KEY RATING DRIVERS
Regulated Revenues: POWERGRID's rating benefits from the regulatory nature of about 95% of its revenue, which has no offtake risks. The latest five-year regulatory tariff period extends to the financial year ending 31 March 2019 (FY19). The revenue from existing operational transmission assets is based on return on equity of 15.5%, and full pass-through of all the fixed costs that are within regulatory norms, including interest charges. The company has no offtake risks as long as it meets the regulatory operational benchmarks - availability of 98% for alternating current systems and 95% for high voltage direct current systems. POWERGRID has maintained its availability for both systems at well over 99% over the years; in FY16, it was 99.72%.
Tariff-Based Projects Not Significant: Since 2011, new transmission projects in India are awarded only through tariff-based competitive bidding - except certain projects of strategic importance, technical upgrades or urgent requirements, which are awarded directly to POWERGRID. POWERGRID currently has eight projects under development awarded through this scheme, with management aiming to complete them by FY20. Returns from these new projects are less protected than that from existing operational assets under a cost-plus tariff model. However, Fitch does not expect tariff-based bidding projects to account for more than 5% of revenue in the medium term. POWERGRID had INR1.44trn of transmission projects under development at end-July 2016, with only INR160bn of projects under the tariff-based bidding scheme.
Dominant Market Position: POWERGRID's ratings also benefit from its very strong market position. The company owns and operates around 90% of India's inter-state and inter-regional electricity transmission network assets. Overall, POWERGRID carried around 45% of the electricity in India in FY16. In line with Fitch's expectations, POWERGRID's projects commissioned in FY16 increased by 46% yoy. The management plans total capex of about INR1trn over FY17-FY20.
Weak Counterparty Profile: POWERGRID's counterparties, which are mainly state utilities, have weak financial profiles. However, POWERGRID has maintained a good receivable collection track record with timely realisation of 97% in FY16. Its healthy receivable position is due to the critical nature of its transmission assets and its position as the dominant inter-state transmission provider in India. In addition, transmission cost payments to POWERGRID form only a small proportion of a state utility's total costs, with the largest payments going to generation companies.
The company also benefits from the letters of credit for 105% of the average monthly revenue and the tripartite agreements between the central government, the central bank and the state governments to ensure timely payments to POWERGRID. The current agreements will expire by end-October 2016; however, POWERGRID expects an extension. According to the management, about half of the 29 states have already agreed to the extensions.
Credit Metrics Likely to Improve: POWERGRID's net leverage, as measured by net debt/EBITDA, has remained at around 6x (FY16: 5.7x) given the high capex levels of around INR240bn a year. Fitch expects leverage to fall to around 5x by FY18, as assets under construction are commissioned, leading to an increase in revenue and profit. Over the years, the company has maintained net-debt/total fixed assets at around 65%. These metrics and the company's strong business profile are supportive of a standalone credit profile of 'BBB'. POWERGRID continues to maintain a robust liquidity, with a well-laddered debt maturity profile
Ratings Constrained by Sovereign: POWERGRID's IDR, which is a notch below its standalone credit profile of 'BBB', is constrained by the 'BBB-' IDR of its 57.9% owner, India. Fitch assesses POWERGRID's linkages with the Indian state to be moderate. The legal linkages are moderate with the government guaranteeing around 20% of the total debt. The operational linkages are also moderate. The strategic linkages are high as POWERGRID is designated as a central transmission utility in the country, and is a key policy implementation tool for the electricity industry. A central transmission utility, in the Indian context, is responsible for planning and co-ordinating inter-state transfer of power and administering the payment sharing mechanism across the inter-state transmission system.
However, the government intends to separate the central transmission utility function from POWERGRID to level the playing field for private companies that bid for transmission projects under the tariff-based competitive bidding mechanism. This may take a few years to implement and take effect, in our view.
Material Secured Indebtedness: POWERGRID has substantial secured debt. At FYE16, around 92% of the total debt is secured against its tangible assets. As such, Fitch rates its senior unsecured debt one notch below its unconstrained rating of 'BBB'.
Fitch's key assumptions within the rating case for POWERGRID include:
- ROE of 15.5% for all of the transmission projects, including projects under the tariff-based competitive bidding scheme, in line with management's guidance
- All costs, including depreciation and interest costs, are passed through within the regulatory norms for projects under cost-plus tariff model
- Capex remains elevated in the medium term - a total of about INR1trn over FY17-FY20
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- A downgrade of India's ratings
- POWERGRID's standalone credit profile could be lowered if its net leverage (net-debt/EBITDA) rises above 6x, fixed-charge cover - including capitalised interest - falls below 2.5x (FY16: 2.5x), and/or the net debt/total fixed assets increases beyond 70% on a sustained basis. Should this happen, POWERGRID's senior unsecured rating is also likely to be lowered given the material secured debt.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- An upgrade in India's rating to 'BBB'. This would result in an upgrade in the IDR, though the senior unsecured rating would remain unchanged
- Fitch does not expect an improvement in the standalone credit profile in the next 12-18 months.
For the sovereign rating of India, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 18 July 2016:
The main factors that individually or collectively could lead to positive rating action are:
- Fiscal initiatives that would cause the general government debt burden to fall more rapidly than expected in the medium term
- An improved business environment resulting from implemented reforms and persistently contained inflation, which would support higher private investment and real GDP growth
The main factors that individually or collectively could lead to negative rating action are:
- Further deviation of the already high public-debt burden from the peer median, which may be caused by stalling fiscal consolidation or greater-than-expected deterioration in the banking sector's asset quality that would prompt large-scale sovereign financial support
- Loose macroeconomic policy settings that cause a return of persistently high inflation levels and a widening current-account deficit, which would increase the risk of external funding stress
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