Fitch Downgrades CIHL to 'B+' from 'BB-'; Outlook Stable

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Fitch Downgrades CIHL to 'B+' from 'BB-'; Outlook Stable
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(The following statement was released by the rating agency) Fitch Ratings-Singapore/Mumbai-April 06: Fitch Ratings has downgraded the Long-Term Issuer Default Rating (IDR) of Cairn India (NS: CAIL ) Holdings Limited (CIHL) to 'B+' from 'BB-'. The Outlook is Stable. The downgrade follows a revision of our forecast for weaker economic growth stemming from the coronavirus pandemic, which is likely to pressure commodities. We have revised down our price assumptions for zinc, aluminium and, most notably, oil and gas (OG), which together contribute about 90% of Vedanta Resources Limited's (VRL, previously known as Vedanta Resources PLC) EBITDA; VRL is the parent of Vedanta Limited (VLTD), India's largest private upstream OG producer, which fully owns CIHL. CIHL's rating is aligned with the credit profile of VLTD, reflecting strong linkages in line with Fitch's Parent and Subsidiary Rating Linkage criteria. The Stable Outlook reflects our expectation that VLTD's credit profile should remain steady, with consolidated coverage (operating EBITDA/ (interest paid)) remaining above 2.0x from the financial year ending March 2022 (FY22). We assess CIHL's Standalone Credit Profile (SCP) at 'b+' due to its concentrated and small operating scale, which is counterbalanced by its low cost position and strong standalone financial profile. Key Rating Drivers Rating Aligned with Parent: Fitch assesses the operating and strategic linkages between CIHL and its parent, VLTD, as 'Strong'. VLTD fully owns CIHL and both entities hold equal 35% shares in the group's largest (OG) block in the north Indian state of Rajasthan. VLTD operates the Rajasthan block, in which Oil and Natural Gas (NS: ONGC ) Corporation Limited (ONGC) holds the remaining 30% stake. VLTD's OG business is its second-largest contributor to EBITDA, after the Indian zinc operation. We believe OG will remain strategically important to VLTD due to its low-cost operation and significant earnings contribution. Weakening Credit Metrics: Fitch expects VLTD's consolidated coverage, at 1.8 in FY21 and 2.1x in FY22, to be weaker than our previous expectations. This reflects a cut of 39% and 21% in our crude-oil price assumptions, a cut of 11% and 10% in our aluminium LME price assumptions and a cut of 15% and 7% in our Zinc LME price assumptions over FY21 and FY22, respectively. However, we expect the company's operations to improve over FY21-FY22 on cost rationalisation at VLTD's zinc and aluminium businesses and volume ramp-up post any temporary weakness due to the coronavirus pandemic, cushioning the effect of weaker prices. We forecast the cost of VLTD's aluminium production to fall to below USD1,500/tonne (t) over the next two years. VLTD's low-cost operations across key commodities should help it to defend its margins during the currently weak industry conditions; this underpins our Stable Outlook. Cash flow volatility is further lowered by VLTD's commodity diversification, with zinc, OG and aluminium contributing 47%, 32% and 9%, respectively, to FY19 EBITDA. OG Weakness: Fitch expects the EBITDA contribution from the OG business to drop by about 45% in FY21 and 20% in FY22 from our previous estimates due to falling oil prices and volume growth. We expect the lower oil prices to be partly offset by decreased operating expenses, as the cost of some raw materials is linked to the oil price. CIHL also expects further cost cuts, as contractor prices are typically negotiated lower in case of a persistent low oil-price environment. Capex Flexibility: VRL has the ability to defer capex for some of its OG and other mineral projects to mitigate a drop in cash flow from the low-price environment. We do not expect the company to proceed with certain big-ticket OG projects till the trajectory of oil prices reverses. The company also has flexibility in adjusting exploration capex. Nonetheless, its overall capex is still substantial, which, along with lower profitability from key business segments, is likely to result in neutral to negative free cash flow over the medium term. 'b+' SCP: CIHL's production scale - based on its 35% share of the Rajasthan OG block, where all fields are producing - is small, at about 60,000 barrels of oil equivalent per day (boepd). This is comparable with that of OG producers in the 'B' category. Fitch takes into consideration only CIHL's share in the Rajasthan block in assessing its SCP and does not factor in any benefit from VLTD's shares in and role as the operator of the block. CIHL, however, benefits from the low-cost structure of the Rajasthan block, with sustainable operating costs of around USD7.5/barrel (bbl) and finding and development costs of about USD5.0-6.0/bbl, with further flexibility to cut costs during a low-price environment. The cost position is significantly lower than that of peers and underpins CIHL's positive free cash flow, despite our forecast for lower oil prices, and its strong financial profile with a net cash position. ESG - Governance Structure: CIHL