Fitch publishes Lakdhanavi’s first time AA+ rating, Outlook stable

Fitch Ratings has published Sri Lanka-based power producer Lakdhanavi Limited’s first-time National Long-Term Rating of ‘AA+(lka)’. The Outlook is Stable. 

Fitch rates Lakdhanavi based on the consolidated profile of the parent LTL Holdings Ltd., (LTLH), due to the strong legal and operational linkages between the two entities, as defined in our Parent and Subsidiary Rating Linkage Criteria. 

The rating reflects LTLH’s leading market position in the country’s power sector, stable cash flow generation stemming from fixed long-term operation and maintenance (O&M) contracts and power purchase agreements (PPAs), strong EBITDA margins offset by the small operating scale of its business segments other than O&M and power generation, which are inherently more volatile. 

The rating also reflects Fitch’s assessment that the group will maintain an adequate financial profile with EBITDA/interest coverage (including proportionate consolidation of subsidiaries Lakdhanavi Bangla Power Ltd. (LBPL: 51%) and Feni Lanka Ltd. (Feni: 56%) above 2.5x over the rating horizon.

We expect Lakdhanavi’s O&M business to contribute significantly to group’s gross profit over the next few years supported by its fixed long-term contract with one of Sri Lanka’s largest thermal power plants, and to a lesser extent from its operations in Bangladesh. Lakdhanavi’s O&M contract with the local power plant has 14 years remaining, which provides strong cash flow visibility. The O&M segment is more profitable compared to rest of the group.

Lakdhanavi’s power plants are secured with a 15-year PPA with the Bangladesh Power Development Board (BPDB). The cash flow is largely guaranteed through capacity-based tariffs payments and cost pass-through mechanisms, supporting stable cash flow. 

The company’s third power plant in Bangladesh, Feni Lanka, commenced operations in late 2019, doubling the capacity to 218MW. We believe the new plant will largely offset the lower capacity charges from existing power plants (eight-nine years of PPA left) in the coming years.

We expect the COVID-19 impact on LTLH’s operations to be largely manageable, as 80% of gross profit is guaranteed through long-term fixed-price contracts. We expect the impact to stem mainly from smaller segments, such as transformers, switchgear and galvanising, owing to lower demand and disruptions to production. 

Overall, we expect a 2% revenue decline in financial year ending 31 March 2021 (FY21) but the gross margin to remain flat, as any weakness in the smaller segments will be offset by increased contribution from the new power plant in Bangladesh, which is comparatively more profitable.

LTLH derives around 60% of its gross profit ultimately from CEB, which is rated at the same level as the parent – Government of Sri Lanka (B-/Negative) – because of the strong linkages. Lakdhanavi and other key power producers and related service providers have received their dues in a timely manner, despite CEB’s weaker credit profile, because of the essential nature of their service. 

The thermal power plant, for which Lakdhanavi provides O&M services, accounts for around 12% of Sri Lanka’s power generation in a country already facing power shortages. Even if there are delays in payments from CEB we expect them to be temporary.

We expect LTLH’s diversification from its Bangladeshi operations and other businesses to mitigate the risks from exposure to CEB. Lakdhanavi’s power plants have received on-time payments from BPDB, a public utility owned by the Government of Bangladesh (BB-/Stable). 

We expect LTLH’s gross profit exposure to CEB to decline to around 50% (FY20: 60%) in the next few years amid increased contribution from the Bangladesh operations. That said, any further improvement in LTLH’s credit profile will be contingent on material improvement in the counterparty profile beyond our current expectations.

LTLH does not have any large confirmed projects in the pipeline, except for the ongoing hydropower plant in Nepal. We expect LTLH to have access to around Rs. 13 billion of cash from a dividend, and the cash will be free of any encumbrances by FY23. This cash is currently restricted, as we expect LTLH to hold the dividend received from its associate, West Coast Power Limited (WCPL), as a guarantee against any default of the project loan due to a breakdown of the WCPL’s power plant. 

The project loan will be paid off by 2022. We expect the company to use this cash to fund its future expansion. The Sri Lankan Government has awarded Lakdhanavi a new 300MW Diesel/LNG power plant in Sri Lanka on a ‘build operate own transfer’ basis following a tender procedure. The company is yet to receive the formal approval from the regulator and sign the PPA. 

Lakdhanavi and another partner will infuse 30% of the project cost with the remainder funded through debt. We expect LTLH to maintain its EBITDA/interest coverage above 2.5x over the next few years, based on the proposed funding structure However, an increase in the investment or inability to find an equity partner could weaken coverage further and weigh on the rating.