Light : Fitch Affirms Light's Ratings

1/21/22, 4:22 PM

Fitch Affirms Light's Ratings; Outlook Stable

RATING ACTION COMMENTARY

Fitch Affrms Light's Ratings; Outlook Stable

Fri 21 Jan, 2022 - 2:18 PM ET

Fitch Ratings - São Paulo - 21 Jan 2022: Fitch Ratings has affrmed Light S.A. and its wholly owned subsidiaries Light Servicos de Eletricidade S.A. (Light Sesa) and Light Energia S.A.'s (Light Energia) Foreign Currency (FC) and Local Currency (LC) Issuer Default Ratings (IDRs) at 'BB-' and National Scale Ratings at 'AA-(bra)'. The Rating Outlook is Stable for all ratings.

The ratings refect Light group's low to moderate business risk profle within the Brazilian electric-energy sector. Light Sesa has exclusive electricity distribution rights in its concession area and Light Energia's generation asset base adds to cash fow predictability. Light group presents a robust liquidity position and lengthened debt maturity profle, but operational ineffciencies in the distribution segment and moderate leverage ratios limit the ratings. The analysis incorporates the beneft from a stronger consolidated EBITDA due to expected favorable tariff review for Light Sesa in March 2022. Fitch rates Light group on a consolidated basis given the strong ties among the three entities.

KEY RATING DRIVERS

Balanced Business Profle: Light group's credit profle benefts from its signifcant position and asset base in the Brazilian electric-energy sector. Light Sesa operates in the distribution segment, serving 4.3 million customers in the State of Rio de Janeiro - a segment characterized by a monopoly position in the concession area and pass-through of non- manageable costs to tariffs. This segment should account for approximately 90% and 70% of the group's consolidated net revenue and EBITDA, respectively, in 2022. Light Sesa's

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Fitch Affirms Light's Ratings; Outlook Stable

concession ends in 2026 and its renewal is deemed very likely since service quality requirements have been met.

In the generation segment, Light Energia contributes to greater diversifcation of cash fows and the dilution of operating risks, which are more prevalent in the distribution segment. The company has 1.2 GW of hydro generation capacity and most of its concessions end in 2028, for which renewal conditions are more uncertain.

Negative Performance on Distribution: Light Sesa's EBITDA is limited by energy losses and provisions for credit losses above tariff coverage, as well as indemnities to consumers. Positively, the company should beneft from the next tariff review on March 2022, which will likely incorporate a BRL2.0 billion increment in asset base and increase regulatory limits for energy losses to at least 21.7% of total load, from 19,2%. Fitch's base case assumes energy losses of 26.5% and a modest 0.5% growth rate on energy demand as of 2022, after an expected decrease of 0.5% in 2021. EBITDA should reach BRL1.2 billion in 2022 and BRL1.3 billion in 2023, signifcantly below the estimated regulatory EBITDA of BRL2.3 billion

Generation Benefts Credit Profle: Light Energia adds predictability to the group's operating cash fows. Its assured energy of 672 aMW was largely sold to industrial clients through medium-term contracts. The company follows a conservative hedge strategy against hydrological risk by keeping 28% of its energy uncontracted for 2022 and 2023. This compensates for the lack of protection related to quotas or regulatory insurance. The company's EBITDA should reach BRL549 million in 2021 and BRL568 million in 2022, with underlying average GSF of 0.77 and 0.80, respectively. Light Energia's EBITDA may slightly decline as of 2024 due to falling long-term energy prices.

Manageable Negative FCFs: The base case scenario for the ratings considers Light group's EBITDA and cash fow from operations (CFFO) of BRL1.6 billion and negative BRL470 million in 2021, and BRL1.8 billion and BRL373 million in 2022, respectively. The cash impact in 2021 derives from a BRL1.3 billion payment from Light Energia, related to GSF renegotiation, and an estimated BRL1.8 billion increase (+27%) in energy cost from Light Sesa, compared to 2020, due to water scarcity in Brazil. Investments should average BRL1.4 billion annually in 2021-2023, mostly focused in the distribution business. FCF is expected to be negative in 2021 and 2022, at BRL2.0 billion and BRL1.2 billion, and moderately positive as of 2023, after dividends of 25% of net income.

Credit Metrics Under Pressure: The group's consolidated net adjusted leverage should be in the range of 4.0x-4.5x until 2023, compared with 4.1x in 2020, according to Fitch's

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Fitch Affirms Light's Ratings; Outlook Stable

criteria. These ratios incorporate guarantees provided to Norte Energia S.A. as off-balance sheet debt (BRL716 million on September 2021). Financial fexibility is limited, since the group has already been distributing minimum dividends and needs to maintain intensive capex. A new cash support sponsored by the government, anticipating future collections from customers, if implemented, might reduce net leverage in 0.2x. It assumes an uncertain cash infow of around BRL400 million in 2022, not incorporated in the rating scenario. Gross leverage is estimated in 6.1x and 5.2x in 2021 and 2022.