has an ESG Relevance Score of '4' for Governance Structure. Our assessment reflects the group's complex shareholding structure and the risk of cash leakage other than dividend distributions to parties outside of its ultimate parent, VRL. Our assessment does not factor in any cash leakage, aside from the dividends to VRL, but we are monitoring whether any group entities are further supporting Volcan Investment Limited, a shareholder of VRL. This follows a CIHL's investment in a Volcan structured product in January 2019, although the investment was subsequently unwound profitably in August 2019. VRL has since committed to abstain from similar transactions. Derivation Summary CIHL's ratings have been aligned to that of its parent, VLTD. Similarly, the rating on Thailand's PTT Exploration and Production Public Company Limited (BBB+/Stable) is equalised with that of its parent, PTT Public Company Limited (BBB+/Stable), reflecting Fitch's assessment of strong operating and strategic linkages between the two companies. Fitch also aligns India-based Hindustan Petroleum (NS: HPCL ) Corporation Limited's (BBB-/Stable) rating with the credit profile of its largest shareholder, ONGC, with the linkages between the two entities assessed as strong. Key Assumptions Fitch's Key Assumptions Within Our Rating Case for the Issuer Commodity prices to average as below in FY21, FY22 and FY23: - Zinc at USD1,925/t, USD2,000/t and USD2,000/t, respectively, and aluminium at USD1,570/t, USD1,650/t and USD1,825/t - 62 Fe CFR benchmark iron ore price to average at USD71/t, USD60/t and USD59/t, respectively - Brent crude to average at USD36/bbl, USD46/bbl and USD52/bbl, respectively Sales: - Zinc sales in India of 708 thousand tonnes (kt) in FY20, 786kt in FY21 and 913kt in FY22 as shaft commissioning at the Rampur Agucha mine supports a higher production run-rate. - Zinc sales in Gamsberg, South Africa, of 128kt in FY20, 200kt in FY21 and 235kt in FY22, as the quarterly production run-rate is ramping up to 45kt in 4QFY20, from around 25kt in 1QFY20. - Aluminium sales of 1,936kt in FY20, 2,003kt in FY21 and 2,063kt in FY22, supported by commissioning of new electrolysis pots and capacity ramp-up. - Per day oil production from Rajasthan block at 160,000 boepd for FY21 and FY22. Gas production from Rajasthan block of 130 million standard cubic feet per day (mmcfd) in FY21 and 187mmcfd in FY22. This reflects a gradual ramp-up of production at the projects, which have almost completed construction. Around a 29% EBITDA margin in FY20-FY22, as structural improvement in the cost of production at some minerals offsets the weakness in commodity prices. Capex of USD1.0 billion in FY21 at VRL, which is lower than our previous expectation of USD1.8 billion due to the coronavirus pandemic. Capex of USD1.4 billion in FY22 is unchanged. RATING SENSITIVITIES Factors That Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade: - An improvement in VLTD's credit profile, provided the linkage between CIHL and VLTD remains strong, could result in the Outlook being revised to Stable Factors That Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade: - Weakening of linkages between CIHL and VLTD - Deterioration in VLTD's credit profile, liquidity and debt structure Best/Worst Case Rating Scenario Ratings of non-financial corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit Liquidity and Debt Structure Adequate Liquidity Position: We expect CIHL to maintain sufficient liquidity to repay its amortising loan due at the subsidiary level with internal cash flow without any refinancing support. Free cash flow should remain positive and sufficient to take care of the loan's repayment schedule, given the deferment of capex in FY21, even during the low oil-price environment. Criteria Variation Fitch applied its Parent and Subsidiary Rating Linkage criteria to derive the credit profile of VLTD. Where we assess 'Strong' or 'Moderate' linkages between a weaker parent and stronger subsidiary, the criteria establishes that the IDRs for both are likely to be based on the consolidated credit profile. VRL's fully consolidated financials reflect cash leakages to significant minority shareholders in its key assets, notably VLTD. Fitch believes that VLTD's creditors have better access to its operating cash flow as compared with VRL and there are some limits on cash leakages. These support VLTD's credit profile being assessed as better than the consolidated group profile. REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria. ESG Considerations CIHL has an ESG Relevance Score of 4 for Governance Structure, which reflects issues related to overall board structure and composition and effective management control. Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit Cairn India Holdings Limited; Long Term Issuer Default Rating; Downgrade; B+; RO:Sta Contacts: Primary Rating Analyst Shubha Sethi, CFA Associate Director +65 6796 7245 Fitch Ratings Singapore Pte Ltd. One Raffles Quay #22-11, South Tower Singapore 048583 Secondary Rating Analyst Mohit Soni, Associate Director +91 22 4035 6163 Committee Chairperson Vicky Melbourne, Senior Director +61 2 8256 0325

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