Debt build-up at Volcan could derail Vedanta's deleveraging plan: Ind-Ra

Parent firms lean heavily on dividends from Vedanta to service their own loans, creating a cash crunch in the subsidiary.

India Ratings and Research (Ind-Ra) believes a further leverage build up at Vedanta Limited’s ultimate parent Volcan Investments Ltd (Volcan) could potentially derail Vedanta’s deleveraging plan. As of March 2019, Vedanta is 50.1 percent held by Vedanta Resources Plc, which in turn is wholly-owned by Volcan.

Vedanta Resources and Volcan are largely dependent on dividend income from Vedanta and its operating subsidiary Hindustan Zinc Limited to meet their debt servicing requirement. This results in major cash leakages for Vedanta, due to the presence of minority shareholders and dividend distribution taxes. Vedanta Resources had total debt of about $6.4 billion at end-March 2019, with limited operational cash of its own to service the debt.

Ind-Ra does not expect Vedanta to provide any additional support to Volcan beyond the dividend pay-outs already factored in by the agency, including funding any stake acquisition in Anglo American Plc. While Cairn India Holdings Limited (CIHL), a wholly-owned foreign subsidiary of Vedanta, had invested in Volcan through a structured transaction in FY19, the management has reiterated to the agency that there will be no further participation in any financial transaction with Volcan and the said transaction will unwind on their maturity dates. A higher-than-anticipated support, including any funding to support acquisition of Anglo American’s voting rights shares, will lead to negative rating action.

In the last annual rating review, the agency forecasted Vedanta’s net adjusted leverage to reduce and remain in the range of 2.5x-3.0x. However, the potential leverage build up at the parent entities necessitating large dividend outflows may deter Vedanta’s deleveraging plan. 

Vedanta’s net adjusted leverage of 3.3x in FY19 was higher than Ind-Ra’s estimate of below 2.5x, on account of the lower-than-expected operating profits and the higher-than-expected dividend and acquisition outflows. Ind-Ra has considered Vedanta’s consolidated debt including operational buyer’s credit and Vedanta Resources’ debt to arrive at the consolidated debt.

Volcan has 3.5 billion pounds of mandatorily exchangeable bonds (MXBs) with a coupon of 3.875-4.15 per cent (to be paid half-yearly). The MXBs are mandatorily exchangeable for the underlying Anglo American’s shares on maturity, subject to the option by Volcan to repay cash in lieu of delivering shares to investors. The voting rights and the option to purchase the underlying shares with Volcan, implies a risk of further leveraging at the parent entities or a likely corporate event. The agency will continue to monitor the incremental issuances of MXBs or any related corporate event, and the resultant impact on Vedanta’s liquidity and leverage.

In FY19, Cairn India Holdings purchased an economic interest in Anglo American shares held by Volcan through a structured investment for GBP428 million. The ownership of the underlying shares and the associated voting interests remain with Volcan. This structure matures in parts in April 2020 and October 2020. Cairn India has paid a portion of this investment at end-March 2019; the agency expects the balance amount of 232 million pounds to be paid in FY20.