(The following was released by the rating agency)
-- Power Grid 's strong market position and a stable regulatory framework for power transmission in India support the company's "satisfactory" business risk profile and "significant" financial risk profile, in our opinion.
-- We believe there is an "extremely high" likelihood of extraordinary government support for the India-based power transmission company in the event of financial distress.
-- We are assigning our 'BBB-' long-term corporate credit rating to Power Grid. We are also assigning our 'BBB-' issue rating to the company's proposed unsecured notes.
-- The negative outlook reflects our negative outlook on the sovereign credit rating on India and the company's sensitivity to government intervention.
On Jan. 4, 2013, Standard & Poor's Ratings Services assigned its 'BBB-' long-term corporate credit rating to power transmission company Power Grid Corp. of India Ltd. The outlook is negative. At the same time, we assigned our 'BBB-' issue rating to the company's proposed issue of up to $1 billion unsecured long-dated notes. The rating on the notes is subject to our review of the final issuance documentation.
The rating on Power Grid reflects the company's near monopoly inter-state transmission business in India and a stable regulatory framework with a cost plus tariff mechanism on most existing projects. We also believe there is an "extremely high" likelihood of extraordinary support from the government of India (unsolicited rating BBB-/Negative/A-3) to Power Grid in the event of financial distress. The weak credit quality of the company's customers and the country and macroeconomic risk associated with India offset these strengths.
Power Grid's stand-alone credit profile of 'bbb-' reflects the company's strong market position. We assess the company's business risk profile as "satisfactory." Power Grid owns and operates nearly 90% of the inter-state transmission network in India. The company's network carries nearly 50% of the total power generated in the country. We believe the company has strong growth prospects despite its leading position due to India's power deficit of about 10% of base demand and the country's need to transmit power across regions. The company also plays the important role of planning for nationwide transmission infrastructure.
The regulatory environment for power transmission in India is stable, in our opinion. The regulator has allowed transmission companies to recover 14%-16% return on equity over the past decade. The tariff also allows for cost recovery based on system availability by Power Grid regardless of the amount of power transmitted through its network. This facilitates stable returns for the company, even if power demand declines, and offers protection against volume risk.
Power Grid has maintained its system availability above 99% over the past few years, and its collection record has been reasonable despite the weak credit profiles of its counterparties--the state electricity boards (SEBs).
Power Grid has a good project execution record. In our view, the company is reasonably protected from the risk of "stranded" assets (where transmission assets are functional but the generation assets are not) due to India's power deficit and billing that is based on the date of project commissioning.
A largely national presence exposes Power Grid to India's country and macroeconomic risk. We believe political considerations will continue to influence the ability and willingness of SEBs to increase tariffs, limiting the improvement in their weak credit profiles.
We assess Power Grid's financial risk profile as "significant" despite its weaker financial ratios because: (1) the company's returns are stable; (2) the nature of the business is regulated with cost pass through; and (3) the cost plus norms applicable to most of Power Grid's projects incentivize a debt-to-capital structure of 70:30 because interest is recoverable based on the actual cost.
We do not expect Power Grid's financial risk profile to change materially over the next two to three years. We anticipate that the company's aggressive capital expenditure plans toward expansion will continue to result in significant negative free operating cash flows. We estimate Power Grid will maintain its ratio of funds from operation (FFO) to debt of 9%-10% and a debt-to-capital ratio of 70%-72% over the next two to three years.
We expect Power Grid to continue to generate returns on capital of 8%-9.5% despite competitive bidding and normative (capital expenditure levels set by a regulator following a planning and consultation process) recovery on capital expenditure for projects awarded after 2011. Nevertheless, our key rating considerations will be Power Grid's returns on these projects once commissioned and its performance on projects where recovery of tariff would be based on normative instead of actual capital expenditure. We expect the company to manage most of its new projects within the regulator's stipulated normative limits.
We view Power Grid as a government-related entity (GRE). In accordance with our criteria for GREs, our view of an "extremely high" likelihood of extraordinary government support in the event of financial distress is based on our assessment of the following Power Grid characteristics:
-- "Very strong" link with the government. We expect the government to retain its majority shareholding (69.4%) in Power Grid with administrative control by the Ministry of Power. The government has also extended a sovereign guarantee on some of the company's foreign currency loans from multilateral agencies.
-- "Critical" role for the government. Power Grid has a near monopoly in the inter-state transmission network in India and a central role in planning for the transmission network as the central transmission utility. We believe the importance and dependence of economic activities on Power Grid's transmission services and its dominant position in a country with power deficits determine its critical role.
We have equalized the rating on the proposed notes with the corporate credit rating. This equalization reflects the absence of a legal review by Standard & Poor's in India that would allow it to form an opinion on the ability to differentiate between secured and unsecured debt in the event of recovery.
Power Grid has "adequate" liquidity, as defined in our criteria. The company's sources of liquidity are likely to cover its needs by about 1.2x in the next 12 months. We expect the company to meet its cash outflows, even if EBITDA declines by 15%. Our liquidity assessment incorporates the following expectations and assumptions:
-- Sources in 2013 include cash and equivalent of over Indian rupee (INR) 33 billion as of March 31, 2012 (including cash that can be utilized only against specific projects), and our projected FFO of over INR60 billion.
-- Power Grid borrowed an additional INR83 billion in the six months ended Sept. 30, 2012, to fund its capital expenditure needs. In addition, the company has tied up committed facilities of about INR190 billion.
-- Power Grid has strong proven access to the domestic capital market because of its status as one of India's largest GREs.
-- Uses of liquidity in 2013 include debt repayment of about INR26 billion, cash dividends of about INR11 billion, and estimated committed and non-discretionary capital expenditure of over INR100 billion (assumed at 60% of total capital expenditure for the year).
Power Grid's debt maturity profile is well spread out. We expect the company to continue to have good access to multilateral agencies from which it has raised funds in the past. We believe Power Grid can access additional banking facilities, if required, due to its stable financial profile and GRE linkage. We expect the company to maintain a cushion on its financial covenants, including a covenant to maintain the debt-to-total capital ratio below 75%.
The negative outlook on Power Grid is consistent with the sovereign credit rating outlook, and reflects Power Grid's sensitivity to government intervention.
We could downgrade Power Grid if we lower the sovereign credit rating or ongoing government support declines, and the company's FFO-to-debt ratio falls sustainably below 9%-10% possibly due to: (1) returns on capital becoming volatile because of normative capital expenditure recovery, a change in tariff, or competitive bidding; or (2) the company's operating efficiency suffering because of a significant delay in project commissioning or lagged payments from weak counterparties.
We could revise the outlook to stable if we revise the sovereign rating outlook to stable and Power Grid's stand-alone credit profile is unchanged.
Related Criteria And Research
-- Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012
-- Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Power Grid Corp. of India Ltd.
Corporate Credit Rating BBB-/Negative/--
Senior Unsecured BBB-