Chorus : S&P increases Chorus credit rating threshold

For personal use only

Chorus Limited

Level 10, 1 Willis Street

P O Box 632

Wellington

New Zealand

Email: company.secretary@chorus.co.nz

STOCK EXCHANGE ANNOUNCEMENT

31 January 2022

S&P increases Chorus' credit rating threshold

S&P has released the attached update on Chorus.

The update states that the downgrade threshold for Chorus has been increased to a debt to EBITDA ratio of 5.0x at the current rating level, compared with a ratio of 4.25x previously.

The long-term rating remains unchanged at BBB stable.

Authorised by:

David Collins

Chief Financial Officer

ENDS

For further information:

Steve Pettigrew

Head of External Communications

Mobile: +64 (27) 258 6257

Email:steve.pettigrew@chorus.co.nz

Brett Jackson

Investor Relations Manager

Phone: +64 4 896 4039

Mobile: +64 (27) 488 7808

Email:brett.jackson@chorus.co.nz

onlyResearch Update:

Chorus Ltd. 'BBB' Ratings Affirmed With Stable

Outlook; Outlook Thresholds Revised With Enhanced

Earnings Predictability

useJanuary 31, 2022

Rating Action Overview

PRIMARY CREDIT ANALYST

Research Update: Chorus Ltd. 'BBB' Ratings Affirmed With Stable Outlook; Outlook Thresholds Revised With Enhanced Earnings Predictability

The shift toward becoming a utility-like business, characterized by high predictability of earnings and low volatility, underpins our view that Chorus can accommodate higher leverage.

Fiber revenues subject to the regulatory regime accounted for a high 60% of Chorus' total revenues in fiscal 2021 (ended June 30, 2021), and this proportion is expected to rise on the back

onlyof increasing fiber uptake, spurred by demand for faster and more reliable connections. We estimate that by fiscal 2024, fiber will account for almost three-quarters of Chorus' revenue.

At the same time, we view the residual execution and cost escalation risks associated with the ultra-fast broadband (UFB) rollout as minimal. The implementation of the new regulatory framework follows Chorus' transition to operating from the building phase of its fiber network. As

f December 2021, the UFB rollout was 97% complete, with 32,000 premises remaining to pass by December 2022. As the rollout completes, we expect Chorus' free operating cash flow (FOCF) to turn positive from fiscal 2023, improving the company's financial flexibility. We project Chorus' capital expenditure (capex) to drop to NZ$560 million-NZ$580 million in fiscal 2022 from the

useNZ$800 million spent in fiscal 2019 during the peak network buildout, and for this to reduce further to below NZ$400 million by fiscal 2024.

How the regulatory framework stays or changes through subsequent resets will drive the leverage tolerance parameters for the rating. Despite application of the regulatory framework, Chorus retains some longer-termexposure to competition from alternative technologies such as wireless network substitution. Vertically integrated mobile network operators have an incentive to

bypass fixed-line wholesalers in order to capture the full value chain and earn a higher margin. As personala result, fiber uptake could be lower than the company expects. The wash-up mechanism partially

mitigates such risks to earnings. Beyond a single regulatory period, however, these risks are also somewhat a function of how the regulator responds to material changes in market dynamics through the regulatory reset periods. Notably, the regulator may choose to move to a price-cap model within the second regulatory period. We will look for clarity of the regulator's stance as Chorus move through the first regulatory period.

We view Chorus as committed to maintaining a leverage level commensurate with our 'BBB' ratings. Chorus has a record of maintaining a disciplined approach to shareholder returns and financial policy decisions. Chorus is transitioning its distribution policy from being a proportion of p ofit to one based on free operating cash flow. This reflects the transition to a regulated entity in which capex is skewed to stay in business levels. We expect this change will help the company manage its leverage according to its operating performance and capex cycle. We project Chorus' d bt-to-EBITDAratio to be 4.0x-4.2xthrough fiscal 2024. That said, we believe the company may have a higher leverage appetite in response to the greater revenue certainty stemming from the introduction of the regulatory regime. Nonetheless, we expect the company to continue to manage its leverage below our downgrade threshold.

ForOutlook

The stable outlook reflects our expectation that Chorus' strong network position and enhanced earnings predictability due to regulation--coupled with increasing FOCF generation and disciplined approach to capital management--will offset risks associated with wireless substitution, line loss to other local fiber companies, and migration from its legacy copper network.

