Fitch Ratings has downgraded Sri Lanka-based Resus Energy PLC's National Long-Term Rating to 'BBB(lka)', from 'A(lka)'.
The Outlook is Negative. Fitch has simultaneously downgraded the National Long-Term Rating of Resus's outstanding senior unsecured debentures to 'BBB(lka)', from 'A(lka)'.
The downgrade follows Fitch's downgrade of the Sri Lanka sovereign's Long-Term Local-Currency Issuer Default Rating (IDR) to 'CC' from 'CCC' in December 2022, and the recalibration of the Sri Lankan National Rating scale to reflect changes in the relative creditworthiness of the country's issuers. For details, see 'Fitch Downgrades Sri Lanka's Long-Term Local-Currency IDR to 'CC'; Affirms 'RD' Foreign-Currency IDR' (published 1 December 2022) and 'Fitch Ratings Recalibrates Sri Lanka's National Rating Scale' (published 19 December 2022).
The downgrade reflects Resus's heightened liquidity risk stemming from the deterioration in the credit profile of its sole counterparty - Ceylon Electricity Board (CEB, B(lka)/Stable). The Negative Outlook reflects the risk that payment delays from CEB may persist and further erode Resus's liquidity.
Key Rating Drivers
Heightened Counterparty Risk: Resus receives 100% of its revenue from CEB and any further payment delays could worsen the company's already tight liquidity position. The payment delays at CEB stem from its diminished financial profile due to the absence of a cost-reflective tariff structure. CEB's proposed implementation of a cost-reflective tariff mechanism from 2023 could therefore ease payment delays and improve the liquidity of power producers such as Resus.
Resus's liquidity has plummeted amid worsening working capital, with receivables from CEB reaching 308 days by end-September 2022 from 219 days at the end of the financial year ending March 2022 (FY22). We forecast Resus's receivable days to rise to 360 by end-FY23, and reduce to 210 by end-FY24, assuming the latest tariff hike is implemented from 1QFY24. However, the timing of the implementation is uncertain and pending regulatory approval.
Interest Cover to Weaken: We expect Resus's EBITDA interest coverage to weaken to 1.3x by FY23 amid high financing costs. Financing costs reached LKR231.7 million in 1HFY23 with domestic interest rates rising by 625bp in the last six months. Interest payments will continue to climb as maturing debt is refinanced at current interest rates. Approximately 65% of Resus's debt was on variable rates at end-2QFY23.
Delayed Capex to Help Leverage: We expect Resus to maintain net debt/EBITDA at around 4.3x in FY23 (FY22: 4.4x) as it defers the construction of its 5MW solar power plant in Sri Lanka's Ampara district owing to the challenging operating environment. We forecast higher investment outflows in FY24 when Resus commences construction of the deferred project, leading leverage to rise to 4.8x by FY24.
PPAs Limit Cost Pass-Through: Resus's generation capacity is fully contracted under long-term power-purchase agreements (PPAs) with CEB, Sri Lanka's monopoly electricity transmitter and distributor. The PPAs provide earnings visibility, but pre-determined tariffs with limited room for escalation limit Resus's EBITDA generation capacity amid rising operating costs, as well as the ability to manage higher debt-servicing costs in the challenging economy.
Small Operating Scale: Resus's operating scale will stay small, even when installed capacity reaches 29MW with the implementation of projects in the pipeline. It accounted for only 0.4% of Sri Lanka's installed power capacity and generation at end-FY22. We also believe the small scale could affect Resus's bargaining power with counterparties such as CEB and its ability to collect timely payments compared with larger power generators.
Derivation Summary
Resus is rated three notches below domestic power producer and engineering, procurement and construction contractor Lakdhanavi Limited (A(lka)/Stable), on account of the latter's large operating scale, geographic and business diversification, and healthy liquidity profile.
We believe CEB may prioritise payments to Lakdhanavi over smaller generators like Resus. Lakdhanavi is the operation and maintenance provider for one of the largest power plants in the country, and its investments in liquefied natural gas power plants are critical to CEB's future strategy. In contrast, Resus's contribution to the country's power sector is less than 1%. The extended payment delays from CEB, from which Resus derives all of its cash flow, have affected liquidity, leading to our Negative Outlook on Resus's rating.
Resus is rated three notches below domestic homebuilder, Home Lands Skyline (Pvt) Ltd. (HLSL, A(lka)/Stable). HLSL is also exposed to Sri Lanka's weakening economic conditions, which could lower demand for housing, challenge receivable collections and delay construction. However, the company's low leverage mitigates some of these risks.
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer:
Revenue to rise by 16% in FY23 and maintain a similar level in FY24;
EBITDA margin of 83% in FY23 and FY24
Receivable days of 360 in FY23 and 210 in FY24
Capex of LKR15 million in FY23 in the absence of project construction, rising to LKR1 billion in FY24 on the construction of a 5MW solar power project
No dividend payments for FY23, except for the already declared dividend
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An improving trend in the receivables position could lead to the Outlook being revised to Stable
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Further deterioration in liquidity due to delayed receivables collection or challenges in refinancing
Net debt/EBITDA at above 6.5x for a sustained period
EBITDA/interest paid below 1.2x for a sustained period
Liquidity and Debt Structure
Weak Liquidity: Resus's cash position of LKR192 million at end-September 2022 was insufficient to cover short-term debt of LKR409 million and the current portion of long-term debt of LKR450 million falling due in the next 12 months. We expect the banks to roll over working capital debt, in light of potential improvements in payments from CEB in 1HFY24, amidst the tariff hike.
In the short term, the capital deferment under the banks' debt moratorium scheme for the domestic power-generation sector will ease Resus's liquidity requirements. We expect any remaining maturities to be financed by short-term facilities from banks. Resus continued to access bank facilities in 1H23 by raising LKR228 million for refinancing.
Issuer Profile
Resus is a small power producer in Sri Lanka with an expanding portfolio of assets. The company had installed capacity of 22.5MW as at December 2022, spread across hydro (14.5MW) and solar (8.0MW).
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
RESUS ENERGY PLC 
