Fitch Downgrades Telefonica del Peru's Ratings to 'BB'

Press Release by Fitch Ratings

January 30th, 2023

Fitch Ratings - Chicago - 30 Jan 2023: Fitch Ratings has downgraded all of Telefonica del Peru's S.A.A.'s (TdP) ratings, to 'BB' from 'BB+'. The rating action applies to the Long Term (LT) Foreign Currency (FC) Issuer Default Rating (IDR), the LT Local Currency (LC) IDR, and the PEN1.7 billion notes due 2027. In conjunction with these moves, Fitch has placed all of these ratings on Rating Watch Negative (RWN).

The downgrade of TdP's ratings reflects the near-term materialization of the company's tax liability, which will result in a material deterioration in the company's leverage profile, although the timing and extent of additional debt financing needed to pay the tax payments remain uncertain. In addition, the company has continued to operate in an intensely competitive environment amid lingering cost inflation pressures and an uncertain economic backdrop in Peru. While TdP benefits from its scale as the largest operator in Peru and its diversified product portfolio, the company's negative FCF has weighed on its financial profile.

KEY RATING DRIVERS

Materialization of Tax Liability: As of Sept. 30, 2022, the total provision for income tax liability on the company's balance sheet was PEN2.8 billion, related to a long-running tax dispute with Peruvian authorities. Peru's supreme court recently ruled in favor of Peru's tax agency, SUNAT, in relation to a big proportion of the outstanding income tax provisions in which TdP will be ordered to make payments in the near term.

At present, the exact amount, timing, and structure of the payments are not yet known, but Fitch expects, according to what the recent shareholders meeting approved, the company will seek additional financing and potential capital contributions to service these payments, which will affect the company's financial profile. Peruvian companies facing tax liabilities have the option to extend a portion of the final settlement payment up to six years by following standard procedures with the SUNAT.

Weak Profitability, Negative FCF Trends: Fitch expects FCF to gradually improve over the rating horizon, but will remain negative and continue to weigh on the company's financial profile. Despite experiencing a partial recovery in mobile revenues and margins off of pandemic lows, EBITDA margins have continued to be relatively weak versus peers in the region.

Fitch expects an acceleration of fiber rollout and low single-digit ARPU growth to offset declining demand for fixed voice, generating revenue growth in the low single digits for the fixed business over the rating horizon. A more stable mobile competitive environment, growing demand for broadband, and cost containment efforts should result in modest EBITDA margin expansion over the rating horizon, albeit below historic levels and below that of investment-grade peers.

Leverage Expected to Worsen: Some modest improvements in YTD EBITDA in 2022 resulted in net debt/EBITDA improving to 2.3x as of September 2022, from 3.1x in 2021, driven in part by cost savings initiatives. Fitch forecasts capital intensity of roughly 11% while margins will likely only improve marginally as competition spurs network investments, limiting FCF improvement. While the extent and timing of new financing to cover near-term material tax payments are not yet known, Fitch expects leverage to materially weaken.

Strong Market Shares and Diversification: TdP's business profile remains solid, particularly in market share and diversification. TdP is well-diversified between fixed and mobile service offerings despite market share losses in recent years due to intense competition, most notably on the mobile side as Entel and Bitel (Viettel Group) continue to attract customers. Fitch estimates TdP has a mobile subscriber share of approximately 30% and a fixed-line subscriber share of over 60%. The company plans to expand and improve its fixed services over the medium term, mainly through the acceleration of fiber deployment. Fitch expects a marginal improvement in ARPUs on price increases as consumer spending improves and the product portfolio shifts to higher-value services.

Linkages with Telefonica S.A.: Fitch rates TdP on a standalone basis, and does not factor in any expectation of support from ultimate parent Telefonica S.A. (TEF; BBB/Stable). TEF has indicated its intention to divest its Hispano-American operations, including TdP, Telefonica Moviles Chile SA (BBB+/Stable), and Colombia Telecomunicaciones SA ESP (BBB-/Stable), and nonrated entities in Mexico, Argentina, and elsewhere. Fitch rates TDP on a standalone basis, given the stronger financial profile of parent Telefonica SA relative to TdP, while legal, strategic, and operational incentives for support from the parent are deemed low.

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