brazil’s southernregion. More recently, the regulator has revised its criteria related to the tariff flag mechanism, allowing for additional energy costs topass through sooner to the end consumer, and allowed a portion of the August 2017 annual tariff adjustment to cover the increase inprojected energy costs due to the drought.

Higher capital expenditures to meet stricter quality of service requirementsFollowing completion of its fourth tariff review on Celesc Distribuiçao in August 2016 the regulator imposed more challenging quality-of-service requirements to the company relating to the frequency and duration of service interruptions within its concession area.Meeting efficiency levels for operating costs and energy losses is important for Celesc because it determines its ability to satisfy theregulatory EBITDA targets on which ANEEL has based its tariffs. Also, failure to comply with any of these indicators for two consecutiveyears, for three out of five years within the cycle, or at the last annual testing date, could lead to cancellation of its concession contract.

Exhibit 3

Target for duration of service interruptions will be challenging to meet

10.5 10.2

8.7

15.2

14.7

12.8

10.0 9.4 8.9

8.6

12.1 11.7

11.2 11.0

2014 2015 2016 2017 2018 2019 2020

FEC - Actuals DEC - Actuals FEC Regulatory Target DEC Regulatory Target

FEC (“Frequencia Equivalente de Interrupção por Unidade Consumidora”) measures the average annual number of interruptions per consumer of the public energy distribution; DEC(“Duração Equivalente de Interrupção por Unidade Consumidora”) measures the average duration (in number of hours) per consumer of service interruptionsSource: ANEEL, Celesc



Exhibit 4

Despite recent improvements loss rates remain above regulatory targets

6.0% 6.0% 6.0% 6.0% 6.0% 6.1% 6.1% 6.1%

1.6%0.9%

3.0% 2.6% 3.0% 2.5% 2.4% 2.3%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q2 17 Q3 17

Technical Non-technical Regulatory target

Source: ANEEL, Celesc

The regulator requires the DEC (indicator measuring the annual duration of electricity interruptions within the network) tocontinuously drop from 12.1 hours in 2017 to around 11 hours by 2020, and the FEC (measuring the frequency of interruption) to fallfrom 10x to 8.6x. This compares with a reported DEC and FEC of 12.8x hours and 8.7x in 2016 respectively, and points to challengesin Celesc D’s meeting the requirements in particular for duration of service interruptions (see exhibit 3). Similarly Celesc's loss ratesremain above regulatory targets which continues to be a drag on the company's operating performance.

To improve the quality service indicators (DEC and FEC) and reduce loss rates, Celesc D will need to continue to invest in the stabilityof its distribution network throughout the review cycle and we expect the company's capex will reach BRL 400-500 million per annumthroughout 2021, compared to BRL350 million incurred on average over the last three years, which will weigh negatively on free cashflow generation.

Diversification expected to grow through the greenfield generation assetsThe hydropower generation assets provide Celesc with some cash flow diversification away from the dominant distribution business.The generation business is relatively protected from adverse hydrology conditions as 66% of its hydropower generation is contractedunder the quota regime and therefore not exposed to variation in the sector’s Generating Scaling Factor (GSF) - an index measuring theindustry exposure to the spot market.

The generation business is still relatively small representing around 18% of the company’s consolidated EBITDA. However it is bound toincrease as the company is involved in greenfield projects and plans to increase installed capacity to 300 MW by 2020.

Celesc also reinforced its position in the transmission business through a bid the company won in conjunction with EDP-Energias doBrasil at the April auction for a lot comprising for three transmission lines cumulating 484 kms in the state of Santa Catarina. WhileCelesc's participation in the bid was limited to 10% (90% with EDP-Energias do Brasil) we understand that the company could reapsome synergies with its distribution segment in its concession area when the lines become operational in August 2022.

