RAM Ratings Lanka reaffirms ratings of A-/P2 to Vidullanka PLC

RAM Ratings Lanka has reaffirmed Vidullanka PLC’s respective long- and short-term corporate credit ratings at A- and P2; the long-term rating has a stable outlook.

The ratings are upheld by the favourable contractual terms of its power purchase agreements (PPA), its low leverage and strong debt-protection measures, good liquidity as well as the positive outlook on power industry.

Meanwhile, the ratings are moderated by Vidullanka’s small stature in the fragmented independent power producer (IPP) industry, renewal risks of the PPAs, revenues that are correlated to weather patterns and construction risks in relation to the new power plants.

Incorporated in 1997, Vidullanka commenced operations as an IPP in 2001. The Group owns and operates mini-hydro power plants (MHPPs) that supply electricity to the Ceylon Electricity Board (CEB). Under the relevant PPAs between Vidullanka and the CEB, the Utility is obliged to purchase all the electricity generated by the MHPPs throughout the tenures of their respective contracts; these profitable PPAs have tenures of 15 years each.

Supported by favourable tariffs and increased energy production, Vidullanka’s margin on operating profit before depreciation, interest and tax (OPBDIT) broadened to 57.52% in FYE 31 March 2011 (FY Mar 2011) (FY Mar 2010: 52.22%).

This improved further to 62.70% in 1Q FY Mar 2012, backed by seasonal rainfall. However, the margin was lower than 68.95% in 1Q FY Mar 2011 due to the lower levels of rainfall observed during 1Q FY Mar 2012.

The Group’s OPBDIT margins are better than those of its corporate counterparts, but in line with those of its peers in the power industry.

Meanwhile, the CEB has traditionally been prompt when meeting its obligations under the PPAs. Nonetheless, renegotiation risk of the PPAs cannot be entirely discounted.

Moreover, Vidullanka’s gearing ratios have been lower than those of the corporates rated by RAM Ratings Lanka; it stood at 0.23 times as at end-FY Mar 2011 (end-FY Mar 2010: 0.24 times).

Despite the increase in its debt level to Rs. 210.65 million as at end-FY Mar 2011, its gearing ratio remained relatively unchanged owing to a Rs. 274.41 million rights issue which strengthened its capitalisation.

Despite the Group’s increased borrowings, its fund from operations (FFO) debt coverage ratio has stayed strong, albeit easing slightly to 1.10 times as at end-FY Mar 2011 (end-FY Mar 2010: 1.29 times).

We note that Vidullanka maintains a conservative financial policy with regard to new projects; the Group aims to fund its new investments with a 60:40 mix between debt and equity.

Furthermore, Vidull-anka’s liquidity is viewed to be good. As at end-FY Mar 2011, it held Rs. 214.57 million of cash and cash equivalents (CCE) compared to Rs. 32.16 million of short-term borrowings.

Its CCE expanded as at end-fiscal 2011 following its rights issue, thus improving its CCE to short-term debt coverage level to 6.67 times.

While the cash from the rights issue had subsequently been used to fund new investments, its CCE to short-term debt coverage remained strong at 1.38 times as at end-June 2011.

Sri Lanka has been posting strong economic growth since the cessation of the ethnic conflicts in its northern and eastern regions. Demand for power has been rising at a steady 5%-8% per annum.

Prospectively, we expect demand to increase further on the back of the government’s objective of electrifying all households in the country by 2012, coupled with more power consumption amid economic growth. On this note, IPPs accounted for 40% of total power generated as at end-December 2010, in comparison to 15.19% a decade earlier.

That said, as at end-December 2010, the fragmented IPP industry contributed 172 MWs to the national grid - through 87 power plants. Vidullanka remains a small player with an effective generation capacity of 5.8 MW. Since 2 of its plants collectively contribute about 80% of its revenue, any operational hiccup at one would have a substantial impact on the Group’s financial performance. In this regard, the management has taken steps to increase the Group’s investments in MHPPs, either on its own or through joint ventures (JVs). The Group faces renewal risk, with its first PPA expiring in 2016. Nonetheless, the management has made efforts to diversify Vidullanka’s revenue through investments in other power projects, which are expected to be commissioned in fiscal 2012.

On a separate note, although the CEB is obliged to purchase all the power generated by Vidullanka, electricity generation and revenue depend solely on rainfall in the catchment areas.

Moreover, Vidullanka’s plants are of the run-of-river variety, which operates without a dam and increases the seasonality of its revenue flow.

On another note, as three of Vidullanka’s MHPPs are still under construction, any delay in completion would affect the Group’s cash flow. Furthermore, Vidullanka may encounter cost overruns.

Historically, there has been no delay with regards to construction; the project management and design have been and are undertaken by its subsidiary, Vidul Engineering Ltd (VEL).  In addition to the in house project management consultancy works, VEL also engages in third party project management and consultancy contracts.