Moody’s and S&P revise their ADSEZ rating outlooks to negative: Moody’s and S&P have revised their rating outlooks on ADSEZ to negative from stable, due to port volume as well as balance sheet-related concerns. Key observations by Moody’s and S&P are below:
Moody’s revision on volume and high indebtedness concerns: Moody’s revision is on sharp declines in coal volumes, high levels of capex, increased loans and advances and consequently higher net debt levels.
ADSEZ growth trajectory may be impacted by sharp decline in coal volumes: The credit rating agency highlighted that coal cargo at ADSEZ ports declined due to (i) reduction in India’s coal imports, and (ii) state-owned utilities shifting their cargo to major ports (central government-owned ports). FY16 overall cargo growth at 5% y-o-y was modest, mainly due to the 8% y-y decline in coal cargo. Moody’s has highlighted that its rating could be downgraded if coal volumes continue to fall, and such a decline is not offset by an increase in container volumes.
Higher capex, increased loans and advances, and higher net debt S&P revision also on increased debt levels and volume concerns S&P’s revision is similarly attributed to declining coal imports, and the subdued economic environment. Specifically S&P mentions that the negative outlook reflects the risk of ADSEZ’s performance not improving in line with expectations, and aggressive investments resulting in FFO to debt remaining below 13% over a prolonged period. However S&P is of the opinion that the company’s financial performance will improve over the next 18 months, in line with expectations of a BBB-rating.
Increase in debt is a result of adverse working capital movements, high capex, advances and deposits: S&P’s calculated FFO/debt is estimated to have further slipped to 10-11% in FY16, compared to 12% in FY15. However, S&P expects improvement in free operating cashflows in the next 12-24 months, on better operating performance due to measures taken to increase cargo volumes, especially in higher-realisation containers. But near-term pressure on cash flows remains from increased capex requirements, like for the acquisition of Kattupalli Port.
S&P expects improvement in Ebitda margins on better mix: Ebitda margins are expected by S&P to improve from 60% in FY16 to 64% in FY19 due to the shift of mix towards higher-margin container business. S&P assumes that R20 bn of related party loans will be recovered over the next three years.
Nomura’s credit research view is also reflective of balance sheet issues (increased debt, loans and advances): A recent research by Nomura’s credit team also emphasises these findings Downgrade to Underweight due to balance sheet developments, published by credit analyst, Gaurav Singhal). Gaurav’s comments include: (i) Q4FY16 and full-year FY16 results are credit negative, as net leverage rose to 4.2x from ~3.7x at the end of Q3FY16, while expectation for end of FY16 net leverage was ~3.6x. This is attributed to increases in loans and advances to more than R10,000 crore from R6,200 crore at the end of FY15 (and R72 bn at the end of H1FY16).
ADSEZ will find it difficult to retain its credit rating: Moody’s said it would consider downgrading its ratings if ADSEZ demonstrates on a sustained basis had an FFO/debt below 15-18% and cash interest cover below 2.75-3.00x. Financial metrics that Moody’s would look for in changing the outlook back to stable include an FFO/debt of 18-25% and a cash interest coverage of 3.0x-4.5x on a consistent basis. S&P does not include SEZ income (R620 crore) for its FFO or Ebitda calculations, which explains the difference between S&P’s threshold of 13% as the lower limit and the Moody’s threshold of 15%.
We have a Neutral rating on the stock. We value ADSEZ at 11x EV/Ebitda for FY18F to arrive at our target price of R228. Key risks: (i) Substantial traffic share is dependent on promoter group companies—while historically, receivables have been an issue from group companies, a change in this could be positive for the stock. (ii) Group companies Adani Power and Adani Enterprises have a substantial capex outlay for the foreseeable future—up to $10 bn. With no immediate clarity on the ways and means for funding this, these plans could remain an overhang for ADSEZ. However, clarity on the same and no liability on ADSEZ could be an upside risk. (iii) Sharper than—expected traffic growth at key port assets could be an upside risk to our estimates. (iv) Reduction in net debt levels would be a positive while a further increase in related party loans and receivables would be negative.