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

Largest Hydropower Player: NHPC's ratings benefit from its position as the largest hydropower producer in India with about 15% of the country's hydropower capacity. It has around 40 years of experience in constructing and operating hydropower projects. Its portfolio is diversified with 20 operational projects across seven states, with no plant accounting for more than 20% of its total operating capacity.

Stable Cash Flows: NHPC does not have any offtake risks as it has long-term power purchase agreements for all of its power plants. The group benefits from a favourable regulatory regime within which it is able to pass through to its customers all of its costs - operational, financial and depreciation. A 15.5%-16.5% return on regulatory equity is built into its tariff structure, along with incentives on exceeding the normative availability factor. The current tariff formula covers five years from April 2014 to March 2019.

High Capex: NHPC's capex will remain high with 3,290MW of hydro-based capacity under construction. The company also has nine hydropower projects that are waiting for environmental and forest approvals - five standalone projects with total capacity of 4,995MW and four plants under joint-ventures/subsidiary with total capacity of 2,186MW. NHPC is also pursuing solar, wind and thermal-based power projects. Given the high level of future capex, Fitch expects the company to post negative free cash flows.

Construction Delays: Most hydro projects are prone to construction delays and cost overruns due to, among other things, their inaccessible locations and protests. Work at NHPC's 2,000MW Subansiri project has been stalled since December 2011. Work at its 160MW Teesta Lower Dam IV (TLDP-IV) was suspended from March 2013 to October 2014. Indian regulations allow prudent cost overruns to be included in the provisional tariff computation, and capitalisation of non-controllable costs incurred - from 4Q of the financial year ending March 2015 (4QFY15). NHPC's FY14 and 9MFY15 profitability was reduced mainly because of the expensing of costs related to these stalled projects.

The costs expensed for TLDP-IV may not be included in the computation of regulatory equity. However, the company expects those expensed for Subansiri to be allowed for regulatory equity computation because the work stoppage there is akin to a force majeure event. Fitch expects the company's cash generation to improve once the project becomes operational. However, the long delay in the completion of Subansiri continues to be a concern as the earnings from the project will also be delayed.

Counterparty Risks: NHPC suffers from poor receivables as more than half of its capacity is allocated to the unprofitable state-owned distribution companies. Most of NHPC's plants are in the north and north-eastern states, so the allocation of power is mostly to these states. At end-December 2015, the receivables increased to INR33.5bn from INR24.6bn at end-March 2015, largely due to the rise in dues from Jammu and Kashmir (J&K), which accounts for around half of the total receivables.

The company is, however, making progress in recovering its dues. NHPC had cut off power supply to its customers on many occasions, and sold the power in the spot market to reduce its receivables and enable faster recovery. In 9MFY16, it recovered INR6.4bn from J&K and expects to receive more with the help of Ministry of Power. NHPC's receivables are secured through letters of credit and a tripartite agreement (due to expire in October 2016) between the central government, central bank and states.

Comfortable Credit Profile: NHPC's net leverage, as measured by net debt/EBITDA, was 2.3x at FYE15 (FYE14: 3.2x, FY13E 2.9x). Fitch expects that the future high capex and consequent negative free cash flows will lead to an increase in leverage to only 2.7x by FYE17. The company has a healthy liquidity position with ready access to capital markets and banks. Fitch estimates NHPC also had readily available cash of INR77bn at FYE15.

Moderate Sovereign Linkages: NHPC has moderate linkages with its 86% shareholder, the state of India (BBB-/Stable). Strategic linkages with the state stem from its position as an important player in the hydropower generation sector in India. The government sets the annual targets and operational parameters of NHPC. The state has provided tangible financial support to NHPC, including unsecured subordinated debt of INR27bn as at FYE15. NHPC's standalone credit profile is assessed at 'BBB-', reflecting its robust operating and financial profile. Should NHPC's standalone credit profile fall below that of India, the company will benefit from a one-notch of rating uplift due to its state linkages.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for NHPC include:
- Revenues are based on allowed costs, a return on equity of 15.5%-16.5% and normalised incentive income
- 160MW TLDP-IV, 330MW Kishenganga and 800MW Parbati II to start commercial operations as scheduled.
- High capex, which also reflects expected resumption of construction at the Subansiri project and construction of other projects following expected receipt of their approval.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- An upgrade of the sovereign rating, provided NHPC's 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 standalone ratings 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
- Weakening in NHPC's standalone credit profile due to a significant increase in receivable days; unfavourable regulatory developments; net leverage (net debt/EBITDA) exceeding 4.5x on a sustained basis.

However, should NHPC's standalone credit profile fall below that of India, the company will benefit from a one-notch of rating uplift due to its state linkages.

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

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- 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 read GDP growth

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- 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.