S&P: Vedanta Resources Outlook Revised To Positive On Expected Improvement In Operating Performance; 'B' Rating Affirmed
"We revised the outlook to reflect our expectation that Vedanta Resources' operating performance will improve on higher metal prices and the company's continuing ramp-up of its aluminum operations," said S&P Global Ratings credit analyst Mehul Sukkawala.
The outlook revision also reflects our view that the company's financial flexibility will improve on better financial performance and the expected merger of Vedanta Ltd. and Cairn India Ltd. We believe this will help reduce refinancing risks for Vedanta Resources.
We expect the operating performance of Vedanta Resources, the ultimate holding company, to consistently improve over the next six to nine months resulting in EBITDA of well above US$3 billion in fiscal 2017 (ending March 31, 2017). The recent improvement in metal prices, especially zinc, will partly support this improvement. On Aug. 26, 2016, we raised our metal prices for zinc by about 40% for the remaining period of 2016 and by about 25% for 2017. We also marginally raised our price expectation for aluminum and iron ore. In addition, the company will also benefit from better operations, in our view. It continues to ramp up its aluminum operations having completed the full ramp-up for its Balco smelter (in the Indian state of Chhattisgarh) and plans to start ramping up the third potline at its Jharsuguda plant (in the Indian state of Odisha).
Higher commodity prices will also help accelerate the improvement in Vedanta Resources' financial performance, in our view. We now expect the company to register funds from operations (FFO) to cash interest cover of well above 2x and FFO to debt of almost 12% in fiscal 2018. This reflects the expected strengthening in financial performance from the very weak levels of 1.5x and 4%, respectively, in fiscal 2016. We calculate our financial ratios on a proportionate consolidation basis to reflect the company's current organizational structure. The improved operating performance more than offsets acceleration in capital expenditure especially at its international zinc operations.
We also expect Vedanta Resources' financial flexibility to improve over the next six to nine months. In addition to improvement in operating and financial performance, the company will also benefit from the expected merger of its majority owned subsidiary Vedanta Ltd. with Cairn India (Vedanta Ltd.'s majority owned oil and gas company). This will result in a significant jump in free operating cash flow generation at Vedanta Ltd. as well as easier access to more than US$3 billion in cash and cash equivalents at Cairn India, even though Vedanta Resources' financial ratios will remain largely unchanged. The company also currently benefits from better access to financial markets as reflected by the significant improvement in its bond yields and its good banking relationships, especially with Indian banks. This is important considering the company has bank loan maturities of US$1 billion at the Vedanta Resources holding company due in fiscal 2018 and about US$2 billion bond maturities and an additional US$500 million in bank loan maturities in fiscal 2019.
The positive outlook reflects our expectations that Vedanta Resources' operating and financial performance will improve over the next six to nine months with higher commodity prices as well as continuing ramp-up of aluminum operations.
"We also factor in our expectation of better financial flexibility post the completion of the Cairn India and Vedanta Ltd. merger," said Mr. Sukkawala.
We could raise the rating if we expect Vedanta Resources' FFO cash interest cover to be 1.75x or more. This could mean consolidated EBITDA of about US$3 billion or more. In addition, the company should have adequate financial flexibility to proactively manage its refinancing risk over the next 12-18 months.
We could revise the outlook to stable if the improvement in the company's operating performance is significantly weaker than our expectations, resulting in FFO cash interest cover of not above 1.75x over the next 12 months. This could happen if commodity prices decline significantly.
We could also revise the outlook to stable if the company's financial flexibility weakens and this increases its refinancing risk. This could happen on account of factors such as: (1) a challenging operating environment and financial market; or (2) the company is not able to complete the merger between Vedanta Ltd. and Cairn India.