Liquidity AnalysisWe regard Celesc’s liquidity profile as adequate. As of 30 September 2017 the company had BRL 965 million in available cash(including marketable securities) and less than BRL 400 million in debt maturing in the next 12 months. Celesc has kept sufficient cashin hand to cover upcoming debt maturities. While we expect significant cash outflows coming from higher capex, working capital needsand repayment of the sector fee arrears in the coming quarters, we anticipate that the growing operating cash flows and the successfulclosing of the loan with the IDB/AFD loan will provide sufficient funding to cover the company’s needs over the foreseeable future.

Celesc’s debentures are subject to financial covenant restrictions that includes the maintenance of a Net Debt/EBITDA above 2.0x.As of 30 September 2017 Celesc D reported a Net Debt / adjusted EBITDA (as reported by the company) of -0.3x and we expect thecompany will keep remain in compliance with its covenants in the foreseeable future.



Structural considerationCelesc’s corporate family rating (CFR) reflect its consolidated debt structure, which is essentially made of senior unsecured obligationseither debentures or loans with domestic banks. The senior unsecured issuer ratings of Celesc Distribuiçao are the same level as theCFR of its parent company Celesc. This reflects the dominance of Celesc Distribuiçao within the group as the distribution subsidiaryaccounts for over 80% of consolidated EBITDA, as well as the high degree of financial linkages between Celesc Distribuiçao and othersubsidiaries within the Celesc group, due to cross default provisions embedded in its debt documents.

Rating Methodology and Scorecard FactorsOver 80% of Celesc's EBITDA derives from the distribution segment and so the principal methodology used in this rating is “RegulatedElectric and Gas Utilities methodology”, published in June 2017. On a 12-18 month forward Celesc ’s rating grid model indicates anoutcome of Ba1, two notches above the assigned ratings of Ba3.

Exhibit 5

Centrais Eletricas de Santa Catarina S.A.

Regulated Electric and Gas Utilities Industry Grid [1][2] Current

LTM 9/30/2017

Moody's 12-18

Month Forward View

As of 12/1/2017 [3]

Factor 1 : Regulatory Framework (25%) Measure Score Measure Score

a) Legislative and Judicial Underpinnings of the Regulatory Framework Ba Ba Ba Ba

b) Consistency and Predictability of Regulation Ba Ba Ba Ba

Factor 2 : Ability to Recover Costs and Earn Returns (25%)

a) Timeliness of Recovery of Operating and Capital Costs Ba Ba Ba Ba

b) Sufficiency of Rates and Returns Ba Ba Ba Ba

Factor 3 : Diversificat ion (10%)

a) Market Position Ba Ba Ba Ba

b) Generation and Fuel Diversity Ba Ba Ba Ba

Factor 4 : Financial Strength (40%)

a) CFO pre-WC + Interest / Interest (3 Year Avg) 2.1x Ba 2x-3x Ba

b) CFO pre-WC / Debt (3 Year Avg) 15.2% Baa 15%-20% Baa

c) CFO pre- / Debt (3 Year Avg) 12.2% Baa 13%-18% Baa

d) Debt / Capitalization (3 Year Avg) 51.5% Baa 55%-60% Ba

Rat ing:

Grid-Indicated Rating Before Notching Adjustment Ba1 Ba1

HoldCo Structural Subordination Notching

a) Indicated Rating from Grid Ba1 Ba1

b) Actual Rating Assigned Ba3

[1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations.[2] As of 9/30/2017(L); Source: Moody’s Financial Metrics™[3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestituresSource:

Ratings

Exhibit 6Category Moody's RatingCENTRAIS ELETRICAS DE SANTA CATARINA S.A.

Outlook PositiveCorporate Family Rating Ba3



NSR Corporate Family Rating A1.brCELESC DISTRIBUICAO S.A

Outlook PositiveIssuer Rating -Dom Curr Ba3NSR Issuer Rating A1.brBkd Senior Unsecured -Dom Curr Ba3NSR Bkd Senior Unsecured A1.br

Source: Moody's Investors Service



© 2017 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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REPORT NUMBER 1100576


http://www.moodys.com


CLIENT SERVICES

Americas 1-212-553-1653

Asia Pacific 852-3551-3077

Japan 81-3-5408-4100

EMEA 44-20-7772-5454


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