Singapore: Following Adani Transmission Limited’s (ATL) planned acquisition of Reliance Infrastructure Limited’s (RInfra) integrated power generation, transmission, distribution and retail business in Mumbai, Fitch Ratings has revised India-based Adani Transmission Limited’s (ATL) Outlook from table to Negative.
Fitch believes the acquisition will not increase the company’s business risk. The addition of retail customers will diversify ATL’s counterparty risk, which would counteract the negative impact of taking on RInfra’s relatively complex operations and the maintenance of its distribution wires, as well as the competition in the electricity supply business. The agency’s Negative Outlook is premised on Fitch’s expectations of a deterioration in ATL’s financial profile due to the largely debt-funded nature of the transaction.
Fitch have affirmed ATL’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR), and the rating on its USD500 million 4.0% senior secured notes due 2026, at ‘BBB-‘.
Fitch on KEY RATING DRIVERS
Financial Profile to Deteriorate: Fitch expects ATL’s financial metrics to deteriorate due to the potentially large debt-funded nature of the acquisition. ATL’s net leverage (adjusted net debt to EBITDAR) is expected to temporarily increase to 4.2x for the financial year ending 31 March 2019 (FY19) from 3.9x in FYE18, before normalising to 3.4x by FYE20. On the other hand, its EBITDAR net fixed-charge cover and adjusted net-debt-to-fixed-assets ratio are expected to remain around our negative rating action triggers of 2.2x and 65%, respectively, over the next few years.
Balanced Business Risk Profile: The transaction will mark ATL’s foray into power distribution from its transmission business. Its business risk will rise due to the new segment’s relatively intricate operations with the need to maintain distribution wires – given intra-city locations and their complex structures – as well as allowed competition among electricity suppliers in Mumbai. However, this will be counteracted by a more diversified counterparty profile, in our view. Mumbai distributors supply about 44% of electricity to commercial customers, around 42% to residential customers, with the balance to industrial customers.
Maharashtra’s state-owned power utility accounts for the majority of ATL’s operating cash profit. The utility is financially weak, although ATL’s receivables position has improved after the state electricity regulator implemented changes to motivate utilities to pay transmission companies on time. The acquisition of RInfra’s distribution business, which has about 3 million retail customers, will diversify ATL’s counterparty exposure. Cash operating profit linked to retail clients will contribute about 40% to the group’s total over the next few years. Fitch also expects the share of ATL’s cash operating profit from Maharashtra’s state utility to drop with the commissioning of new transmission projects in other states with considerable exposure to a central transmission utility.
Supportive Regulatory Framework: ATL’s credit profile benefits from a stable and favourable regulatory environment as India’s regulators have a long track record of delivering predictable outcomes. Revenue for four of ATL’s key operating transmission assets, along with RInfra’s generation, transmission, distribution and supply businesses, are based on a cost-plus tariff. We expect the combined businesses to contribute about 80% to the group’s consolidated cash operating profit in FY20.
The rest of the cash operating profit will be contributed by transmission assets awarded to ATL on a tariff-based competitive bidding (TBCB) mechanism. All new transmission assets in India are awarded on the TBCB mechanism, which provides less protection than the older, cost-plus tariff model. Nevertheless, revenues are still based on system availability and are not exposed to volume risks. The low operating risk profile of transmission assets and ATL’s strong operating performance in excess of regulatory benchmarks provide the company with long-term revenue visibility.
Growth in Assets: ATL acquired 3,063 circuit km of transmission assets from RInfra last year. The company also has about 2,369 circuit km of greenfield transmission assets in its pipeline. The combination of these assets and the 540 circuit km under RInfra’s Mumbai business will more than double ATL’s transmission operating capacity by FYE20. Fitch expects ATL to maintain its track record of bidding for, or acquiring, new projects prudently to achieve a robust return on its investments and to ensure its financial profile is not compromised.
Structural Enhancements for Bond Issue: ATL’s US dollar bonds benefit from a defined cash waterfall and structural enhancements, including limitations on incurring additional indebtedness. The capital expenditure cannot be undertaken or contracted if the liquidity reserve account within the waterfall is unfunded. In addition, there are restrictions on the business activities of ATL’s non-obligor subsidiaries. The notes’ obligor group consists of ATL, the issuing entity, and two of ATL’s subsidiaries, which own four key operational transmission assets.
Power Grid Corporation of India Ltd (PGCIL, BBB-/Stable) is ATL’s closest peer. We assess PGCIL’s standalone profile at the ‘BBB’ rating level. PGCIL operates at a much larger scale although scale by itself is not necessarily an advantage for regulated businesses, in our view. ATL has demonstrated very high levels of project execution skills and operational performance. The difference in their business profiles and ratings is primarily due to ATL’s significant exposure to a single financially weaker state-based counterparty. We note that ATL’s counterparty profile will be more diversified with the ongoing acquisition of RInfra’s power business and the completion of projects under construction. According to the management’s estimates, EBITDA contribution from Maharashtra’s state utility will decline from 60% to 25% over the next three to four years.
Fitch’s Key Assumptions Within our Rating Case for the Issuer:
– For the four key operating transmission assets, revenues are based on all relevant costs, regulated return on equity and incentive income linked to asset availability. For committed transmission projects and uncommitted growth capex, returns are broadly in line with existing operational transmission projects
– Forecast capex includes INR24 billion of committed projects under development over FY18-FY20 and annual uncommitted capex of INR6.4 billion from FY20
– The two transmission projects acquired from RInfra to contribute revenue from FY18
– Substantially debt-funded acquisition of RInfra’s Mumbai power business, which we expect to be completed in FY19. The business to contribute stable EBITDA of about INR16 billion per annum.
– Dividend pay-out ratio of 30% over the next three years
Developments that May, Individually or Collectively, Lead to Positive Rating Action
The Outlook may revert to Stable at the current rating if
– EBITDAR net fixed-charge coverage – including capitalised interest – stays above 2.2x,
– Net leverage stays below 5x, and/or
– Adjusted net debt (excluding working capital facilities)/fixed assets stays below 65%
Developments that May, Individually or Collectively, Lead to Negative Rating Action
– EBITDAR net fixed-charge coverage – including capitalised interest – falls below 2.2x (FY17: 2.5x)
– Net leverage rises above 5x (FY17: 4.3x)
– Adjusted net debt (excluding working capital facilities)/fixed assets above 65% (FY17: around 78%)
– Sustained significant increase in receivable days
Negative rating action on India (BBB-/Stable), particularly India’s Country Ceiling (BBB-), will also lead to negative rating action on ATL’s Foreign-Currency IDR and the rating on its notes.
Adequate Liquidity: ATL had cash balance of INR4.6 billion at end-FY17. We expect ATL to generate cash flow from operations of about INR12 billion in FY18. ATL has also refinanced its borrowings over the last few years. This has resulted in spread-out maturities and lower interest costs for the firm. The group’s liquidity position is good with around INR6 billion of debt maturing in FY18. ATL also has good access to banks and capital markets in India.