OREANDA-NEWS. Fitch Ratings has assigned India-based NTPC Limited's (NTPC; BBB-/Stable) proposed senior unsecured notes an expected rating of 'BBB-(EXP)'. The notes are to be issued out of its USD4bn medium-term note programme.

The notes are rated at the same level as NTPC's senior unsecured debt rating as they will constitute direct, unconditional, unsubordinated and unsecured obligations of NTPC. The final rating is contingent upon the receipt of final documents conforming to information already received.

Dominant Market Position: NTPC is the largest power generation company in India, accounting for a fourth of total power generated in the country. Of India's total installed power generation capacity of 288 gigawatts (GW), more than two-thirds is thermal. NTPC accounts for nearly 22% of India's thermal power generation capacity.

Robust Business Model: NTPC's ratings benefit from stable operational cash flows due to the favourable regulatory framework. The company has long-term power purchase agreements (PPAs) for all its plants, which allow for the pass-through of fixed costs as well as fuel costs. Offtake risks are limited as the fixed costs for each plant are payable by the customers if the plant has achieved the regulatory benchmark availability. Its revenue and profit are regulated based on invested capital and a rate of return and incentives under a transparent regulatory model. There is regulatory certainty until March 2019, the end of the latest five-year regulatory tariff period.

New Tariff Block Narrows Profitability: The new tariff block that was effective from April 2014 has affected NTPC's profitability. The new tariff block has maintained the return on equity at 15.5%; however, the lower tax grossing rate and the linkage of incentives to plant load factor (PLF) led to lower profitability. These were partly offset by the benchmark availability rate for fixed-cost pass-through declining to 83% from the earlier 85%, with all of NTPC's plants achieving availability of more than 83% in the financial year ended March 2015 (FY15: 88% and 9MFY16: 91%).

The average PLFs for Indian generation companies have been falling over the last 12 months, driven by lower demand from the distribution entities. NTPC's PLF has fallen to around 78% during 9MFY16 from over 80% in FY15. Only five of NTPC's 17 coal-based plants have PLFs of more than 85% while none of NTPC's seven gas-based plants have PLFs of over 85%.

Weak Counterparties: NTPC has managed its counterparty risks well despite most of NTPC's customers being state utilities with weak financial profiles. The payables are backed by letters of credit equivalent to 105% of average monthly payments and the tri-partite agreement between NTPC, Reserve Bank of India and state governments, which runs until October 2016. The company has signed supplementary agreements with all the state utilities that allow it to have first charge over customers' receivables.

NTPC's strong bargaining position - as the lowest-cost electricity producer and the supplier of a large share of electricity bought by the state utilities - also helps to ensure timely payments. The company has been able to convert 100% of its receivables into cash over the past 12 years.

High Capital Expenditure: NTPC's capex is likely to remain at over INR250bn a year, which will lead to negative free cash flows. The company has incurred capex of INR207.9bn during 9MFY16. The capex risks are mitigated as the company has strong experience in setting up power projects and by its policy of embarking on new projects only once the PPAs, allocated land, environmental clearances, and fuel linkages are in place. The capex is likely to remain high at over INR300bn in FY17 as the company also plans to increase capacity from solar power plants.

In addition, NTPC plans to bid for two ultra-mega power plants - with 4GW capacity each. Fitch has not factored this into its ratings, and will analyse the impact if and when they materialise. Fitch expects NTPC's leverage to remain high around the FY15 levels over the medium term on account of its high capex. The company's net leverage (Net debt/ operating EBITDAR) increased to 4.43x at end-FY15 from 2.97x at end-FY14 driven by its high capex and the bonus debenture issue of INR103bn during the year.

Linkages with Sovereign: Fitch assesses that the linkages between NTPC and the Indian state (BBB-/Stable) are moderate to high, with strategic linkages being especially strong. Based on the agency's parent and subsidiary linkage criteria, Fitch will provide a one-notch rating uplift on the standalone credit profile of NTPC if the company's standalone ratings were to be lower than that of the sovereign, provided that the linkages remain intact.

Fitch's key assumptions within our rating case for the issuer include:
- Revenue is based on a return on equity of 15.5% and the allowed costs plus incentives
- Plants under construction will be commissioned as scheduled, which will lead to an increase in revenue
- Profitability will be in line with that in FY15

Positive: Future developments that may, individually or collectively, lead to positive rating action include
-An upgrade in India's rating to 'BBB'.

Negative: Future developments that may, individually or collectively, lead to negative rating action include
-A downgrade of India's ratings

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.