S&PCORR: S&P Affirms Espirito Santo Centrais Ratings.

NEW YORK--(BUSINESS WIRE)--Standard & Poor's--

July 27, 1999--Standard & Poor's today affirmed its double-'B'-minus local currency issuer credit rating and single-'B'-plus foreign currency issuer credit rating on Espirito Santo Centrais Eletricas S.A. (ESCELSA).

The outlook is negative.

ESCELSA is the primary electricity distribution utility in the Brazilian state of Espirito Santo, providing about 92% of the state's energy consumption. ESCELSA's rating reflects the risks of:

-- Operating in Brazil under an evolving regulatory framework and unstable macroeconomic environment;

-- An expressed interest in acquiring other electric utilities with possible debt financing; and

-- A weak financial profile with continued exposure to the high interest-rate environment.

These weaknesses are offset by an exclusive concession to transmit and distribute electricity in its service territory, continued high electricity demand growth, and a portfolio of financial investments that provide some insulation from the current capital market environment.

ESCELSA's rating is affected by a still incomplete and untested regulatory regime. As the first electric distribution utility to be privatized by the Brazilian Government (1995), ESCELSA's concession contract does not contain a tariff formula or the accompanying "X" factor as do all the other privatized distribution companies. Still, ESCELSA has received annual inflation-related increases and fuel adjustments comparable to those of other privatized distribution companies with explicit tariff formula-contracts.

Itaipu is Escelsa's second-largest energy supplier and accounts for 26% of Escelsa's energy purchases. In June 1999, Agencia Nacional de Energia Electrica (ANEEL), the industry regulator granted Escelsa a 17% tariff increase (R$52 million annualized), enabling the company to pass through increased costs of energy purchases, resulting from Itaipu dollar indexed prices, after the real devaluation earlier in the year. This rate increase is expected to fully compensate Escelsa for increased cost related to Itaipu. More importantly, ANEEL's action helps to reduce the operating risk of a still relatively untested regulatory regime.

The rating is also constrained by uncertainties arising from ESCELSA's expressed interest in acquiring other privatized utilities. Current investments include ENERSUL, a 61%-owned distribution company, operating in the State of Mato Grosso do Sul, which contributes about 32% of ESCELSA's consolidated revenues. Enersul benefited from a 12% tariff increase (R$7.5 million annualized) in March 1999 as a full pass-through of increased costs of Itaipu's energy. ESCELSA benefits from a monopoly to distribute electricity within its concession area. Competition is minimal, as customers must use ESCELSA's wires to transport electricity, even if supply is procured independently. Over the past 10 years, ESCELSA's energy growth rate has been twice the national average, bolstered by particularly strong residential growth. Demand in ESCELSA's concession area is expected to increase approximately 5% annually over the next five years. However, in the first quarter of 1999, ESCELSA's energy sales were reduced by 6.8%, compared with the prior-year period, mainly attributable to reduction in industrial consumption. Since industrial customers have the lowest tariff schedule, net revenues were reduced only by 4%.

Standard & Poor's subjected ESCELSA's forecasted cash flows to various tests designed to evaluate the utility's capacity to withstand Brazil's current macroeconomic stress. The company's ability to cover increased interest expenses with cash from operations under a scenario of moderated electric sales growth, protracted harsh exchange rates, and high local interest rates, appears sound at the current rating levels. ESCELSA does not face refinancing risk over the near term. The company's resilience under a stress scenario is mainly attributable to substantial investments, albeit in Brazilian securities, expected to yield earnings in excess of interest expenses in 1999. This advantage will moderate as local interest rates decline.

ESCELSA has a weak financial profile, with consolidated funds from operations (FFO) to interest coverage for 1998 at 2.3 times (x). However, coverages will decline in line with local interest-rate movements, as the investment portfolio provides lower returns. FFO to interest coverage could fall to about 1.5x over the next several years. Also of concern is the refinancing risk resulting from the relatively large percentage (52%) of ESCELSA's consolidated long-term debt that carries a 10-year bullet maturity and comes due in 2007.

OUTLOOK: NEGATIVE

The negative outlook reflects that of the sovereign. Deterioration in the economic and operating environment in Brazil is expected to negatively impact local consumer usage and industrial production levels, which may dampen expected electricity demand. In addition, weakened investor confidence and increased interest rates have reduced the financial flexibility of Brazilian companies, Standard & Poor's said.--CreditWire