September, 14, 2022
Fitch Ratings - Colombo - 14 Sep 2022: Fitch Ratings has downgraded Sri Lanka-based Resus Energy PLC's National Long-Term Rating to 'A(lka)', from 'A+(lka)'. The Outlook is Negative. Fitch has simultaneously downgraded the National Long-Term Rating of Resus's outstanding senior unsecured debentures to 'A(lka)', from 'A+(lka)'.
The downgrade follows our expectation that Resus's financial flexibility will deteriorate, undermined by a steep rise in funding costs and working capital stress, which will weaken its credit metrics and liquidity, respectively. We calculate that Resus's substantial variable-rate debt exposure will see its EBITDA interest cover drop to around 1.5x in the financial year ending March 2023 (FY23), from 3.4x in FY22, following the steep hikes in domestic interest rates.
The Negative Outlook reflects risks caused by continued payment delays by Resus's sole counterparty - Ceylon Electricity Board (CEB, AA-(lka)/Stable). The delays have tightened Resus's liquidity and elevated its refinancing risks, although we expect liquidity to improve once CEB's payments normalise following a consumer tariff hike in August 2022. Near-term liquidity should be further supported by Resus's plans to avail of a moratorium for part of its debt under the central bank's relief scheme for borrowers in select industries.
Steep Interest Rate Hikes: Sri Lanka's average prime lending rate surged to 25.3% by end-August 2022, from 9.5% at end-March 2022, impacting Resus's borrowing costs and weakening its credit metrics. The aggressive tightening by the central bank, with policy rates increasing by 800bp since end-March, followed the country's rapid economic deterioration amid weakening external finances, acute currency depreciation and high inflation.
Large Variable Rate Exposure: Approximately 65% of Resus's debt outstanding was variable rate at end-1QFY23. The variable rate exposure could dampen the company's cash flow, as we do not expect interest rates to ease in the near-term owning to persistent inflationary pressure and weak external finances.
Weakening Liquidity on Delayed Payments: Liquidity has plummeted amid worsening working capital, with receivables from CEB reaching 293 days at end-1QFY23 (FY21: 152 days). The payment delays at CEB stem from its diminished financial profile due to the absence of a cost-reflective tariff structure. That said, cash flow from CEB should improve in 2HFY23 following the August 2022 tariff hike, helping to ease Resus's liquidity pressure.
However, the improvement in receivables is likely to be gradual, given CEB's billing cycle and large outstanding financial obligations. Our rating-case forecasts Resus's receivable days to improve to 210 in FY23 and 150 in FY24. We also believe energy-price reforms - likely a key component of the sovereign's fiscal restructuring - can boost CEB's financial profile over the medium term, though implementation risks remain.
Interest Cover to Decline: We expect higher financing costs to weaken Resus's EBITDA interest coverage to 1.4x by FY23 and for coverage to remain below 2.0x over the next few years. Resus's financing costs reached LKR85.2 million 1QFY23, representing a 120% year-on-year rise, and are likely to continue climbing as maturing debt is refinanced at higher interest rates. Our rating case assumes Resus's effective interest rate will increase to 18.2% in FY23, from 6.3% in FY22.
Delayed Capex to Support Leverage: We expect Resus to maintain net leverage at around 3.8x in FY23 (FY22:4.4x) in the absence of major expansion. Resus is likely to defer the construction of a 5 megawatt (MW) solar power plant in Sri Lanka's Ampara district owning to the challenging operating environment. We project investment outflow to rise in FY24 as Resus commences construction of the deferred project. This is likely to see leverage reach 4.5x, but this remains below our negative rating trigger of 5.5x.
PPAs Limit Financial Flexibility: Resus's generation capacity is fully contracted under long-term power-purchase agreements (PPAs) with CEB, Sri Lanka's monopoly electricity transmitter and distributor. The PPAs provide earnings visibility, but pre-determined tariffs with limited room for escalation limit Resus's EBITDA generation capacity and the ability to manage higher debt servicing costs in the current challenging economic environment.
