Fitch Ratings has downgraded all of Telefonica del Peru's S.A.A.'s (TdP) ratings, to 'BBB-' from 'BBB'.

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. The Outlook on the IDRs remains Negative.

TdP benefits from its scale as the largest operator in Peru, with a diversified product portfolio and leading fixed and mobile market shares. These attributes are in line with other investment-grade operators throughout the region. TdP's revenue and margin declines, however, have contributed to a deterioration of the company's financial profile, which is weak for an investment-grade issuer.

An improvement in subscriber trends and cash flow generation could result in a stabilization of the ratings. Otherwise, Fitch will likely downgrade the TdP.

KEY RATING DRIVERS

Negative Revenue, Profitability Trends: From FY2016 through FY2020, TdP's revenues have fallen from PEN9.4 billion to PEN6.6 billion and EBITDA margins have fallen from 30% to 12%. The mobile segment has been hit especially hard by vigorous price competition. The mobile segment has lower ARPUs and fared worse than its competitors in 2020. After a 19% fall in mobile revenues, led by the 43% collapse in handset sales, the company stands to benefit from an improving economy.

The company also experienced revenue declines in the fixed consumer and B2B segment in 2020, which Fitch expects to improve to mid-single-digit growth in 2021, as the company focuses on accelerating its fiber rollout. A resumption of growth in 2021, along with operating expense and personnel cost discipline, should push EBITDA margins above 15%.

Leverage Expected to Increase: TdP's declining revenues and EBITDA compression caused Net Debt/EBITDA to increase to 2.8x as of YE2020. Fitch forecasts capital intensity of 12%-14% as competition spurs network investments, driving FCF generation lower. As a result, Fitch expects the company's leverage to rise in the medium term as the company increases debt and EBITDA margins in the 15%-16% range. Positively, proceeds from asset sales should mitigate the need for debt financing in the near term. Fitch forecasts net and gross leverage of around 3.0x and 3.5x over the rating horizon.

A rebound in the Peruvian economy should help drive an improvement in operating performance, which will be offset by the high level of competition in mobile and fixed. Increased capital expenditures, or a near-term payment of the tax liability in 2021 or 2022 would add pressure to the capital structure.

Strong Market Shares and Diversification: TdP's business profile, particularly in market share and diversification, remains consistent with investment grade. 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 over 30% and a fixed-line subscriber share of over 60%. Mobile handsets and prepaid services were hit especially hard in 2020, continuing years of a negative trend and leading to a year of especially weak mobile revenues.

The company plans to focus on expanding and improving its fixed services in 2021, mainly through the acceleration of fiber deployment. TdP currently offers fiber to approximately 10% of clients and aims to reach 30% by YE2021 through differentiation of Pay TV content and capacity advantages. Fitch expects marginal improvement in APRUs on price increases as consumer spending rebounds and the product portfolio shifts to higher value services.

Peruvian Operating Environment: Peru (BBB+/Negative) endured one of the most severe lockdowns in the region, which caused GDP to fall by 10.4% in 2020. The severity of the lockdown had a negative effect on telecom revenues, as approximately 2/3 of Peru is prepaid and broadband penetration is low. Despite these, Telefonica del Peru's 16.5% fall in revenue far outpaced Claro's 2.5% fall and Entel's 3.0% fall, even though the latter two being far more dependent on mobile revenues. Fitch expects Peruvian GDP to increase by 11% in 2021, which bodes well for TdP's revenues.

Adequate Liquidity Supports Flexibility: Fitch expects Telefonica del Peru to maintain adequate liquidity over the rating horizon. As of Dec. 31, 2020, the company has PEN154 million in short-term debt, and readily available cash of PEN877 million. TdP benefits from its manageable amortization schedule, with PEN2.19 billion of its PEN2.94 billion long-term debt, maturing beyond 2025. The company's average scheduled amortizations in 2021 - 2024 are around PEN 250 million. The company's debt consists of primarily of long-term bonds (PEN3.09 billion), with a minor portion of short-term bank loans (PEN8 million). The company's debt is completely payable in PEN, limiting FX risk for the company.

Uncertain Prospects for Strategy: TDP has so far been unable to execute its growth strategy to offer quad-play services through the Movistar Total. Expanding 4G coverage and fiber coverage have failed to translate into subscriber growth or revenue growth. In particular, stubbornly low broadband penetration in Peru and high competition have impacted the company's ability to profit from increased demand for data packages.

