Fitch Rates Comision Federal de Electricidad's Certificados Bursatiles Issuances 'A-'

Fitch Ratings has assigned a long-term local currency International rating of 'A-' and a National long-term rating of 'AAA(mex)' to the following Comision Federal de Electricidad's (CFE) debt instruments:

--Additional Certificados Bursatiles of the first opening of the Certificados Bursatiles issuance with ticker CFE 14-2. The issuance amount is - together with other issuance referred to herein - up to MXN10 billion with maturity on Nov. 25, 2025 at a fixed rate;

--Certificados Bursatiles issuance with ticker CFE 15. The issuance amount is - together with other issuance referred to herein - up to MXN10 billion for a term of five years at a variable rate.

KEY RATING DRIVERS

CFE's ratings incorporate the company's position as the largest electricity generator in Mexico and its monopoly on transmission and distribution activities, which makes it strategically important for the country. Also reflected are CFE's strong linkage with the Mexican government, and the government's implicit support. CFE's foreign and local currency IDRs are at the same level as Mexico's sovereign rating. CFE's ratings also incorporate high debt levels, unfunded pension liabilities, negative free cash flow (FCF) during the cycle, and risk of political interference.

Strong Linkage with Government

CFE is a state-owned productive enterprise which now has greater budgetary and financial independence of the Mexican federal government. Previously, CFE's budget needed to be approved by the Ministry of Energy, the Ministry of Finance and ultimately by the Congress. The relationship between CFE and the government is strong and extends beyond its ownership. CFE is governed by a board of directors, which includes the ministers of energy, finance, economy, and environment and natural resources. The board also includes the undersecretary of the Secretaria de Energia (SENER), four independent members, and the minister of the national executive committee of the only union of electrical workers in Mexico. In addition, the government directly sets electricity tariffs to all electricity users, except for those high-volume industrial users that decide to participate in the wholesale market and establishes subsidies for specific customers; CFE's debt is considered national debt.

Strategically Important for the Country

CFE will keep its monopoly on distribution and transmission activities; nevertheless, energy reform enables the company to enter into agreements with private investors to develop and finance the infrastructure in these subsectors on its behalf. Regulatory framework forbids granting concessions to private parties in these segments. While CFE's monopoly position decreases competitive risks and other risks related to business operations, the company's electricity generation will face competition after new regulations are put in place.

Energy Reform Opens Sector

The energy reform is intended to create an open and competitive wholesale market. High-volume industrial users will be allowed to enter into bilateral contracts with new private investors (NPIs), independent power producers (IPPs) or CFE. In February 2015, SENER presented to the Federal Regulatory Improvement Commission (COFEMER) the draft of the operating rules for the wholesale electricity market in Mexico, which will come into operation in January 2016. Fitch estimates that CFE might not see high-volume industrial demand decline immediately, as almost all IPPs are currently under contract with CFE and termination clauses are limited, and the construction of generation plants takes approximately two years before start of operations. At the end of 2014, high-volume industrial users represented 17.8% of CFE's total revenues (17.9% average over the past five years). The opening of electricity generation to the private sector improves prospects for a decline in tariffs over the medium term for high-volume industrial users.

Fitch believes CFE would be able to offer competitive rates for those industrial users in order to compete against NPIs, through the import, transport to CFE plants, and sales to third parties, of natural gas, via five pipelines located in the north of the country which will be contracted by CFE under 25-year agreements. Participation in the marketing of natural gas will not only represent an additional source of income, but will be a fundamental tool to reduce electricity generation cost. In addition, good rainfall conditions in 2014 and 2015 have supported cheaper hydroelectric generation.

Risk of Political Interference

The electricity rate settlement by the government, which covers all electricity users except those high-volume industrial users that decide to participate in the wholesale market, exposes the company to regulatory risk and political interference. Subsidies to agricultural and residential sectors also expose CFE to unfavorable tariffs, which at times could be set below operating costs.

Energy reform does not deal directly with existing cross-segment subsidies. Fitch believes preferential tariffs for agricultural and residential customers will continue due to their social component and the political cost of eliminating them. Future funding for subsidies could be a challenge for CFE; future central government support through cash injections and/or explicit guarantees is uncertain and goes against the spirit of the energy reform, which converted the company into a state-owned productive enterprise.

RATING SENSITIVITIES

Absent an improved operating and financial profile, an upgrade of CFE's ratings could result from an upgrade of the sovereign or increased financial support from the government. Negative rating actions could be triggered by a downgrade of the sovereign's rating, the perception of a lower degree of linkage between CFE and the sovereign as a result of the energy reform in conjunction with a weak operating and financial profile.

LIQUIDITY AND DEBT STRUCTURE

High Leverage with Manageable Debt-Maturity Profile

As of March 31, 2015, total on-balance-sheet debt was MXN378.8 billion and unfunded pension liabilities amounted to MXN572.8 billion. CFE's debt maturity profile is manageable, with MXN83.4 billion maturing within the next two years, of which MXN50.4 billion is short-term, compared to MXN53.7 billion in cash. FCF has been negative, on average, during the last five years, mainly due to high capital expenditures.

FULL LIST OF RATING ACTIONS

Fitch currently rates CFE as follows:

-- Long-term Issuer Default Rating (IDR) at 'BBB+';

-- Local currency long-term IDR at 'A-';

-- USD3 billion senior unsecured notes at 'BBB+';

-- National scale long-term rating at 'AAA(mex)';

-- MXN70.5 billion unsecured Certificados Bursatiles at 'AAA(mex)';

-- National scale short-term rating at 'F1+(mex)';

-- Short-term Certificados Bursatiles Program at 'F1+(mex)'.

Date of Relevant Committee: May 12, 2015

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

National Scale Ratings Criteria (pub. 30 Oct 2013)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=720082

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=985629

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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