Agency assigns newly spun-off telco a medium grade rating; sees increasing debt through to 2019, negative free cash flow. | Telecom upgraded from negative to stable outlook. UPDATE: S&P rates Chorus BBB.
UPDATE 4pm: Standard & Poors has assigned the newly minted Chorus a BBB rating with a stable outlook.
In a statement, S&P said its rating "reflects our view of the company's strong market position as the dominant fixed line network in New Zealand, high capital barriers to competition, and strong operating cash flow."
Like Moody's (below), S&P noted the stable nature of the Crown fibre roll-out, but the possible competitive threat from consumers ditching telephone and landline broadband in favour of going all-mobile.
Chorus shares [NZX:CNU], which listed November 23 at $2.94, closed down 2.43% to $2.21.
Telecom [NZX:TEL] closed down 1.72% to $1.995, against an NZX50 fall of 0.08%.
Moody’s has assigned a Baa2 (medium grade) credit rating to Chorus, with a stable outlook.
The ratings agency has also upgraded Telecom's rating outlook to stable from negative and affirmed its A3 senior unsecured long-term rating and P-2 short term rating.
Chorus officially demerged from Telecom yesterday, November 30, taking the lion's share ($1.7 billion) of the company's debt with it.
In a statement, the rating agency said Chorus’ Baa2 rating reflected the stable and regulated nature of the group's forecast cash flows, the high margins it earns from fees charged to retail telcos accessing its nationwide fixed-line copper and fibre network, and its entrenched, dominant position in the New Zealand.
"This is the first example, globally, of a full structural separation of an incumbent telco within Moody's-rated portfolio" said Moody’s lead analyst Nicola O'Brien.
Chorus Group has a significant capex program in the coming eight years as it rolls out 70% of the Ultra-fast broadband network in New Zealand, Moody’s noted.
The rating is supported by the funding provided by the New Zealand Government, through Crown Fibre Holdings, to partially fund the UFB. Chorus will receive $929 million from the government, through Crown Fibre Holdings, evenly split between non-voting equity and an interest-free loan to be repaid from 2025.
"Execution risk related to the capex program constrains the rating, as Chorus Group lacks the flexibility to recover higher costs through price increases, or by accessing additional Government funding" Ms O'Brien noted.
Moody's expects the company's dividend policy (25 cents per share for 2012) - combined with its capex program - to result in increasing debt each year until at least 2019 and negative free cash flow (measured as cash flow from operations less capex less cash dividends).
Accordingly, Moody's expects debt/EBIDTA to increase over the following five years to 3.3 times from around 2.7 times. Debt/EBITDA is measured on an adjusted basis by Moody's, which includes a portion of the Crown Fibre Holdings' debt and equity investments as debt.
"This increase in gearing is factored into the capital structure and is manageable within the rating, Ms O'Brien said, adding "However, softer revenues, capex blowouts or changes to dividend policy would put negative pressure on the rating."
Two key drivers of Chorus Group's overall revenue and its composition are the rate at which users switch from copper to fibre, and the rate at which users forgo fixed connections altogether, opting for mobile only voice and data services (referred to as "fixed-mobile substitution" or FMS). Price regulation, demand for data intensive services such as internet TV, developments in mobile technology, and the continuation of free local calling in New Zealand are all factors influencing these drivers.
The stable rating outlook reflects Chorus' stable cash flows, appropriate funding structure and liquidity profile, and our expectation that financial profile will be well within the rating guidance.
During the UFB rollout over the next eight years, there is limited scope for a rating upgrade, due to the scale and complexity of Chorus Group's capex program. That said, the rating could face upward pressure if FMS is lower than expected or Chorus Group experiences greater than expected customer demand for higher priced fibre products, leading to higher free cash flow and more internal funding of capex. Debt/EBITDA dropping below 2.5 times on a consistent basis or FFO plus Interest/Interest exceeding 4.5 times on a consistent basis would also place upward pressure on the rating, Moody’s said.