Tax Liability Forgiveness, Uncertainty: In February 2021, the Constitutional Court of Peru voided PEN729 million of interest related to Telefonica del Peru's liability for back taxes. As of Dec. 31, 2020, the total tax liability on the company's balance sheet was PEN2.2 billion. Pre-pandemic, Fitch expected additional clarity on the timing and size of the payment. Post-pandemic, the timing and structure of the remaining PEN1.5 billion liability (1.8x EBITDA) are unclear. Fitch does not forecast support from parent Telefonica SA.

Linkages with Telefonica S.A.: Fitch rates TdP on a stand-alone basis, and does not factor in any expectation of support from parent Telefonica SA (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 the individual operations on a stand-alone basis, as ties between the parent and the subsidiaries tend to be weak. Telefonica has been selling entire subsidiaries in Central America, as well as selling certain infrastructure assets separately. Depending on the structure of the HISPAM divestiture, Fitch may rate the subsidiaries more closely.

DERIVATION SUMMARY

TDP's business position compares well with regional peers in the 'BBB' rating category relative given its still-leading market positions in the Peruvian telecom industry. The company's financial profile has deteriorated since 2016 due to intense competition. This has caused a decline in operating margins and cash flow generation, which are more in line with 'BB' category issuers. Total Debt/EBITDA at the company, above 3.5x, is at the upper end of investment grade.

TdP's business position is roughly in line with sister company Telefonica Chile (BBB+/Stable) in terms of service diversification and market position, although TCH is stronger financially, supported by lower leverage and consistently positive FCF. TdP's business profile compares favorably to Colombian peers UNE EPM Telecomunicaciones S.A. (Tigo UNE) (BBB/Negative) and Colombia Telecomunicaciones S.A. E.S.P. (BBB-/Stable) due to its leading market shares in fixed and mobile, although Tigo UNE and ColTel have higher margins and lower leverage metrics that are more in line with investment-grade issuers. TdP is rated one notch above competitor Empresa Nacional de Telecomunicaciones S.A. (Entel) (BBB-/Negative), which was downgraded several times following its entry into the highly competitive Peruvian market. Although TdP's large fixed-line presence supports its business position in Peru, Entel has a superior financial profile due to the continued strength in its Chilean operations and improving profitability metrics in Peru.

KEY ASSUMPTIONS

Mobile revenues growing from PEN3.0 billion to PEN3.6 billion over the rating horizon;

Flat overall mobile subscribers, with modest ARPU growth and handset sales resuming their pre-pandemic trend as consumer spending rebounds;

Fixed revenues growing from PEN3.5 billion to PEN4.1 billion over the rating horizon;

Continued double digit declines in fixed-line telephony subscribers, partially offset by broadband and pay-tv subscribers growing in the low single digits, causing fixed ARPUs to increase by ;

EBITDA margins of approximately 15%-16%, due to headcount, cost control on other operating expenses;

Capex of around PEN800-900 million in 2021, 12-14% of revenues thereafter;

Fitch does not factor in a payment of the tax liability in the base case, due to uncertainties.

RATING SENSITIVITIES

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

An upgrade of the ratings is unlikely, given the company's subscriber trends and the competitive environment in Peru;

Stabilization of the ratings is dependent on the company resuming revenue and subscriber growth, and improving EBITDA margins;

Expectation of Total Debt to EBITDA around 2.5x and Net Debt to EBITDA of around 2.0x.

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

Total Debt / EBITDA sustained above 3.0x or Net Debt / EBITDA above 2.5x;

Large debt-funded tax liability payments.

BEST/WORST CASE RATING SCENARIO

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

LIQUIDITY AND DEBT STRUCTURE

Adequate Liquidity Supports Flexibility: Fitch expects Telefonica del Peru to maintain adequate liquidity over the rating horizon. As of Dec. 31, 2020, the company has PEN154 million in short-term debt, and readily available cash of PEN877 million. TdP benefits from its manageable amortization schedule, with PEN2.19 billion of its PEN2.94 billion long-term debt, maturing beyond 2025. The company's average scheduled amortizations in 2021 - 2024 are around PEN 250 million. The company's PEN1.7 billion note is due 2027.

The company's debt consists of primarily of long-term bonds (PEN3.09 billion), with a minor portion of short-term bank loans (PEN8 million). The company's debt is completely payable in PEN, limiting FX risk for the company.

SUMMARY OF FINANCIAL ADJUSTMENTS

Operating lease adjustments made.

Operating income adjusted for nonrecurring items like restructuring and asset sales.

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.fitchratings.com/esg

RATING ACTIONSENTITY/DEBT	RATING		PRIOR
Telefonica del Peru, S.A.A.	LT IDR	BBB- 	Downgrade		BBB
	LC LT IDR	BBB- 	Downgrade		BBB

senior unsecured

LT	BBB- 	Downgrade		BBB

VIEW ADDITIONAL RATING DETAILS

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