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Analytical Approach: Ind-Ra continues to consider the consolidated profile of HMEL and its wholly owned subsidiary HPCL Mittal Pipelines Limited’s (HMPL, ‘IND AA+’/Stable), referred to as HMEL group, to arrive at the ratings, given the strong linkages between the two entities. To arrive at the ratings of HMEL group, Ind-Ra has considered the strong legal, operational and strategic linkages between HMEL group and Hindustan Petroleum Corporation Limited (HPCL, ‘IND AAA’/Stable) which holds 49% stake in HMEL. The ratings have derived support from HPCL, given the presence of an offtake agreement and the support undertakings provided by HPCL to HMEL. While arriving at the ratings of HPCL, Ind-Ra considers the strong linkages between HPCL and GoI and follows a top-down rating approach. Similarly, to arrive at the ratings of HMEL group, Ind-Ra has applied a top-down rating approach as per its Parent-Subsidiary Rating Linkage criteria and assessed the ratings of HPCL without the GoI support and then notched down the ratings of HMEL group. The ratings of HMEL would move in line with the ratings of HPCL arrived at by Ind-Ra without factoring the government support.
KEY RATING DRIVERS
Strong Sponsor Support; Strong Linkages: HMEL’s linkages with HPCL are underscored by the presence of a take-or-pay product offtake agreement with HPCL to buy all of HMEL’s liquid products (about 82% of the total production). According to the agreement, any shortfall in the annual contracted quantity would result in the buyer paying to the seller an amount required to keep the debt service coverage ratio for the relevant contract year at 1.0x. The arrangement has been revised to include the additional quantities produced due to an expansion of HMEL’s refinery capacity in line with the existing terms and conditions. After the likely commissioning of an upcoming petrochemical project in 1HFY22, the share of liquid products in the overall volumes would fall to around 62% from 82%, while their contribution to EBITDA would reduce to around 65% from 90%. However, Ind-Ra considers the linkages to be meaningful as i) even after the refinery expansion in HPCL (to 22.3mmt from 15.8mmt), HMEL would continue to account for 32% (from 42%) of HPCL’s combined refinery capacity, and ii) expansion of HMEL’s petchem capacity is strategically important for HPCL, enabling forward integration in the petchem sector and reducing the exposure to volatility in the global refining margin cycle. Sharp deterioration in the credit profile of HPCL could lead to a rating action in HMEL.
During FY20, HMEL’s refinery output stood at 42% of HPCL’s total refinery output (FY19: 40%). The company contributed 74.5% to HPCL’s north India sales in terms of volumes in FY20 (FY19: around 73%). Furthermore, HMEL’s petrochemical capex constitutes roughly 23% of the HPCL’s group capex plan and 65% of its capex for joint ventures over FY18-FY23. The strong sponsor support is also underlined by the sponsor support agreement signed by the promoters, HPCL and Mittal Energy Investment Pte Ltd, Singapore (a L. N. Mittal group company), with the lenders of the petrochemical project to meet any shortfall in internal accruals or cost overrun to maintain the debt/equity ratio of the project to below 2.0x.
GRM to Improve from 2HFY21: HMEL’s gross refining margins (GRMs) declined to USD4.5/barrel (bbl) during 4MFY21 (FY20: USD9.2/bbl, FY19: USD12.4/bbl), driven by i) lower capacity utilisation (4MFY21: 81%, FY20: 108%, FY19: 110%), and ii) lower crack spread of key petroleum products due to COVID-19 led global demand disruption. However, HMEL’s GRMs continue to outperform the industry’s – the benchmark Singapore GRM stood at a negative USD0.9/bbl in 1QFY21 – on account of i) a high Nelson Complexity Index of 12.6; ii) presence of polypropylene; iii) a distillate yield at 78% with 44% being diesel, iv) CST benefits available to the company (4MFY21: INR1.5 billion, FY20: INR6.8 billion, FY19: INR7.1 billion) at nearly USD1/bbl, v) the use of circulating fluidised bed combustion boiler using pet-coke as a fuel to meet energy needs and vi) the use of pipeline to transport crude which adds another USD1.5/bbl.
Furthermore, post the implementation of the petrochemical project, Ind-Ra expects a structural upward shift and reduced volatility in the GRMs, as the overall refinery Nelson Complexity Index would be upwards of 19. According to the management, even if the refinery margins fall, the forward integration should aid the company to maintain healthy GRMs. HMEL is allowed deferment of CST benefit income of nearly INR9 billion annually till FY25 and repayments from 16th year onwards in 30 half yearly instalments. The company has elected to settle the liability on net present value basis, and the annual cash outflow would be limited to INR2 billion-2.5 billion. HMEL has been adjusting the CST liability payable against interest-free loan (IFL) of INR12.5 billion from the Punjab government. However by 4QFY21, the entire INR12.5 billion liability would be settled.
Ind-Ra expects the GRMs to gradually start improving from 3QFY21, as a global economic revival would lead to an improvement in the crack spread of key petroleum products. HMEL’s capacity utilisation of refineries exceeded 110% in July 2020 from around 63% in April 2020, with a revival in domestic demand. A higher margins build-up in fuel prices owing to the upgradation to BS-VI norms should also support the refining margins over the long term.