Consolidated Approach: The ratings consider the strong legal and strategic links between Light S.A. and its main subsidiaries, Light Sesa and Light Energia. These companies should generate 30% and 70% of all dividends to be received by the parent in 2021-2024, respectively. The parent guarantees most of the debt instruments issued by the subsidiaries and there are cross-default provisions between these debts.

DERIVATION SUMMARY

Light's IDRs are lower than several electric energy groups in Latin America, such as Empresas Publicas de Medellin E.S.P. (EPM, LC IDR BBB-/Rating Watch Negative), Grupo Energia Bogota S.A. E.S.P. (GEB, LC IDR BBB/Stable) and Enel Americas S.A. (LC IDR A-/Stable). Light operates in Brazil (BB-/Negative), while its peers are more exposed to higher rated countries, like Chile (A-/Stable) and Colombia (BB+/Stable). Light's business profle is also worse than these peers because it is more concentrated in energy distribution, wherein operating cash fows tend to be more volatile.

Compared to the Brazilian Companhia Energetica de Minas Gerais (Cemig, LC IDR BB/Stable), Light has somewhat weaker business profle, with less diversifed asset base and the generation business accounting for around 30% of its consolidated EBITDA, lower than Cemig`s ratio of 45%. In the distribution segment, Light faces weaker operating performance and poor growth prospects. Light's fnancial profle is also weaker. Average net leverage in 2021-2022 is estimated at 4.5x for Light and 2.3x for Cemig.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer

• GSF: 0.77, 0.80, 0.85 and 0.94, from 2021 to 2024, on average;
• Energy short-term prices (BRL/MWh): 274, 190, 82 and 62, from 2021 to 2024, on average.

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Fitch Affirms Light's Ratings; Outlook Stable

Light Sesa

• Energy demand: 0.5% decline in 2021 and 0.5% growth as of 2022;
• Gross proft (after non-manageable costs): BRL2.9 billion in 2021 and BRL3.1 billion in 2022;
• Energy losses: 26.5% of total load (total market + losses);
• Provision for credit losses: 5.8% of energy supply revenues (sales + network usage).

Light Energia

• Annual average values for 2021-2024;
• Existing sales contracts: 366 aMW at BRL220/MWh;
• New sales contracts: 77 aMW at BRL199/MWh;
• Existing purchase contracts: 54 aMW at BRL221/MWh;

Light S.A. (consolidated)

• Average annual investments of BRL1.3 billion in 2021-2024;
• Dividend distribution equivalent to 25% of net income;
• Cash infow of BRL179 million in 2022 for the sale of assets (equity stakes in Lightger and Guanhaes).

RATING SENSITIVITIES

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

--Improvements in distribution segment operating performance, with the company's EBITDA closer to the regulatory EBITDA;

--Net leverage consistently less than or equal to 3.5x; --Total leverage consistently less than or equal to 4.5x.

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1/21/22, 4:22 PM

Fitch Affirms Light's Ratings; Outlook Stable

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

--Deterioration of the company's liquidity profle;

--Net leverage consistently at or above 4.5x;

--Total leverage consistently at or above 5.5x.

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

Sound Liquidity Profle: Light's liquidity profle improved after the BRL1.4 billion follow-on and successful liability management transactions, despite the strong negative FCF in 2021. The group has been able to refnance existing debt with lower funding costs and a longer debt-amortization profle. Light's consolidated cash and equivalents were BRL3.5 billion at the end of September 2021. This amount covered more than three years of debt amortization, but Fitch estimates refnancing needs in 2022 - even considering a BRL179 million receipt from the sale of generation assets. Short-term debt was BRL924 million at the end of September 2021. Total adjusted consolidated debt of BRL11.3 billion mainly consisted of debentures issuances (BRL6.2 billion) and Eurobonds issued in June 2021 (BRL3.3 billion), and included off-balance sheet debt of BRL716 million related to guarantees provided to Norte Energia S.A.. There is no debt at the holding level.

ISSUER PROFILE

Light S.A. is a corporation listed at B3 and a non-operational holding of a mid-size Brazilian energy group. The two main subsidiaries, Light Sesa and Light Energia, hold a 4.0 aGW power distribution concession and a 1.2 GW portfolio of hydro plants.

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