TEXT-S&P revises outlook on Tata Power to negative; ratings affirmed

Mon Jul 9, 2012 5:28am EDT

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(The following statement was released by the rating agency)

July 09 -

Overview

-- Funding for Tata Power's Mundra project could be limited in the next six to nine months after the company breached a debt-to-equity ratio covenant on loans to the project.

-- The India-based power utility's cash flows and financial risk profile are likely to deteriorate due to potential project delays and a need for the company to fund project expenses if project loans are curtailed.

-- We are revising our outlook on Tata Power to negative from stable. This reflects a one-in-three chance that the rating may be lowered in the next 12 months.

-- We are also affirming the 'BB-' long-term corporate credit rating on Tata Power and the 'BB-' issue rating on the company's senior unsecured notes.

Rating Action

On July 9, 2012, Standard & Poor's Ratings Services revised its outlook on India-based power utility Tata Power Co. Ltd. to negative from stable. At the same time, we affirmed our 'BB-' long-term corporate credit rating on Tata Power and our 'BB-' issue rating on the company's senior unsecured notes.

Rationale

The outlook revision reflects our expectation that Tata Power's cash flow and financial risk profile could deteriorate over the next six to nine months because the company has breached a debt-to-equity ratio covenant on loans to its Mundra project. The availability of loans to the project, which Tata Power's 100%-owned subsidiary Coastal Gujarat Pvt. Ltd. (CGPL) controls, could therefore be limited.

The outcome of Tata Power's negotiations with lenders on the technical breach in the loan covenant is yet to be finalized. In the absence of the waivers, CGPL will not be able to avail of the loan facility once its drawdown reaches the currently approved level of 83% of the project facility. Nevertheless, we understand that current disbursements from project facilities have not been curtailed. In our view, Tata Power is likely to receive waivers from lenders to the project.

Tata Power has booked an impairment in CGPL assets resulting from a sharp depreciation of the Indian rupee (INR) against the U.S. dollar over the past 12 months. The currency depreciation has also increased CGPL's foreign currency debt. The reduction in CGPL's equity and its higher debt resulted in the breach of the debt-to-equity ratio covenant. The covenant requires the project to have the ratio at less than 3x at the time of each loan disbursement.

In our view, limited availability of project loans will increase Tata Power's project expenses because the company is likely to fund the construction of the remaining units of the Mundra power plant. This also increases the uncertainty over the timing of commissioning of some units of the power project. We expect Tata Power's ratio of funds from operations (FFO) to adjusted debt to be 10%-12% over the next 24 months.

The Mundra project also exposes Tata Power to a risk that coal prices could increase because the company can only partially pass through fuel costs to customers. Tata Power's stakes in coal companies provide a natural hedge to higher coal prices and support its cash flows. Nevertheless, the hedge does not fully eliminate the company's exposure to coal price volatility. Tata Power's cash flows from the Mundra project and from the ownership of coal companies could be lower on a consolidated basis if coal prices trend downward. The ability of the Mundra power plant to operate using blended fuel with some low calorific value coal may mitigate some of this risk. Tata Power is negotiating with bank lenders a mechanism to include the cash flows from the coal companies in the calculation of financial covenants for the Mundra project.

The rating on Tata Power also reflects the company's increasing exposure to competitive generation projects. The positive demand outlook for electricity in India, Tata Power's good operating efficiency, and the competitive position of the company's core licensed operations temper the above weaknesses.

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