During 4MFY21, HMEL on a standalone basis reported negative EBITDA of INR1.4 billion against EBITDA of INR17.2 billion in FY20 (excluding exceptional inventory loss of INR2.4 billion) and INR37.7 billion in FY19. As against a total inventory loss of INR17.7 billion in FY20 resulting from a steep decline in crude prices in 4QFY20, HMEL earned a marginal inventory gain of INR0.2 billion in 4MFY21.
Credit Metrics Improve from FY23 Post Commissioning of Petchem Project: In FY20, HMEL’s consolidated gross interest coverage (EBITDA/gross interest expenses) and net leverage net debt/EBITDA) deteriorated to 1.7x (FY19: 3.3x) and 13.6x (5.8x), respectively, driven by the lower EBITDA and the debt undertaken for the petrochemical project. Excluding this, net leverage stood at 10.1x in FY20 (FY19: 5.2x). Ind-Ra expects HMEL’s leverage to increase further in FY21, on account of the increased borrowing for the petchem plant, lower refining margins and planned shutdown of refinery for 40-60 days during February-April 2020 for the integration of petchem plant. Ind-Ra expects the leverage to start improving from 2HFY22, led by a revival of refining margins and contribution from the petchem plant. The management expects to bring down the net leverage to 4x by FY23.
HMEL’s total consolidated debt (including acceptances for crude purchase and credit extended by capital goods supplier) increased by INR57.1 billion to INR332.1 billion in FY20 (FY18: INR202.4 billion); of this, the petrochemical project debt amounted to INR80.6 billion (FY19: INR25.3 billion). HMEL has been using usance letters of credit/acceptances for purchasing crude (FY20: INR23.4 billion, FY19: INR21.4 billion) since FY18 and has started availing a factoring facility without recourse to it amounting to INR14 billion (utilised as of FYE20 at INR8.8 billion) beginning FY20, which had led to receivables declining to INR4.9 billion as of FYE20 (FYE19: INR25.7 billion) to reduce its working capital requirements. Ind-Ra expects the net leverage to moderate below 5x in FY23, driven by the commissioning of the petrochemical project, improvement in GRM and freeing-up of working capital.
Liquidity Indicator – Adequate: HMEL’s cash and cash equivalent stood at INR23.2 billion at FYE20 (FY19: INR3.3 billion, FY18: INR0.1 billion), with almost nil utilisation of the fund-based limits (consortium/outside consortium), as of July 2020, i.e. average utilisation of 1% of secured working capital limits of INR25 billion during the 12 months ended July 2020 and 10% average utilisation of unsecured short-term limits of INR33.6 billion during March-July 2020. Also, HMEL has strong banking relationships and access to the domestic and offshore markets. During FY20, HMEL cash balances were significantly higher on account of a decline in inventory to INR52.7 billion (FY19: INR67.7 billion) because of lower crude and FG prices, though the quantum of inventory was higher. The cash balances were also supported by the debtor factoring facility used by HMEL; however, this was offset to certain extent by a decline in trade payables as the crude prices fell. Given the free-up in the working capital, the cash flow from operations was healthy in FY20 at INR23.9 billion (FY19: INR29.2 billion), despite the weak EBITDA generation. HMEL has not availed the Reserve Bank of India-prescribed debt moratorium.
HMEL has additional fund-based limits of INR45 billion and non-fund-based limits of INR36 billion. HMEL’s debt repayments stand at INR0.09 billion and INR17.0 billion in FY21 and FY22, respectively. The company proactively does a liability management exercise to ensure the alignment of debt with cash flows. The debt repayments for the petrochemical project would begin from 3QFY24.
Faster Project Execution Leads to Higher Debt Drawdown; Execution Risks Remain: Management amid COVID-19 led disruptions expects the petrochemical project (1.2mtpa) to now be commissioned in 2QFY22 as against the earlier target of 1QFY22. Management however does not expect any meaningful increase in project cost (INR232 billion, excluding CENVAT benefit of INR26 billion) as the expected increase in expenses would be mitigated by a reduction in interest rates. Timely commissioning of the project within the expected costs would be a key monitorable. Given that most petrochemical projects face teething problems in the first year, Ind-Ra would continue to monitor the status of the plant post commissioning and its impact on the financials.
Ind-Ra draws comfort from the management’s ability to plan and execute projects in a cost and time-bound fashion, and the brownfield nature of the petrochemical expansion project. HMEL expects to fund project cost overruns using internal accruals. The entire debt of INR134.4 billion has been tied-up, with part of it being denominated in US dollars (external commercial borrowings of USD475 million). HMEL on a cash basis based on CA certificate incurred cumulative capex of INR115 billion (net of CENVAT) till FY20 (FY19: INR57.7 billion), funded through equity of INR37.9 billion (INR35.3 billion), debt of INR61.6 billion (INR24.7 billion) and extended credit adjusted with cash in hand of 15.5 billion (INR 8 billion). The entire balance equity of INR33.7 billion is to be funded from internal accruals. Given the likely low GRMs in FY21, the company could resort to more cash free-up on working capital through increased debtor factoring facility of up to INR25 billion and payables, to increase internal accruals. Also, HMEL has kept its debt servicing commitments low during FY21 and FY22. However, the promoters have agreed to bring in additional equity in case the project’s debt to equity ratio exceeds 2x.
Negative: Any weakening of HMEL’s linkages with the sponsor or any significant time or cost overruns on the petrochemical expansion project, leading to deterioration in the credit metrics, all on a sustained basis, could result in a negative rating action.