Vedanta Resources Ltd. Downgraded To 'B-' On Weaker Liquidity Indicators; Outlook Stable

  • We expect Vedanta Resources Ltd.'s liquidity over the next one to two years to be weaker than we had previously expected due to lower commodity prices and the recent volatility in the capital markets.
  • The expected improvement in Vedanta Resources' operating performance, such as product volumes and cost position especially in aluminum, is unlikely to be fully realized in the next 12 months due to likely lower product prices.
  • On March 24, 2020, S&P Global Ratings lowered its long-term foreign currency issuer credit rating on Vedanta Resources and its long-term issue rating on the U.S. dollar-denominated senior unsecured notes the company issued or guarantees to 'B-' from 'B'.
  • The stable outlook reflects our view that the India-based commodities producer will address debt maturities, despite increased funding challenges.
SINGAPORE (S&P Global Ratings) March 24, 2020--S&P Global Ratings today took the rating actions listed above. We lowered the ratings because we expect Vedanta Resources' liquidity to weaken over the next 12 months due to a challenging refinancing environment and volatility in commodity prices. In particular, the sources of funds at the Vedanta Resources level are likely to be significantly lower than the expected uses. We also expect the company's earnings growth to be slower over the next 12-24 months compared with our earlier forecast, due to lower commodity prices. Most of the improvement is likely only in fiscal 2022 (year ending March 31, 2022). The downgrade incorporates our revised metal price assumptions dated March 18, 2020, and revised oil price forecasts dated March 19, 2020.
Vedanta Resources' capital structure and corporate structure contribute to the downgrade, especially amid the currently volatile commodity and capital markets. Debt at Vedanta Resources--the holding company--is high at around US$7 billion currently. And the likelihood of dividends from subsidiaries increasing meaningfully from current levels in the coming quarters is low due to lower commodity prices. This makes access to capital markets paramount for the company. We also expect Vedanta Resources' dependence on dividends from subsidiary Hindustan Zinc Ltd. to increase in 2020. That's given a likely material weakening in cash flow from the oil business as we expect Brent crude to average US$30/barrel (bbl) for the year. Improvement in the earnings of the aluminum business offers some mitigation, but on a consolidated basis, operating cash flow will likely be largely flat in fiscal 2020.
Vedanta Resources' established banking relationships and track record of refinancing support its funding profile despite the challenging environment. While our base case remains that the company will meet its near-term maturities, the risks have risen given increased uncertainty in both the commodity and capital markets. The company has some time till a US$670 million bond becomes due in June 2021. However, regaining consistent access to markets will remain key. Growth in earnings from its oil and aluminum business, where progress has been slower than we expected, will also be key to meeting refinancing needs. We assume that any potential non-compliance with covenants, especially the net debt/EBITDA covenant of 3.25x, where headroom is thin, will not affect the company's refinancing ability.
We expect Vedanta Resources to make meaningful progress operationally over the next 12-24 months. These include material cost reductions in its aluminum business with cost of production lower than US$1,500/ton, increased volumes in zinc production (both domestic and international), and increased oil production. However, the benefits of these improvements will be more visible only in fiscal 2022 given lower commodity prices in fiscal 2021. Consequently, our previous expectation that the company will allocate a substantial portion of its free cash flow to debt repayment over the next 12 months is unlikely to be met. We also expect the company's funds from operations (FFO) interest coverage to fall below 2.0x, the downgrade threshold for the previous 'B' rating.
The stable outlook is based on our expectation that Vedanta Resources will maintain a stable balance sheet and credit metrics in fiscal 2021 relative to fiscal 2020, despite lower commodity prices. Higher product volumes and cost efficiencies, especially in the aluminum business, will enable the company to maintain such stability. Vedanta Resources will also likely make progress toward meeting its upcoming debt maturities despite rising market uncertainties.
The outlook also reflects our view that Vedanta Resources' earnings will grow meaningfully in fiscal 2022.
A downgrade to the 'CCC' category is possible if there is a lack of visibility over the refinancing of Vedanta Resources' next large debt maturity in June 2021, by the end of this year. Indicators of this would be risks in accessing the capital markets and failure to make progress on earnings heading into fiscal 2022.
We may upgrade Vedanta Resources if its liquidity position improves. An improvement would depend on better capital market access as well as a significant increase in earnings, likely to over US$4.5 billion by fiscal 2022. A more diversified earnings profile across zinc, aluminum, and oil will also support an improved liquidity position.
Vedanta Resources is a U.K. incorporated commodities producer with assets primarily in India. It owns 50.1% of Vedanta Ltd., its Indian subsidiary, which holds a large part of its assets. Vedanta Resources derives a key part of its cash flow from its zinc producing assets, followed by oil and aluminum. The company has a small presence in steel, iron ore mining, and thermal power generation. Vedanta Resources is ultimately fully owned by Volcan Investments Ltd., controlled by the Agarwal family.
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