Fitch Ratings has affirmed India-based port operator Adani Ports and Special Economic Zone Limited’s (APSEZ) Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘BBB-‘. The Outlook is Stable. A full list of rating actions is at the end of this commentary.
The affirmation reflects Fitch’s view that the Hindenburg report alleging governance issues at the Adani group has a limited near-term impact on APSEZ’s cost of funding and access at the current rating level.
We expect APSEZ’s financial flexibility to remain supported by its robust portfolio of seaports, which comprises strategically located assets with best-in-class operational efficiency and an adequate liquidity position. APSEZ’s internal cash surplus is sufficient to cover its near-term operations and debt obligations as well as its budgeted capex.
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About half of APSEZ’s cargo is sticky, which includes contractual take-or-pay cargo, cargo that is unlikely to be diverted to other ports due to infrastructure restrictions, such as the lack of facilities to handle crude oil, and cargo from joint-venture partners. APSEZ has timing flexibility in its expansion projects. Management has budgeted capex of about INR40 billion-45 billion for the year ending March 2024 (FY24), but this could be restricted to maintenance capex of about 10% of total capex budgeted.
Nevertheless, governance weaknesses at the sponsor level and other Adani group entities – including highly concentrated shareholding structures across group entities and aggressive debt-funded investments at some entities – expose even the group’s robust cash-generative businesses such as APSEZ to higher contagion risks, which could affect financial flexibility. We have revised the ESG assessment for Governance Structure and Group Structure for APSEZ to ‘4’ from ‘3’. Fitch’s governance assessment, along with India’s (BBB-/Stable) Country Ceiling of ‘BBB-‘, now constrains APSEZ’s rating at ‘BBB-‘. The company’s financial profile is stronger than that commensurate with a ‘BBB-‘ rating.
KEY RATING DRIVERS
Best-in-Class Port Operator – Revenue Risk (Volume): Stronger
APSEZ handled a quarter of India’s seaborne cargo in 9MFY23 through the 12 ports it operates. Most are primary ports of call in their regions. Its flagship Mundra Port is the gateway to north-western India. Traffic is mainly origin and destination, with limited transshipment cargo. APSEZ’s advanced transport infrastructure, operational efficiency and integrated logistics solutions, which transport cargo from its ports to its inland depots via railways, have resulted in market share gains and faster organic throughput growth than its peers and India’s economic growth.
Cargo that is difficult to switch to other ports makes up about half of total throughput. APSEZ continues to diversify its throughput from the west coast, with its east-coast terminals of Gangavaram, Krishnapatnam, Dhamra, Kattupali and Ennore accounting for 40% of total throughput. The company’s expanded logistics business covers all of India and it has built multimodal logistics for warehousing, rail transportation and distribution. Its logistics business now operates 87 railways and includes container, auto, grain and bulk rakes under the general-purpose wagon investment scheme.
Flexibility in Modifying Tariffs – Revenue Risk (Price): Midrange
APSEZ’s portfolio is mainly private ports, which have the freedom to fix their own tariffs. These are generally higher than at other Indian ports, but this is justified by APSEZ’s better operational efficiency and connection with the hinterland, which lowers shippers’ overall logistics costs, according to management.
The company’s take-or-pay contracts accounted for about 12% of port revenue in FY22, with a revenue-weighted remaining contract term of 16 years. Take-or-pay contracts insulate revenue from throughput volatility. The assessment is constrained to ‘Midrange’ due to regulated tariffs at certain ports, although their contribution to the group’s EBITDA is minimal.
Internally Funded Capex – Infrastructure Development and Renewal: Stronger
APSEZ’s capacity is sufficient to support medium-term throughput growth. However, the company plans to further upgrade its infrastructure, diversify its cargo mix and expand its logistics business. The plan includes the upgrade of its ports, and the addition of warehousing and bulk rakes for its logistics business. However, most of this is discretionary capex, which the company can postpone without a major impact on its operations.
Fixed-Rate Bullet Bonds Dominate – Debt Structure: Midrange
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APSEZ’s consolidated debt comprises mainly US dollar and Indian rupee bullet bonds. We expect its business strengths, established capital-market access and relationships with banks to mitigate refinancing risk. APSEZ also has limited exposure to floating interest rates due to its use of fixed-rate bonds and bank loans. The bonds do not benefit from restrictive financial covenants or reserve accounts and the company relies on natural hedging to manage foreign-exchange risk. Nearly a third of its revenue is in US dollars, which should be sufficient to cover its US dollar debt servicing.
