ENERJİSA ENERJİ A.Ş. — Audit Report / Information 2017

Dec 20, 2017

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FITCH AFFIRMS ENERJISA ENERJI A.S. AT 'AA(TUR)'; OUTLOOK STABLE

Fitch Ratings-London-19 December 2017: Fitch Ratings has affirmed Turkish utilities company Enerjisa Enerji A.S.'s (Enerjisa) National Long-Term Rating at 'AA(tur)' with a Stable Outlook.

The affirmation reflects Enerjisa Enerji's profile post-group restructuring. Following the carveout of the generation and trading business about 85% of Enerjisa's earnings will be generated by regulated distribution activities. The remainder will come from the retail division, which is supported by the sector's transition to a liberalised market and of which half the earnings are also regulated. The distribution business benefits from medium-term visibility and regulatory support, with capex fully reimbursed in 10 years at a real rate of return of 11.91%. The latter has been increased to 13.61% for the remainder of the third regulatory period (RP3) for 2018-2020.

Although Enerjisa's assets are reimbursed quicker than European peers' and at higher returns, uncertainty arises over the longer term from risks associated with the size of new allowed investments in the future as growth capex may slow. Turkish networks operate under long-term licence agreements rather than legal ownership.

KEY RATING DRIVERS

Healthy Performance: Enerjisa performed well in its first year of the current regulatory period of 2016-2020 (RP3), due to higher-than-initially allowed investments. The company has increased its capex projection for RP3 based on expansion needs, for which the regulator's approval will be sought. Fitch maintains a more conservative forecast for growth, but assumes more investments than the original amount allowed by the regulator at the start of RP3. We also forecast more assets to be commissioned between 2016 and 2018, leading to steeper growth of the regulatory asset base (RAB) at the start of the period.

The liberalised retail earnings saw some erosion this year, due to higher sourcing costs in combination with a slightly reduced national tariff. For 2018 the eligibility limit has been reduced to 2.000kwh from 2.400kwh in 2017, resulting in higher eligible volumes. Furthermore FIT (feedin tariff) costs are now included in the calculation of the regulated profit margin. However, the full effect of liberalisation is yet to be seen.

Gradual Deleveraging: We forecast negative free cash flow (FCF) until 2020, driven by an intensive investment programme. While new assets lead to higher returns and reimbursements, we expect funds from operations (FFO) to increase at a slower pace, due to higher interest costs as capex is mostly financed by debt and not fully offset by retail cash flows. However, capex incurred at the beginning of RP3 should start to have a material impact before the end of the period as increase in reimbursements lead to a material decrease in FFO adjusted net leverage to 3.2x in 2020 from slightly over 4.0x in 2017. We expect Enerjisa to start paying dividends in 2018 while keeping in line with its financial policy of maintaining leverage below 3.5x net debt-to-EBITDA including reimbursements.

Returns Driven by Investments: Most of Enerjisa's EBITDA comes from distribution return allowed on investments and capex reimbursements but also incentives and outperformance of regulatory targets. It is unclear at what return level the regulator will remunerate maintenance and repair capex once capex requirements slow. However, the Turkish distribution infrastructure is in need of investment and the high investment cycle is likely to continue well into the next decade.

Retail Market Liberalisation: The liberalised market should allow Enerjisa to increase earnings and achieve larger margins by optimising its sourcing costs and by increasing its customer base and its market share. Until the market is fully liberalised earnings may show some volatility due to changes in sourcing costs and customer switching between various tariffs.

Limited Forex Risk: Enerjisa's debt is denominated in TRY with the exception of EUR69.6 million (5% of total debt) in legacy EIB and World Bank loans. Its limited forex exposure is positive for the ratings compared with corporate peers in Turkey. However, we see some interest rate risk, particularly since debt maturities are fairly short-term.

Structural Subordination: Despite the consolidated approach to our credit assessment of Enerjisa we view its creditors as structurally subordinated to the creditors of its subsidiaries. This would be reflected in our recovery assumptions and any instrument rating. This assessment is in line with Fitch's view that in instances where there are multiple operating entities Fitch evaluates the claims at the entity level and views only residual cash flows as being available to the creditors of the parent.

DERIVATION SUMMARY

Enerjisa is characterised by more predictable earnings than other rated corporate issuers in Turkey such as Arcelik A.S. (BB+/Stable/AA(tur)) but also by high investment requirements in the near term. Fitch views the current regulatory regime as favourable for investments; however, uncertainty remains over profitability once capex slows down after the current regulatory period ends in 2020. No country-ceiling or operating environment aspects cap the ratings. Based on the parent subsidiary linkage analysis Fitch rates Enerjisa and its subsidiaries on a consolidated basis.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

-Slow decline in inflation to 7.4% in 2020 from 8.5% in 2016;

-Allowed weighted average cost of capital of 11.91% (pre-tax, real) for 2016 and 2017 and increased to 13.61% for 2018-20 in line with Energy Market Regulatory Authority's decision on 7 December 2017;

-Supply volume growth of 3% CAGR (vs. management assumption of 5%); and -Dividend payments from 2018.

RATING SENSITIVITIES

Future Developments That May, Individually or Collectively, Lead to Positive Rating Action

-FFO adjusted net leverage below 3.0x and FFO fixed charge cover above 3.0x, both on a sustained basis.

-Better clarity on regulation after high-intensity investment ends. -Improvement in liquidity position and debt maturity profile.

Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -FFO adjusted net leverage above 4.0x and FFO fixed charge cover below 2.0x, both on a sustained basis.

-Adverse regulatory effects including delays in recoveries of investments.

-Adverse developments in the process of the retail market liberalisation.

-Deterioration in available liquidity.

-Unhedged foreign currency debt exposure

LIQUIDITY

Constrained Liquidity: We view liquidity and debt management as rating constraints. Enerjisa maintains a minimum cash balance and short-term debt as a share of total debt is high. We forecast negative FCF for 2017-2020. There are no committed facilities because the Turkish market operates on spot / overnight loans, which are utilised without any security or obligations from shareholders and there are no fees charged, since the amounts are not committed. However, funding sources are well-diversified, and Enerjisa has a solid track record of utilising these credit lines as well as superior access to domestic debt capital markets. Forex exposure is limited since Enerjisa's debt is mostly denominated in TRY.

Contact:

Principal Analyst Siddharth Singh Analyst +44 20 3530 1565

Supervisory Analyst Ana Gaspar Director +44 20 3530 1601 Fitch Ratings Limited 30 North Colonnade London E14 5GN

Committee Chairperson Josef Pospisil Managing Director +44 20 3530 1287

Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com.

Summary of Financial Statement Adjustments - Fitch calculated FFO adjusted net leverage based on adjusted EBITDA, which includes capex reimbursements.

Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary.

Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) https://www.fitchratings.com/site/re/901296 National Scale Ratings Criteria (pub. 07 Mar 2017) https://www.fitchratings.com/site/re/895106 Parent and Subsidiary Rating Linkage (pub. 31 Aug 2016) https://www.fitchratings.com/site/re/886557

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