Moody’s stands by Vedanta Resources' rating downgrade after latter terminates services

Anil Agarwal's Vedanta Resources Plc was incorporated in 2003.

Soon after billionaire Anil Agarwal-led Vedanta’s London-based parent company Vedanta Resources Ltd (VRL) discontinued the rating engagement with Moody’s Investors Service, the international rating agency on November 7 came up with a credit opinion note that explains the rationale for the rating downgrade, and further strengthens (downgraded rating) stance.

On October 31, Moody’s Investors Service downgraded the corporate family rating (CFR) to ‘B3’ from ‘B2’, and downgraded the rating for the senior unsecured bonds issued by London-based indebted VRL to ‘Caa1’ from ‘B3’. The outlook on the ratings remains negative. Subsequently, on November 3, VRL said in a statement that it is discontinuing its engagement with the rating agency. VRL has also asked Moody’s to withdraw all the outstanding ratings.

“The negative outlook reflects the company’s persistently weak liquidity profile and our concerns over the elevated refinancing risk arising from holdco VRL's looming debt maturities,” Moody’s said in the note on November 7.

Vedanta is yet to respond to a query emailed by Moneycontrol seeking their clarifications on Moody's credit opinion.

The rating agency flagged off the risk of a potential downgrade and said that VRL's senior unsecured bonds were rated at Caa1, one notch lower than the B3 CFR, which reflected its view that the bondholders were in a weaker position relative to the operating subsidiaries' creditors.

The one-notch differential between the bond ratings and the CFR reflects the legal and structural subordination of the holding company bondholders to the rest of the group, the note added.

The rating agency expects VRL to find sufficient funds through bank loans and dividends to address its debt maturities until June 2023. But it has listed some possible instances that could potentially lead to a rating downgrade:

1) VRL fails to address its January 2024 US dollar bond maturity by June 2023, after depleting liquidity at operating subsidiaries to repay near-term debt maturities
2) VRL pursues aggressive financial policies, in particular, large debt-funded investments that materially skew its financial profile
3) There is exposure to VRL's ultimate shareholder, Volcan Investments, other than through modest dividends
4) A sustained breach of any of the company's financial covenants limits its ability to raise debt, or
5) An adverse ruling on any of the company's lawsuits results in large cash outflows.

It highlighted a scenario of softening commodity prices also posing a threat of downgrade for VRL’s EBITDA (earnings before interest, taxes, depreciation, and ammortisation) and free cash flow generation, causing a sustained weakening in credit metrics, such as adjusted debt/EBITDA staying above 5.5 times, EBIT/interest coverage remaining below 1.0 time, or cash flow from operations less dividends/debt sustains below 7 percent.
Moody’s also ruled out the chances of an upgrade given the outlook of the downgrade action on October 31, 2022, and the negative outlook on all ratings.

However, it underscored that outlook could return to stable if VRL adopts prudent financial and liquidity risk management strategies, including a sustained approach to proactive refinancing, and maintains sufficient funding to fully address its debt maturities on a 12-18-month forward basis.

Below is an attempt at translation of what VRL’s strained finances would mean for the finances of operating subsidiaries.

1) How weak is the liquidity profile of VRL?

Answer: Moody’s Investors Service estimates VRL to have cash deficit of nearly $2.1 billion by March 31, 2024, despite having a cash balance of $0.1 billion as of March 31, 2022, fund raising to $3.1 billion from VRL holding company and expected dividend income of $4.2 billion.

2) What is the duration of VRL’s debt liability?

Answer: As per the company’s information available at September 2022, around 38 percent of VDL's consolidated debt is due for repayment by March 2024. Another 36 percent of debt matures by March 2025. And lastly, 17 percent matures in FY26, and beyond.

3) What are VRL’s main operations? Where does it get its revenues from?

Answer: London-based indebted company, VRL, still does not have any operating assets and remains dependent on management fees and dividends from its operating and intermediate companies, which provide some liquidity to the holding company.

The company's main operations are held by its 69.7 percent-owned subsidiary Vedanta (VDL, an operating company), which is listed on the Bombay Stock Exchange. And, the Indian zinc operations are held at VDL's 64.9 percent-owned subsidiary, Hindustan Zinc Limited (HZL).

For fiscal 2022, Vedanta Ltd generated revenue of $17.5 billion and reported an EBITDA of $6 billion. Zinc, oil and gas, and aluminium segments contributed 25 percent, 10 percent, and 39 percent of the company's consolidated revenue, accounting for 39 percent, 13 percent, and 38 percent of EBITDA, respectively.

For the first half of fiscal 2023 (H1 fiscal 2023), VDL reported consolidated revenue of Rs 745 billion ($9.3 billion) and consolidated EBITDA of Rs 188 billion ($2.3 billion).

4) Would an aid to the parent impact India-listed Vedanta’s financials?

Answer: As per Moody’s, VRL’s operating subsidiaries, i.e. HZL and Vedanta could pay dividends using their cash balances to somewhat ease the holding company’s cash needs. However, large dividend payments will erode the liquidity of operating subsidiaries, as Vedanta also has cash needs.
For instance, VDL reported consolidated cash of $3.3 billion. If the entire $3.3 billion at VDL were to be distributed in the form of dividends, VRL would receive around $1.5 billion.

Until such time that operating cash flows replenish liquidity at VDL and its subsidiaries, they would need to borrow to pay any further dividends, said Moody’s.

It further highlighted that 38 percent of VDL’s consolidated debt is due for repayment during the 18 months till March 2024.

5) Does VRL continue to depend solely on operating companies?

Answer: Since the holding company does not have operations of its own, it continues to rely on dividend income from its operating subsidiaries to
service debt.

Moody’s suggests that an increase in VRL’s shareholding in Vedanta and growing EBITDA generation from the latter's aluminium business will help reduce the cash leakage while extracting such dividends. It is worth noting that VRL has increased its stake in Vedanta to 69.7 percent in December 2021 from 50.1 percent in November 2020 and this has only partially addressed the rating agency’s concerns over cash leakage, given the presence of minority shareholdings in VDL and other cash-rich subsidiaries.

For instance, with VRL's 69.7 percent holding in VDL, VRL will receive $42.3 for every $100 paid by its step-down 64.9 percent-owned zinc subsidiary HZL, it explained.