(Repeat for additional subscribers)
Feb 11 (The following statement was released by the rating agency)
Fitch Ratings has downgraded Hong Kong-based Cheung Kong Infrastructure Holdings Limited's (CKI) Long-Term Issuer Default Ratings (IDR) to 'BBB+' from 'A-'. The Rating Watch Negative (RWN) on all ratings has been removed, and a Stable Outlook has been assigned to the Long-Term IDR. Simultaneously, CKI's senior unsecured rating has been downgraded to 'BBB+' from 'A-' and its USD300m fixed rate callable perpetual securities issued in February 2012 have been downgraded to 'BBB-' from 'BBB'.
KEY RATING DRIVERS
HKE Spin-Off: The rating actions follow a reduction by Power Asset Holding (PAH), in which CKI has a 38.9% stake, of its 100% shareholding in Hong Kong Electric Company (HKE). HKE, via CKI's shareholding in PAH, is the highest quality asset in CKI's dividend portfolio and the single largest dividend contributor (via PAH) to the company. PAH cut its HKE stake to between 42.4% and 49.9%, through a spin-off and separate listing of HKE. Fitch views the quality of CKI's cash flow stream and hence its business risk profile as negatively affected, even though CKI's management has indicated that dividend flows to CKI from PAH will not fall from 2012 levels in 2013 and 2014. With the spin-off of HKE, we perceive there to be a sufficient dilution of the credit quality of dividends from PAH, which contributes around a third of CKI's cash inflow, to tip the aggregated portfolio of CKI dividends into the high 'BBB' category (taking account of both structural subordination issues and a strong CKI management team).
HKE is a regulated integrated utility in Hong Kong, operating under a transparent regulatory framework, the Scheme of Control (SoC), which allows a permitted rate of return and operating cost-pass through until 2018. Until its spin-off, HKE constituted PAH's core business but PAH has non-majority stakes in a number of international regulated utility assets from which it receives dividends.
While PAH can make up for the loss of pay-outs from HKE with cash raised from the divestment of interest in HKE (for approximately HKD24.1bn) to maintain its dividend payments in the short-term, dividends over the longer-term will depend on PAH's investments and returns generated using the cash from the HKE spin-off.
Cash from Transaction: Positively, the potentially large amount of cash at PAH following the transaction can avert any cash calls on shareholders - including CKI - to support PAH's future growth in the medium term. PAH intends to use the cash to acquire international utility assets, which will contribute to a weakened quality of cash inflows to PAH, compared with pre-transaction, and therefore also to CKI over the medium term. Future investments by both CKI and PAH are unlikely to be in the 'A' category, further contributing to portfolio credit dilution. The current investments of CKI and PAH are predominantly in businesses with 'BBB' category credit profiles.
Stable Income Stream: CKI's ratings are underpinned by its stable and predictable income stream from a diversified portfolio of investments comprising mainly of regulated utility assets. Cash flow contributions from regulated utility assets accounted for over 85% of CKI's FY12 cash inflows. Key contributors include PAH in Hong Kong; UK Power Networks Holdings Ltd, Northumbrian Water Group and Northern Gas in the UK; and SA Power Networks/Powercor/Citipower in Australia. Regulatory frameworks in these countries are mature, stable and supportive, with no regulatory price resets until 2015, contributing to visibility of earnings and cash flows.
Structural Subordination Risk: CKI faces structural subordination risk as its funds from operations (FFO) are largely derived from upstream dividends and interest received on shareholders' loans. While CKI has less than controlling stakes in its key investments, it jointly invests - typically with PAH as well as with other affiliates in the Cheung Kong group, thus maintaining strong control of its major associate and joint-venture investments.
Reduced Credit Quality of Portfolio: CKI's investments in the last two years, while increasing the diversity of its portfolio, have reduced the overall average credit quality of its investment holdings. Fitch has previously highlighted to investors that CKI had little headroom under its negative rating guidelines - primarily its FFO to interest coverage of 5.0x - to maintain a rating at the 'A-' level. We believe it is unlikely that the CKI portfolio will be strengthened by further acquisition activity.
Negative: Future developments that may collectively or individually lead to negative rating actions include:
- FFO interest coverage below 4.5x on a sustained basis (FY12: 3.9x);
- Further deterioration in the quality of cash inflow from investments due to significant acquisition in the non-regulated utility sectors that weakens the overall credit profile of current invested entities
Positive: While considered less likely over the medium term, future developments that may collectively or individually lead to positive rating actions include:
- FFO Interest Cover of greater than 5x on a sustained basis (FY12: 3.9x); and
- Significant improvement in the quality of cash inflow (dividend quality); and
- No parent constraint, Hutchison Whampoa Limited (HWL, A-/Stable)