ECONOMYNEXT – Fitch Ratings said it had confirmed a ‘AA+(lka)’ rating of Lakdhanavi Limited, a Sri Lanka-based power firm which also part-owns a unit in Bangladesh.
The rating is based its ability to maintain debt and its position as a the main operation and maintenance (O&M) segment in the country’s power sector, which bring is cashflows, the rating agency.
The firm was subject to counterparty risks from contracts with power distributors.
Fitch Ratings has affirmed Sri Lanka-based Lakdhanavi Limited’s National Long-Term Rating at ‘AA+(lka)’. The Outlook is Stable.
Fitch rates Lakdhanavi based on the consolidated profile of its parent LTL Holdings (Private) Limited (LTLH) due to the strong legal and operational linkages between the two entities, as defined in our Parent and Subsidiary Linkage Rating Criteria.
The affirmation reflects LTLH’s ability to maintain net leverage, with proportionate consolidation of its subsidiaries, 51%-owned Lakdhanavi Bangla Power Limited (LBPL) and 56%-owned Feni Lanka Limited (Feni), below its negative rating sensitivity of 5.5x in the next few years, despite debt-funded investments.
The rating also reflects LTLH’s leading market position in the operation and maintenance (O&M) segment in the country’s power sector, stable cash flow generation from fixed long-term power generation contracts in Bangladesh, and strong EBITDA margins, which are offset by its high counterparty risk.
KEY RATING DRIVERS
Strong Linkages with Parent: We view the operational and legal linkages between Lakdhanavi and its weaker parent, LTLH, to be strong under our Parent and Subsidiary Linkage Rating Criteria. The linkages include LTLH’s strong control over Lakdhanavi’s board, presence of a centralised treasury, unrestricted cash flow fungibility between the two entities and upstream guarantees provided by Lakdhanavi.
LTLH’s Weak Linkages with CEB: We view LTLH’s links with its parent, Ceylon Electricity Board (CEB, AA-(lka)/Stable), as weak and assess it on a standalone basis. CEB controls LTLH’s board, but the presence of minority shareholders, LTLH’s independent management team, separate financing arrangements and LTLH’s record of no cash leakages other than modest dividends after prioritising its investments supports our view of weak linkages.
We believe CEB has limited incentive to access LTLH’s cash beyond dividends because of the latter’s small size; but large outflows could pressure Lakdhanavi’s rating.
Investments to Weaken Leverage Temporarily: We expect LTLH’s net leverage to rise to 5.0x by the financial year ending 31 March 2024 (FY24) from 1.1x in FY21 due to its USD190 million investment in a 350MW combined cycle power plant. The Sobhadanavi plant will start operating in FY24 and has secured a 20-year power purchase agreement (PPA) with CEB. Lakdhanavi will inject 30% of the equity funding for the plant, with the rest raised from a project loan. We expect Sobhadanavi to account for about 40% of group gross profit when online, which will help cut leverage to around 2.5x by FY25.
We believe this investment has materially weakened LTLH’s balance sheet, and hence its ability to invest in similar projects in the near term. The company is seeking to dispose of up to 49% of the Sobhadanavi plant to an equity partner, which should improve the headroom under the current rating.
However, the credit profile could come under pressure
if LTLH continues its investment drive without taking adequate steps to strengthen its balance sheet.
Increasing Counterparty Risk Manageable: LTLH derives around 55% of gross profit from lower-rated CEB and we expect this to rise to 80% by FY25 with Sobhadanavi. LTLH has continued to receive its dues from CEB promptly, despite the latter’s weakening credit profile, given the essential nature of their services. We believe Sobhadanavi, which is one of the first liquid natural gas (LNG) power plants in the country, is important to CEB to meet the current shortfall in power supply and move away from high-cost heavy-oil plants. Therefore, we expect CEB to make payments to Sobhadanavi without delays.
We believe LTLH’s Bangladeshi operations mitigate the counterparty risk from CEB. Historically, Lakdhanavi’s power plants have received on-time payments from Bangladesh Power Development Board (BPDB), which is owned by the government of Bangladesh (BB-/Stable). LTLH currently has around 35% of gross profit from Bangladesh, but this will fall to around 15% once Sobhadanavi comes online. However, the company continues to seek to invest in large power projects in Bangladesh, which could reduce counterparty risk further if any materialise.
Cashflow Stability from Long-Term PPA: LTLH derives 85% of its gross profit from long-term PPAs in its power generation and O&M segments. Lakdhanavi’s power plants in Bangladesh are secured with a 15-year PPA with the BPDB. The cash flow is largely guaranteed through capacity-based tariffs and cost pass-through mechanisms. Lakdhanavi’s O&M business has 14 years remaining under its current PPA with Sri Lanka’s largest thermal power plant, and its largely capacity-based tariffs should not be affected even if CEB decides to shift from thermal to alternative sources in the future.
