23 October 2019

Infratrack

Action stations

 

Infrastructure and project finance policy actions and asset performance will be crucial to recovery in FY17

 

India Ratings and Research (Ind-Ra) has maintained a negative outlook on the overall infrastructure sector for FY17 with diverse outlooks on the subsectors. The negative outlooks on toll roads and thermal power sectors and high loan exposure to these sectors continue to weigh down the overall sector outlook. The infra sector continues to grapple with the high concentration of poorly performing assets resulting in not only fragile coverage metrics but also lower-than-expected equity returns to the sponsors.

The stable outlook on ports, airports and renewables are broadly governed by improved throughput levels and favourable policies although this is amid expected timely revenue realisations and weak financial profile of state distribution companies. Government’s policy interventions across the sub-sectors aim to resolve several teething problems. However, the results are likely to be harvested over the intermediate term. While policy actions from the government cannot be underplayed, performance of assets is a crucial recovery driver.

 

Inadequate traffic rebound in toll roads:

Toll roads’ negative outlook reflects the absence of a strong widespread traffic recovery, toll rates contraction, and stressed sponsors’ credit profile. However, traffic has improved in some stretches. The government’s steps to address key issues through policy actions in FY16 could play out positively with lag effect only in the medium term. Nevertheless, the rating agency believes that the sector’s inflection point will continue to be consistent traffic, which is elusive yet and also is a function of macroeconomic revival. In the absence of any accumulated reserves to fund lifecycle costs in FY17, the projects with weak sponsors may have to borrow additionally thereby further constraining their already frail finances. That said, the slight improvement in the projects awarded until 10MFY16 and increasing number of projects tapping the capital markets indicate signs of recovery. Nevertheless, cash based contracts are expected to be the preferred form of project awards by the government, due to a continuing lukewarm demand for the build, operate and transfer space.

 

Counterparty woes sapping thermal power recovery:

The utilities continue to delay the call for long-term offtake bids and rely on short-term buying to manage demand supply mismatches. Despite policy interventions and improved fuel supply position, the tepid demand curtailed plant load factors (PLFs) and many plants are operating at sub-optimal levels. According to Central Electricity Authority (CEA), energy requirement growth was 2.2 per cent in 9MFY16 as against 8.8 per cent 9MFY15. Notwithstanding the rupee depreciation, the dip in imported coal prices has benefitted the project companies. 10,000MW of capacity addition is expected from independent power producers (IPPs) before the end of 12th Five-Year Plan (FY12-FY17) which will exert more pressure on short-term rates and PLFs. Despite improved coal supply and low imported coal prices, new projects commencing operations in FY17 could further pressurise the sub-optimal plant load factors. The The recent policy action to revive the state discoms through Ujjwal Discom Assurance Yojna (UDAY) could improve the liquidity position after acquisition of debt by the states. However, strengthening of the credit profile of utilities is a gradual process and could be protracted.

 

Favourable policy props up renewables:

The outlook for renewables remains stable for FY17 based on the stable regulatory environment for the sector in terms of must-run status, no inter-state transmission charges, renewable purchase obligations and generation-based incentives. The outlook for existing renewable projects remains stable based on the fixed-price, long-term revenue contracts that typically underpin cash flows. Capital costs for solar technology continue to fall and improve competitiveness, despite diminishing tax advantages and rupee depreciation. Given the radical change in solar tariffs, the sector will no more be the same as it was during the previous years. However, the quality of photovoltaic (PV) panels, which are yet untested, could pose a threat to the existing rating levels. The quality of performance warranties and contractual maintenance for the panels, and the quantum of insurance for failure of these panels could address the performance risks. Newer insurance products guaranteeing a minimum PLF may evolve for wind and solar projects. Roof-top solar projects are expected to pick up action in FY17.