Small Scale: Resus's scale will stay small, even when installed capacity reaches 29MW with the implementation of projects in the pipe line. Resus accounted for only 0.4% of Sri Lanka's installed power capacity and generation at end-FY22, and we do not expect a significant improvement in the next few years, despite the capacity additions. We also believe the small scale could affect Resus's bargaining power with counterparties and ability to secure timely payments compared with larger power generators.
Fitch rates Resus multiple notches below domestic power producer and engineering, procurement and construction contractor, Lakdhanavi Limited (AA-(lka)/Stable), due to latter's large operating scale as well as geographic and business diversification. Lakdhanavi's exposure to counterparty risk stemming from its exposure to CEB is mitigated by the cash flow it receives from the Bangladesh Power Development Board, which is owned by the government of Bangladesh (BB-/Stable); this cash flow comprises around 35% of gross profit. We believe CEB will prioritise operation and maintenance payments to Lakdhanavi, as it maintains one of the country's largest power plants. Lakdhanavi also maintains a comfortable liquidity position with a strong cash balance.
We rate leading consumer durables retailer, Singer (Sri Lanka) PLC (A+(lka)/Negative), one notch above Resus to reflect its low exposure to the sovereign and large operating scale. Singer has navigated through the challenges posed by Sri Lanka's deteriorating operating conditions - including weakening demand on low disposable incomes, difficulties in importing raw materials and finished goods as well as rising interest rates - by building sufficient inventory and passing on cost escalations to retain margins. However, Singer's rating may come under pressure if persistent import bans affect its core operations.
Resus is rated at the same level as domestic homebuilder, Home Lands Skyline (Pvt) Ltd. (HLSL, A(lka)/Stable), due to the latter's limited operating history and sales record, which could lead to execution risks with its expanding portfolio. HLSL is also exposed to Sri Lanka's weakening economic conditions, which could lower demand for housing, challenge receivable collections and delay construction. However, the company's low leverage mitigates some of these risks, while its wide customer base, which is more granular than that of Resus, mitigates counterparty risk.
Fitch's Key Assumptions Within Our Rating Case for the Issuer:
- Revenue to rise by 16% in FY23 after 7MW in solar capacity comes online (FY22: 26%)
- EBITDA margin of 83% in FY23 (FY22:83%)
- Weighted average interest rate of 18% in FY23 (FY22: 6%)
- Receivable days of 210 in FY23 (FY22: 219)
- Capex of LKR15 million in FY23 in the absence of project construction, rising to LKR1 billion in FY24 on the construction of a 5MW solar power project
- No dividend payments for FY23, except for the already declared dividend
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- An improved counterparty risk profile, reflected in timely payments, could lead to the Outlook being revised to Stable
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- Further deterioration in liquidity due to delayed receivables or challenges in refinancing
- Net debt/EBITDA at above 5.5x for a sustained period
- Coverage, defined as EBITDA/interest paid, below 1.5x for a sustained period
Reliance on External Financing: Resus's readily available cash of LKR115 million at end-1QFY23 and unutilised credit facilities of LKR59 million was insufficient to cover short-term debt of LKR321 million and the current portion of long-term debt of LKR383 million. We expect the banks to revolve the working capital obligations considering the potential resumption of payments from CEB amid the tariff hike.
The planned capital deferment under the banks' debt moratorium schemes will ease liquidity requirements in terms of contractual maturities, with remaining contractual maturities likely to be financed by a mix of short-term fund facilities from banks and commercial paper. Resus expects payments from CEB in the range of LKR300 million in next three months, which will further support its liquidity position.
Resus is a small power producer in Sri Lanka with an expanding portfolio of assets. The company had installed capacity of 17MW as at March 2022, spread across hydro (15MW) and solar (2MW).
The principal sources of information used in the analysis are described in the Applicable Criteria.
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