OREANDA-NEWS. Fitch Ratings has affirmed India-based GAIL (India) Limited's (GAIL) Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB-'. The Outlook is Stable.

KEY RATING DRIVERS

Comfortable Standalone Credit Profile: GAIL's strong operating profile and robust financial position support a 'BBB' standalone credit profile. These are driven by its dominant market position and regulated utility business, which accounted for 34% of EBIT in the financial year ended 31 March 2015 (FY15) and 60% during in the nine months to end-2015. Fitch expects GAIL's credit profile to remain comfortable over the medium term.

Fitch expects net leverage (net adjusted debt/ EBITDAR) to trend down to below 3x over medium term, although its financial profile may temporarily weaken in FY16 with net leverage deteriorating beyond 3.5x (FY15: 2.8x). GAIL's profitability is likely to improve, primarily due to better margins in its petrochemical business. GAIL's financial profile is also supported by its comfortable liquidity position, with cash balance of around INR17bn as of end-FY15. Fitch does not expect GAIL to make any contribution (FY15: INR10bn) to subsidies for state-owned oil and gas marketing companies that sell petroleum products below market price in the near to medium term.

Dominant Natural Gas Player: GAIL's rating benefits from its dominant position in the Indian gas industry with nearly 70% share of the country's transmission network and more than half of natural gas sales. In FY15, the company transported 92 million standard cubic feet per day (mmscmd) through its network and marketed 72mmscmd. The gas business's share of GAIL's EBIT rose to over 90% in 9MFY16 EBIT, on account of losses in petrochemical business from about 40% in FY15.

Pipeline Tariff Increase: GAIL's Krishna-Godavari Basin (KG Basin) pipeline tariff rose to INR45.3 per million British thermal units (mmbtu) in March 2016 from the INR5.56/mmbtu previously. The revised tariff applies from April 2016 to February 2017. Fitch expects the increase to support a modest improvement in GAIL's revenue and EBIT margin in FY17. GAIL is also expecting the regulator to make decisions on the tariffs of five other pipelines following its appeal against earlier tariff orders. Fitch does not expect any revisions in the tariffs to result in any major downside to earnings in the transmission segment.

Renegotiation of Gas Contract: GAIL in December 2015 renegotiated lower prices for its long-term contract to purchase gas from RasGas. The gas prices in the previous contract resulted in high landed costs for GAIL's liquefied natural gas purchases and resulted in lower volume sales to end-users during 2HFY15 and 9MFY16. Fitch expects the lower renegotiated gas prices and the government's policy of pooling of gas for power plants to support growth in gas transmission volume in FY17 and FY18. Fitch also expects lower feedstock prices to boost profitability of GAIL's largely gas feedstock-based petrochemical business.

Weak Petrochemical Performance: GAIL's petrochemical segment had EBIT losses of INR7bn in 9MFY16, compared with a profit of INR3bn a year earlier. The weak performance was due to higher gas feedstock prices and soft petrochemical product prices, although losses were limited by lower production volumes. Costs in the petrochemical business also rose because capacity expanded during 3QFY16.

Fitch expects profitability for this segment to improve in FY17 because of lower feedstock prices and higher volumes from expanded capacity. GAIL increased its petrochemical capacity by 400,000 tonnes per annum during 3QFY16 while its 70%-owned subsidiary, Brahmaputra Cracker & Polymer Limited, commissioned a new petrochemical plant during 4QFY16. Fitch, however, expects its petrochemical margins to remain depressed in the near to medium term because of weak product prices.

Linkage with Sovereign: Fitch assesses the linkages between GAIL and its largest shareholder (56.1%) - the Indian state (BBB-/Stable) - to be medium to strong. GAIL's IDR is constrained by that of the state because of the state's majority shareholding. GAIL is a strategically important entity given its dominant position in the natural gas industry. As such, should GAIL's standalone credit profile fall below that of India, a one-notch uplift may be provided.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for GAIL include:
- Growth in natural gas transmission volumes by 1%-3% in FY17 and FY18
- Capacity utilisation levels of 60%-70% across the increased petrochemical capacity in FY17
- EBIT margin of the petrochemical business turns positive in FY17 and improves thereafter
- Capex of around INR40bn-INR45bn over the next three years
- No subsidy burden over the next three years (FY15: INR10bn)

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- An upgrade of the sovereign rating provided the rating linkages with the state remain intact.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- A downgrade of the sovereign rating

Future developments that may, individually or collectively, lead to the standalone credit profile being downgraded to 'BBB-' include:
- Weak profitability or large debt-led capex resulting in net leverage of over 3.5x or gross EBITDA interest cover of less than 4x (FY15: 3.8x) on a sustained basis

For the sovereign rating of India, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 7 December 2015.

The main factors that individually or collectively could lead to positive rating action are:
- Fiscal consolidation or fiscal reforms that would cause the general government debt burden to fall more rapidly than expected in the medium term
- An improved business environment resulting from implemented reforms and persistently contained inflation, which would support higher investment and real GDP growth.

The main factors that individually or collectively could lead to negative rating action are:
- Deviation from the fiscal consolidation path, causing the already high public debt burden to deviate further from the median, or greater-than-expected deterioration in the banking sector's asset quality that would prompt large-scale financial support from the sovereign
- Loose macroeconomic policy settings that cause a return of persistently high inflation levels and a widening current account deficit, which would increase the risk of external funding stress.