 

Airports poised for stable performance:

Credit fundamentals in Ind-Ra rated airports are stable, and the trend is expected to continue in the intermediate term thanks to a sustained uptick in enplanement throughputs, especially domestic passenger growth, improvement in fundamentals for airlines, and growing share of non-aero revenue. Large airports depend on the timely monetisation of commercial properties failing which their debt servicing ability could be impacted. A reversal of disallowance of user development fees (UDFs) and regulatory clarity on the ‘till’ mechanism are likely to improve the credit metrics of airports and create a favourable investment climate. Sustainable historical traffic gains, particularly domestic passengers growth (November 2015: 20.4 per cent yoy) and reasonable diversification in non-aeronautical services underpinned the cash flows of these airports. With the current passenger traffic growth rate, the total pax volumes could cross 220 million in FY16. However, large airports’ dependence on commercial property development will rise in the coming years. Timely monetisation of real estate revenues is critical and hence is a crucial rating driver. In addition, experienced and proven airport operators have kept costs in line with inflation.

 

Sustained throughput bodes well for seaports:

Continued growth is expected in ports’ throughput volumes driven by economic growth. However, the contraction in volume handled in non-major ports until 6MFY16 could impact the prospects. Management of evacuation issues and increasing freight volumes, both inside and outside port gates, remain in focus as vessel size and cargo loads continue to grow. Investments in port infrastructure will also be a focus area for both private and public sectors as economic growth continues. Macroeconomic trends globally will affect throughputs and shifts in trade volumes, though long-term contracts at ports should insulate cash flow from volume volatility. Ind-Ra rated private ports (excluding the largest port and minor sea ports) operated above 50 per cent of the created capacity in FY15, and the agency expects it to remain above 50 per cent in FY16 as well.

Steady performance for availability-based projects: The credit quality of off-takers, established demand and the essentiality of these projects are considered key factors to provide a steady performance. In general, rated credits such as transmission lines and other annuity infrastructure projects are operating in line with expectations.

 

OUTLOOK SENSITIVITIES

Financial Re-engineering: Some of the major financial issues faced by the sector include a compressed amortisation profile and the lenders’ inability to accommodate a repayment structure and high interest cost. The regulator has provided relief to the lenders by allowing them to raise funds exempt from the mandatory regulatory reserves. The overall outlook could be positively revised if infra projects benefit from these steps through a stretched amortisation profile with a reasonable concession tail and reduced interest rates.

 

Better economic fundamentals: A reduction in interest rates and the stability of the Indian rupee can help ease the overall pressure on projects’ cash flow while a pick-up in gross domestic product (GDP) growth rate will have a salutary effect on traffic volumes and energy demand, leading to portfolio-wide increases in coverage. With lower fuel prices, airlines and shippers may see cost structure benefits which allow for more services on a system-wide basis. The toll roads that are in the ramp-up phase would benefit in particular. Besides, a buoyant economy will be more conducive for asset sales and raising the much-needed equity.

 

Fall in imported coal prices: The impact of the continuous fall in imported coal prices could alter the dynamics of the power purchase by the state utilities. Power plants may substitute imported coal with domestic coal and that could aid in retaining the short term trading prices at low levels.

 

KEY FINANCING TRENDS

Debt Tenor to Match Economic Life of the Asset: The oft-quoted mismatch between the economic life of assets and loan tenor is being addressed due to the recently evolving debt structures. New bank loans and evolving capital market instruments feature a refinancing risk after a certain period. The shift from the fully amortising shorter period loan to a fixed-rate debt with refinancing risk after five or six years eliminates the annual interest variations risk. Given the long economic life of assets, the project could refinance every five or six years contingent on a stable project performance. The rating adequately captures the refinancing risk for such instruments and the agency expects similar instruments in FY17.

 

 Emerging Capital Market Instruments: Refinancing, with or without additional top-up to better match repayments with expected inflows has improved coverage metrics especially for matured assets. Replacement of a variable bank loan with fixed-cost debt, proposed pooling of projects under a single SPV, partial credit enhancements, and adequate reserve mechanisms even in the absence of sponsor undertakings have benefited the credit profile of some project companies. The infrastructure sector has seen increasing interest evinced by private equity funds, which augurs well for the sector and is reflected in the improved rating profile of project companies. These instruments also strengthen the overall credit profile of the project and reduce the project’s dependence on the sponsors for any implicit support during the life of the debt. The rating agency expects a surge in capital market transactions in FY17. Operational power projects and transmission are keen to tap the short-term capital market instruments.




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