Fitch Ratings has today affirmed the UK-based metals and mining company Vedanta Resources PLC's (Vedanta) Long-term Issuer Default Rating (IDR) at 'BBB-' with Negative Outlook. Fitch has also affirmed Vedanta's USD500m and USD750m senior unsecured unsubordinated bonds due January 2014 and July 2018, respectively, and its USD600m senior unsecured bonds due February 2010 at 'BB+'. This rating action follows the company's announcement of a revival of the earlier deferred 1,980MW power project at its subsidiary, Sterlite Energy Ltd (SEL), which would increase capex by USD2.1bn over the next three years.
The ratings reflect the company's sizable cash balances and low net debt levels of USD1bn for the half year ended 30 September 2009. However, total debt has risen significantly - by around USD1.8bn from FY09 - primarily in the form of fresh debt for capex at subsidiaries, and through convertible bonds at the parent level. After H1FY10, the company raised a further USD1bn of convertible bonds at subsidiaries.
The earlier planned USD2.6bn acquisition of US-based Asarco is no longer likely, although the impact is offset by the additional investment in the revived power project, and a further USD500m in a new 400kta custom copper smelter with captive power at its subsidiary, Sterlite Industries India Ltd. Vedanta plans to invest a total of around USD10.5bn over FY10-FY13 of which USD1.8bn has already been spent in H1FY10, with the largest investments in FY10 and FY11.
The Negative Outlook reflects the substantial execution risk given ongoing capex. With higher capex slated for FY10 and FY11, the extent of deterioration in the company's leverage will be higher than anticipated during the agency's last review in July 2009. Fitch believes that Vedanta's gross debt/EBITDA could rise well beyond the earlier expected 3x-3.5x in FY10 if earnings do not significantly improve over H2FY10. Also, the extent of the company's de-leveraging from FY11 will be moderated by additional capex, which will result in higher-than-expected negative free cash flows. Any improvement in credit metrics would be a result of earnings improvements rather than gross debt pay downs. Ongoing sizable negative free cash flows over FY10 and most of FY11 remain a concern.
The company's performance over H1FY10 has been mixed across its businesses, although overall earnings growth has been positive, primarily due to the benefits of higher prices of zinc, copper and aluminium. The majority of the earnings growth has come from zinc, although the extent of benefit has been limited by the slight increase in operating costs due to higher input prices. EBITDA from the copper business has grown due to better performance at subsidiary KCM. These positives have, however, been offset by the decline in earnings from iron ore due to lower prices and lower volumes in Q2FY10 as a result of the monsoons. Margins for H1FY10 were at 25%, in line with Q4FY09. For H1FY10, the company reported revenues of USD2.99bn, and an EBITDA/ interest (excluding capitalised interest) of 7.1x.
However, with increased volumes from capex, and higher metal prices expected for H2FY10, Fitch expects the company's earnings to improve. The extent of earnings growth will be driven by Vedanta's ability to achieve target output levels from new plants and improvements in operating costs. The current ratings remain contingent on the company's ability to realise these benefits over the near term.
Fitch notes that lower or delayed returns from capex would act as negative rating triggers. Sustained gross debt/EBITDA above 2x from FY11 onwards would trigger a downgrade. The company's ability to de-lever over the medium term could be limited by its sizable gross debt levels; consequently materially higher gross leverage (beyond 3.5x for FY10) could also trigger a downgrade.
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