GMR has recovered airport capital spending

S&P Global Ratings expects GMR Hyderabad International Airport Ltd’s (GHIAL) healthy cash reserves and good operating performance to provide sufficient buffer amid regulatory uncertainties over the next two to three years.

Based on these performances, the rating group has affirmed ‘BB+’ rating with stable outlook on 20 Mar 2019.

The continuing delay in the implementation of the lower “control period 2” (CP2) tariff will allow the company to increase its cash reserves, helping to de-risk its upcoming spending plans.

“In our view, the regulatory mechanism still results in reasonably predictable cash flows for GHIAL over the five-year regulatory period, despite interim tariff volatility due to delayed regulatory resets.

“This is because we believe that the tariff mechanism will allow for the eventual recovery of costs, capital spending, and returns, as well as a “true up” mechanism that ensures target revenue levels if traffic volumes are lower-than-anticipated.

“Unlike in other countries with more established regulatory regimes such as Australia or Hong Kong, recovery of costs and returns in India is not uncertain,” S&P pointed out.

The timing of regulatory decisions remains the key hindrance in realizing a fully supportive regulatory framework in India. For GHIAL, this has translated into strong leverage ratios in the past three years.

This is because the company has effectively recovered its earlier capital spending, resulting in ratios that have been better than our estimates.

“As the company pursues its next phase of expansion, we now envisage a temporary weakening in leverage ratios to potentially below our downgrade trigger,” said the rating agency.

Nevertheless, S&P expect that over a five-year regulatory block, leverage will remain broadly within its rating threshold.

S&P estimate GHIAL’s leverage will materially increase over the next three years, as a result of higher capital spending and the likely drop in tariff following the upcoming reset.

“We project the company’s ratio of funds from operations (FFO) to debt to fall sharply to 8%-9% by fiscal 2021 (year ending 31 March 2021), from about 30% in fiscal 2018,” it said.

The decline will be driven by GHIAL’s increased spending of up to Indian rupees 60 billion over the next three years, as the airport increases its capacity.

At the same time, S&P expect the regulator to reset the company’s tariff at 50% lower than the current levels in the implementation of the CP2 tariff (April 2016-March 2021). It now expects that CP2 could come into effect by September 2019, from earlier estimates of April 2019.

We believe that the eventual tariff drop in CP2 will increase GHIAL’s dependency on the timely implementation of the subsequent control period 3 (CP3) tariff (April 2021-March 2026) to support its financial ratios. This is because more than 70% of GHIAL’s upcoming spending plans will only be recovered under the CP3 tariff, which we expect will be higher than CP2.

A prolonged delay in the CP3 tariff reset could thus result in a mismatch of the company’s actual spending and its eventual recovery, which could pressure cash flows and leverage.

Nevertheless, S&P believes the ongoing delay in the CP2 tariff could help de-risk some of GHIAL’s upcoming large capital spending plans. That’s because the company continues to charge its higher control period 1 (CP1) tariff (April 2011-March 2016) of Rs.420 per passenger, which has allowed it to accumulate over-recoveries of about Rs.10 billion.

This amount will add to GHIAL’s cash balance of almost Rs.13 billion (as of 30 Sept 2018) and will contribute to supporting its capital spending.

In S&P opinion, the tardiness in tariff resets stems not just from the less-established nature of the regulator. Given the negative direction of the CP2 tariff reset, GHIAL has also strategically used regulatory contentions to prevent the regulator from implementing a lower tariff earlier.

“Therefore, despite a track-record of delayed resets, we see a higher likelihood of CP3 tariff being set and implemented in a more timely manner. We believe the company will likely litigate regulatory contentions separately to pursue a higher CP3 tariff more efficiently,” said S&P in a release on 20 Mar 2019.

The stable outlook reflects S&P’s view that GHIAL will manage the execution risks on its enlarged capital spending plans and have strong passenger growth.

It expects the company’s ratio of FFO to debt to be above 9% and FFO cash interest coverage to be more than 2.0x over the next 12-24 months. It also assumes that the company’s working capital will not come under sustained pressure owing to delayed payments from Indian airlines.

“We could lower the rating if we expect GHIAL’s ratio of FFO to debt to be less than 9% on a sustained basis. This could occur if tariff delays or disputes result in inadequate returns on investments or costs are not recovered,” S&P pointed out.

Significantly higher capital spending than anticipated or cost overruns could also lead to a downgrade. CP2 tariff that is significantly lower than S&P expectation, or a delay of more than one year in the implementation of CP3 tariff could also lead to downward pressure on the rating.

“We are unlikely to upgrade GHIAL in the next 12-18 months,” the rating agency added.

However, S&P may raise the rating if the company’s exposure to regulatory uncertainties diminishes sufficiently such that the company can sustain a ratio of FFO to debt of more than 18%. This would be predicated on a record of timely tariff resets and strong passenger growth, resulting in greater stability and predictability of GHIAL’s cash flows, it said. fiinews.com