Light : Fitch's Rating Report

RATING ACTION COMMENTARY

Fitch Downgrades Light's IDRs to 'CCC+'

Thu 02 Feb, 2023 - 11:53 AM ET

Fitch Ratings - São Paulo - 02 Feb 2023: Fitch has downgraded the Local Currency and Foreign Currency Issuer Default Ratings (IDRs) of Light S.A. (Light) and its wholly owned subsidiaries Light Servicos de Eletricidade S.A. (Light Sesa) and Light Energia S.A.'s (Light Energia) to 'CCC+' from 'BB-'. Fitch has also downgraded the National Scale Ratings of these entities to 'CCC(bra)' from 'AA-(bra)'. The ratings of foreign currency and local currency debt instruments were downgraded to 'CCC+'/'RR4' and 'CCC(bra)'.

The downgrades refect substantial credit risk for Light in making timely payment of principal and interest on its obligations following the announcement that it had hired Laplace Finanças with the purpose to improving its capital structure and the more restrictive credit market due to Americanas' default. The confuence of these factors substantially reduces the group's ability to raise fnancing needs to support its expected negative FCF and debt amortization. Prior to these recent developments, Fitch expected Light to raise up to BRL1.8 billion in 2023 through the securitization of receivables to meet its funding requirements.

KEY RATING DRIVERS

Potential Debt Restructuring: To avoid a restructuring in the midst of a challenging backdrop, Light will need to maintain access to bank or capital market funding. In the absence of additional funding, the company will need some combination of asset sales, a follow-on equity offering, or more clarity on the renewal of the concession of Light Sesa, the company's main subsidiary. Fitch believes that the engagement of Laplace, which has

been an advisor for several companies that have restructured debt in Brazil, materially reduces creditors' willingness to provide new fnancings to the group to cover its 2023 and 2024 funding needs.

Americanas' recent judicial recovery may also play a role in the group's ability to raise debt, as several lenders suffered material losses. The potential effect upon Light's ability to refnance debt due to the uncertainty surrounding the renewal of Light Sesa's concession had already been a key credit consideration for the last revision of the Outlook to Negative from Stable, but new debt issuances will likely become more challenging.

High Refnancing Needs: Fitch has concerns about Light's ability to secure funding. The agency had estimated that the group would raise up to BRL1.8 billion of fnancing in 2023, and at least BRL1.5 billion in 2024. In case of non-renewal of the Light Sesa concession, the company should receive an indemnity for unamortized assets equal to its asset base, currently valued at BRL10.1 billion, which compares with on-balance-sheet consolidated debt of around BRL13 billion and a cash position of BRL4.0 billion in September of 2022. The indemnifcation supports the recovery prospect of debt holders, if needed.

Moderate Consolidated Leverage: Light's consolidated adjusted leverage should remain at moderate levels, despite being moderate to high at Light Sesa's level. The base case scenario estimates a net adjusted debt/EBITDA of 4.3x in 2022 and 4.1x in 2023, including guarantees provided to Norte Energia S.A. as off-balance sheet debt (BRL733 million on September 2022). For Light Sesa, net leverage is estimated at 5.5x in 2022 and 5.2x in 2023, from 6.9x in September of 2022.

Debt Ratings Capped: Fitch applies a bespoke approach to recovery for issuers rated 'B+' and lower, using the higher of going-concern and liquidation estimates to enterprise valuation. In the case if Light, Fitch forecasts recovery rates commensurate with an 'RR1' for secured debts (BRL1.7 billion) and 'RR3' for unsecured debts (BRL11.0 billion), which could potentially lead to uplift on the bonds' rating from Light's FC IDR.

However, Fitch's "Country-Specifc Treatment of Recovery Ratings Criteria" caps at 'RR4' the recovery for debt instruments in Brazil, resulting in an instrument rating equal to Light's FC IDR. These caps refect Fitch's concerns over the enforceability of creditor rights in certain jurisdictions, where average recoveries tend to be lower.

DERIVATION SUMMARY

Light's accessibility to capital has signifcantly weakened its credit profle, as refected in the downgrade. The company faces credit risks similar to those of GOL Linhas Aereas S.A. (GOL; Long-Term Foreign and Local Currency IDRs B-/Negative) and InterCement Brasil S.A. (InterCement; FC and LC IDRs B-/Stable). Both Gol and InterCement operate in sectors with higher business risk and their cash fows have been pressured by macroeconomic factors, such as high fuel costs. Their high fnancial leverage coupled with high interest rates weaken their fnancial fexibility.

RATING SENSITIVITIES

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

• Light maintains its ability to receive funding from banks or the capital market;
• The group sells assets or raises equity in a follow-on issuance;
• Renewal of Light Sesa's concession on more favorable terms.

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

• The announcement of a debt restructuring plan;
• Insuffcient liquidity to cover funding requirements over the next 12 months.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defned 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 (defned 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-specifc best- and worst-case scenario credit ratings, visit https://www.ftchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Heightened Refnancing Risk: Light's ability to secure funding in the short term is uncertain. At the end of 3Q22, Light reported BRL4.0 billion in cash and equivalents, which should cover the expected negative FCF (BRL1.6 billion) and debt payments (BRL2.2 billion)

through 2023. Adjusted consolidated debt was BRL13.5 billion, of which BRL2.6 billion was short-term. The remaining included BRL356 million due 4Q23 and BRL2.3 billion due 2024. Adjusted debt mainly comprises of debentures (BRL7.8 billion) and Eurobonds (BRL3.2 billion), with off-balance sheet debt of BRL733 million related to guarantees provided to Norte Energia S.A. There is no debt at the holding level.

ISSUER PROFILE

Light Sesa is the fourth largest power concession in Brazil, serving more than 70% of Rio de Janeiro's consumption, and accounts for 70% of the group's EBITDA. Light Energia has 511 MW of assured energy, on a consolidated basis. Light S.A. is listed on B3 and has a pulverized share ownership.

SUMMARY OF FINANCIAL ADJUSTMENTS

--Remuneration of concession's fnancial asset not included in EBITDA calculation;

--Construction revenues and costs excluded from the Income Statement.

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.ftchratings.com/esg.

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