ESG – Governance Structure and Group Structure: Fitch has revised the ESG Relevance Score for Governance Structure and Group Structure to ‘4’ from ‘3’ to reflect governance weaknesses at the sponsor level and other Adani group entities.
We expect low contagion risk on APSEZ, if any, from the Indian securities regulator’s investigation, and will treat any material adverse development with a higher-than-expected impact on APSEZ’s financial flexibility as an event risk. In the longer term, maintaining strong access to financing and cost of funding will be key drivers for APSEZ’s ratings.
The Fitch base case (FBC) assumes about 10%-12% annual growth in cargo volumes and around 3% to 5% annual growth in tariffs over the next few years. Fitch expects an EBITDA margin of about 60% over the period. We assume capex of INR50 billion-60 billion per annum in the FBC, and cash outflow from acquisitions at 25% of FY23’s outflow annually starting FY24. Our base-case debt/operating EBITDA remains high at about 4.5x in FY23 before reducing to less than 4.0x in FY25.
The Fitch rating case (FRC) assumes a 10% haircut from the FBC’s cargo and volume growth percentage, an additional 2pp stress on the EBITDA margin, a 10% stress on the FBC’s capex, and similar cash outflow assumptions for acquisitions. The rating-case debt/operating EBITDA remains high at about 4.6x in FY23 and FY24 before reducing to around 4.0x in FY26.
We think APSEZ is most comparable with JSW Infrastructure Limited (JSWIL, BB+/Stable). Both JSWIL and APSEZ have diverse portfolios and similar debt profiles with limited protective features. However, APSEZ benefits from a more diverse cargo and counterparty mix, larger scale of operations, and a bigger portion of cargo throughput with long-term cargo contracts than JSWIL. APSEZ’s rating is however constrained by its ESG assessment and India’s Country Ceiling. We therefore assessed APSEZ a notch higher than JSWIL, despite a much stronger business profile.
Port of Melbourne (issuing entity Lonsdale Finance Pty Ltd: BBB/Stable) is the primary port of call in the state of Victoria and serves Australia’s broader market with limited competition. Its rating benefits from a diversified landlord port business model, long concession life and low infrastructure development and renewal risk. However, it is much smaller in operational scale than APSEZ and its average net debt/EBITDA of 8.8x under Fitch’s rating case is higher than APSEZ’s 4.6x. Nevertheless, its stronger qualitative attributes support the higher leverage, resulting in the ‘BBB’ credit assessment.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– Prolonged deterioration in the FRC debt/EBITDA to above 6.0x;
– Evidence of material contagion risk from adverse developments at the sponsor level and other group entities, resulting in significant impairment of financial flexibility and/or the financial profile of APSEZ;
– Lowering of India’s Country Ceiling to ‘BB+’.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
– A revision of India’s Country Ceiling to ‘BBB’, provided risk to APSEZ’s credit profile from the Adani group’s governance-related issues recedes materially.
Best/Worst Case Rating Scenario
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance
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APSEZ handled about 24% of India’s total cargo volume in 9MFY23, with Mundra continuing as the largest container handling port. Cargo throughput increased by 19% yoy while revenue rose by 16% after the consolidation of revenue from Gangavaram Port, which was previously an associate of APSEZ. Excluding Gangavaram Port, APSEZ’s cargo throughput revenue increased by 7% yoy, in line with the cargo throughput increase. Mundra and Krishnapatnam Port contributed the highest cargo growth, driven by coal (14% yoy) and containers (5% yoy).
In 4QFY23, APSEZ completed the acquisition of a controlling interest in Haifa Port in Israel and a joint-venture stake in Indian Oiltanking Ltd, the country’s third-largest third-party liquid tank storage company. Management expects FY23 capex to be around INR86 billion, mainly for the capacity expansion of its existing ports. Its cash balance and cash flows from operations are adequate to cover its current debt obligations for both financial years.
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.
PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS
APSEZ’s ratings are capped by India’s Country Ceiling along with governance issues at the sponsor level.
APSEZ has an ESG Relevance Score of ‘4’ for Governance Structure due to the complexity of its group structure at the shareholder level, which has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.
APSEZ has an ESG Relevance Score of ‘4’ for Group Structure due to the concentration of ownership, with a large majority stake indirectly held by Adani Group, which has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.
Source: Fitch Ratings