Lower Margins: We expect LTLH’s EBITDA margin to contract to the low 20s in the medium term from 39% in FY21 as the group expands in low-margin power generation and construction. Consequently, the benefit from LTLH’s O&M segment, which carries a higher margin compared with the rest of the group, would be diluted over time. The EBITDA margins in Lakdhanavi’s older power plants in Bangladesh are also likely to contract due to lower tariff rates during the latter part of their PPAs.
Lakdhanavi’s rating reflects its stable cash flow generation from fixed long-term O&M contracts and power purchase agreements. Lakdhanavi is rated one notch lower than diversified conglomerate Hemas Holdings PLC (AAA(lka)/Stable) and Sri Lanka’s leading beer manufacturer, Lion Brewery (Ceylon) PLC (AAA(lka)/Stable), to reflect its high counterparty risk and appetite for investments. We expect Lakdhanavi’s financial risk profile to weaken materially in the next few years compared with that of Hemas and Lion due to the company’s large debt-funded investment in new power projects.
Lakdhanavi is rated at the same level as domestic conglomerate Sunshine Holdings PLC (AA+(lka)/Stable) to reflect Lakdhanavi’s exposure to the Sri Lanka sovereign as a key counterparty. Sunshine has a smaller scale than higher-rated peers and its cashflows are volatile due to the competitive value-added tea segment and regulatory risks in its pharmaceutical distribution business. We believe Lakdhanavi could withstand higher
leverage for the same rating level than Sunshine, given its ability to generate stable cashflows through the cycle.
Lakdhanavi is rated at the same level as domestic tire manufacturer Ceat Kelani Holdings Pvt Limited (CKH:AA+(lka)/Stable). The latter faces heightened business risk from extensive competition as well as cyclical end-market demand, which is counterbalanced by a strong financial risk profile, which is evident from its net cash position.
The leaders in the consumer durables retail sector in Sri Lanka, Singer (Sri Lanka) PLC (AA(lka)/Stable) and Abans PLC (AA(lka)/Stable), are exposed to more discretionary demand and have weaker financial profiles than Lakdhanavi. Furthermore, they are exposed to sovereign stress in the form of import restrictions and controls, given they import the majority of the products they sell. Therefore, we rate Lakdhanavi one notch above Singer and Abans.
Given the credit strengths of Lakdhanavi, it is rated higher than a number of large banks, non-bank financial institutions and insurance companies in the country. Despite their individual credit strengths, these large financial institutions are more exposed to sovereign stress than Lakdhanavi, mainly due to the substantial sovereign-issued securities held for regulatory reasons, as well as their broader exposure to numerous sectors in the local economy, in the case of the banks and non-bank financial institutions.
Fitch’s Key Assumptions Within Our Rating Case for the Issuer:
– Revenue to increase by 170% in FY22, driven by a rise in revenue from the Bangladesh power plants, revenue from construction work for the Sobhadanavi power plant and the demand recovery across most other businesses. Revenue should rise again from FY24 once Sobhadanavi starts commercial operations.
– EBITDA margin to average around 20% in the next two years due to increased contribution from low-margin power generation and construction segments, which would dilute the benefit from the high-margin O&M segment.
– Capex of LKR25 billion in FY22 and LKR14 billion in FY23, mainly on the Sobhadanavi plant
– Dividend pay-out of LKR3.0 billion-4.0 billion a year over FY22-FY25.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
We do not anticipate any positive rating action in the next two years due to the company’s significant investment plans and counterparty risk profile
Factors that could, individually or collectively, lead to negative rating action/downgrade:
LTLH’s consolidated net debt/EBITDA (with proportionate consolidation of LBPL and Feni) rising above 5.5x on a sustained basis
– LTLH’s consolidated operating EBITDA/interest paid (with proportionate consolidation of LBPL and Feni) falling below 2.0x on a sustained basis (FY21: 3.7x)
– Material increase in the counterparty risk;
– Any strengthening of LTLH’s linkages with the parent, CEB.
LIQUIDITY AND DEBT STRUCTURE
Manageable Liquidity Position: The group had LKR15.8 billion of unrestricted cash available at end-March 2021 to meet LKR13.8 billion of debt maturing in the next 12 months. Around LKR3.0 billion of LTLH’s debt maturities in the next 12 months are short-term working capital lines, which we expect it will be able to roll over as they fall due in the normal course of business. We expect the remaining LKR10.0 billion of contractual maturities to be met through internally generated cash and the group’s access to over LKR3.0 billion of unused uncommitted credit lines. We expect banks to stand by these lines because of LTLH’s strong credit profile and stable cashflow generation.
Lakdhanavi is a leading Sri Lanka-based engineering, procurement and construction company. It is involved in the power sectors in Sri Lanka, Bangladesh and Nepal with operations in power generation, O&M services, power plant construction and other ancillary services.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.