OREANDA-NEWS. Fitch Ratings has affirmed India-based hydropower producer NHPC Limited's (NHPC) Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'BBB-'. The Outlook is Stable.

KEY RATING DRIVERS

Stable Cash Flows: NHPC benefits from a favourable regulatory regime, where it is able to pass through to its customers all operational costs, and depreciation and interest costs. A 15.5%-16.5% return on regulatory equity is also built into its tariff structure. The current tariff formula covers the five years from April 2014 to March 2019. NHPC's revenue increased to INR74bn in the financial year ended March 2014 (FY14) from INR64bn in FY13 after four new projects started operation.

Dominant Hydropower Player: NHPC's ratings also benefit from its position as the largest hydropower producer in India with 15.9% of the country's hydropower capacity. It has around 40 years of experience in constructing and operating hydropower projects. Its operations are diversified with 20 projects across seven states, with no project accounting for more than 20% of the capacity.

High Capex: NHPC has a high level of capital expenditure, with 3,290MW of capacity under construction. The company also has 10 projects that are waiting for environmental and forest approvals - five standalone projects with total capacity of 5,115MW and five joint-venture plants with total capacity of 3,536MW. Given the high level of future capex, Fitch expects the company to post negative free cash flows.

Construction Delays: Most hydropower projects are prone to construction delays and cost overruns due to their inaccessible locations. Indian regulations allow 85% of the overruns to be included in the provisional tariff computation. Work at NHPC's 2000MW Subansiri project and 160 MW Teesta Lower Dam IV (TLD IV) has stalled, and the costs of INR12.7bn for both projects were expensed in FY14 and INR4.6bn in 9MFY15. This led to a fall in NHPC's net profits to INR12bn in FY14 from INR26bn in FY13.

The costs expensed for the smaller Teesta Lower Dam IV (INR2bn) will not be included in the computation of regulatory equity. However, the company expects those expensed for Subansiri to be included in the regulatory equity computation because the work stoppage there is akin to a force majeure event; as such, Fitch believes company's cash generation will benefit from this when the project becomes operational. However the long delay in the completion of Subansiri continues to be a concern as the earnings on the project will also be delayed.

Counterparty Risks: NHPC's customers are largely state electricity boards, which have weak financial positions. As most of NHPC's plants are located in the north and north-eastern states, the allocation of power is mostly to these states. The revenue concentration reflects the population density of the states, with the top three customers accounting for around 50% of revenues. NHPC's receivables are secured by the tripartite agreement between the central government, the central bank and the states, which helps it get better recoveries; however, this arrangement expires in October 2016.

At end-December 2014, NHPC's receivables increased to INR30bn from INR24bn at end-March 2014, largely due to the increase in receivables from Jammu and Kashmir state, which accounts for more than a third of the total receivables.

Comfortable Credit Profile: NHPC has a comfortable credit profile with net leverage, as measured by net debt/EBITDA, of around 3.0x (FY14: 3.2x, FY13: 2.9x). Fitch expects that the future capex and subsequent negative free cash flow will lead to an increase in leverage to around 4.0x. The company also enjoys a healthy liquidity position and good access to capital markets and banking relationships. Fitch estimates it had cash of INR69bn at end FY14 (FY13: INR82bn).

Sovereign Linkages: NHPC has moderate linkages with its 86% shareholder, the state of India (BBB-/Stable). The government sets the annual targets and operational parameters of NHPC. Strategic links with the state also stem from NHPC's position as an important player in the hydropower generation sector in India. The state has provided tangible financial support to NHPC, including unsecured subordinated debt of INR23bn at FYE14.

NHPC's stand-alone credit profile is assessed as 'BBB-', reflecting its robust operating and financial profile. However, given the linkages with the state, a one-notch of rating uplift will be provided in the event NHPC's stand-alone credit profile falls below that of India.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- revenues are based on a return on equity of 15.5% and the allowed costs plus incentives
- the plants under construction will be commissioned as scheduled, which will lead to an increase in revenues
- capex will increase over the years because construction at the Subansiri project resumes and some of the projects awaiting approvals are given the greenlight
- profitability will be impacted in FY15 due to the accrual of costs of the stalled projects, and improve thereafter

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include
-An upgrade of the sovereign rating, provided rating linkages with the state remain unchanged
- Given the substantial development capex and associated risks, and the weak customer credit profile, we do not expect an improvement in NHPC's stand-alone credit profile in the next 18-24 months

Negative: Future developments that may, individually or collectively, lead to negative rating action include
- A downgrade of the sovereign rating, as NHPC's stand-alone credit profile is same as that of India currently
- Weakening in NHPC's stand-alone credit profile due to a significant increase in receivables days; unfavourable regulatory developments; net leverage exceeding 4.5x on a sustained basis.

For the sovereign rating of India, the following sensitivities were outlined by Fitch in its Rating Action Commentary of April 11, 2014. The main factors that individually, or collectively, could trigger negative rating action on India include:

- Deviation from the fiscal consolidation path in such a way that it results in continuation of large general government budget deficits.
- A prolonged period of disappointing real GDP growth, for instance in the context of a further deteriorating investment climate.
- A loose macro policy setting that would cause inflationary pressures to persist and/or the current account to widen to such an extent that it would lead to external funding stress.
- Greater-than-expected deterioration in the banking sector's asset quality that would prompt large-scale financial support from the sovereign.

The main factors that individually, or collectively, could trigger positive rating action on India include:

- Sustained fiscal consolidation or fiscal reforms, which lead to a sharp decline in the ratio of gross general government debt to GDP.
- New reform momentum with the implementation of far-reaching reforms that raise the potential growth rate.
- Establishing a credible low inflation environment, for example through the use of a transparent and clear monetary policy framework and tackling structural impediments to lower food price inflation.