We will monitor the extent to which Chorus is forced to respond to wireless substitution risk under

Research Update: Chorus Ltd. 'BBB' Ratings Affirmed With Stable Outlook; Outlook Thresholds Revised With Enhanced Earnings Predictability

the new regulatory framework. We may further adjust the company's debt capacity at the 'BBB' rating level, either upward or downward, to reflect our view of the stability of the new regulatory regime, particularly how the regulator manages medium-to-long term returns, regardless of market dynamics.

onlyDownside scenario

Downward rating pressure could occur if the ratio of debt to EBITDA is sustained at 5x or more or a material decline in the group's covenant headroom or liquidity were to occur.

Changes to the new regulatory regime that materially reduce the amount, predictability, and sustainability of the group's earnings generation or stability could put downward pressure on the rating or debt capacity at the 'BBB' rating level.

useUpside scenario

We consider upward rating momentum to be unlikely over the next few years, given the company's capital management objectives. It would require Chorus to adopt and adhere to a more conservative financial policy such that its debt-to-EBITDA ratio remains substantially below 4x.

The establishment of a regulatory track record demonstrating earnings that are sustainable, highly predictable and resilient to wireless substitution risks could provide incremental debt

capacity at the 'BBB' rating level.

personalCompany Description

Chorus is a provider of telecommunications infrastructure throughout New Zealand. The company owns most of the telephone lines and exchange equipment in New Zealand and responsible for building about 75% of the new fiber optic UFB network. The government-backed UFB will cover 87% of the population by the end of 2022.

Chorus owns and operates the majority of New Zealand's fixed-line telecom access network, including the legacy copper network. The group provides wholesale access to copper and fiber networks to retail service providers. In 2011, Chorus was structurally separated from Telecom New Zealand, later rebranded as Spark New Zealand prior to the UFB rollout.

Our Base-Case Scenario

Assumptions

For- New Zealand's GDP to recover after contracting 1.1% in 2020, with a growth of 5.3% in 2021, 3.0% in 2022 and 2.8% in 2023. The advent of the regulatory regime reduces the impact of GDP growth as a revenue driver, but inflation could drive up the business' operating expenses.

- Chorus' revenue to be virtually flat in fiscals 2022 and 2023, before rising about 1%-3% in fiscal 2024. The revenue composition will change, however, with fiber-based revenues (fiber broadband and fiber premium) growing to account for almost three-quarters of revenue by fiscal 2024, up from about 60% in fiscal 2021. In contrast, copper-based revenues will decline and contribute to less than 15% of total revenues, down from about 30% in fiscal 2021. This shift is due to copper-to-fiber migration as consumers seek faster connections.

Research Update: Chorus Ltd. 'BBB' Ratings Affirmed With Stable Outlook; Outlook Thresholds Revised With Enhanced Earnings Predictability

- Adjusted EBITDA margin to improve from 68.6% in fiscal 2021 and be 69%-71% over fiscal 2022 to fiscal 2024 reflecting Chorus' cost-reduction efforts.

- Capex of NZ$560 million-NZ$580 million in fiscal 2022. This amount will decline as UFB network rollout completes by end of 2022, and is projected to be NZ$440 million-NZ$470

*All figures adjusted by S&P Global Ratings. Year ending June 30. a--Actual.e--Estimate.f--Forecast.

Liquidity

We consider Chorus' liquidity to be adequate, reflecting our expectation that the group's sources f liquidity will cover its uses by about 1.2x over the 12-month period ending June 30, 2022. We also expect the company's net sources to remain positive even if EBITDA were to decline by 15%.

Al o supporting the group's liquidity are its sound relationships with banks as well as its generally high standing in credit markets. Chorus has accessed funding in the domestic New Zealand and eu o medium-term note markets.

Principal liquidity sources include:

- Cash and cash equivalents of NZ$53 million as of June 30, 2021.

- Undrawn committed bank facilities of about NZ$210 million, expiring beyond 12 months, as of June 30, 2021.

- Cash funds from operations of NZ$500 million-NZ$510 million over the 12 months to June 30, For2022.

- Funds received from Crown Infrastructure Partners (CIP) and other government funding of NZ$140 million-NZ$150 million over the same period.

Principal liquidity uses include:

- Debt of about NZ$140 million maturing within a year as of June 30, 2021.

• Capex of NZ$570 million-NZ$580 million over the 12 months to June 30, 2022.
• Dividend of 26 cents per share over the same period.