Following Adani Abbot Point’s recent downgrade by Moody’s to sub investment grade, we look at the continued investment thesis for the terminal. While credit concerns have increased, we believe some patience is key at the moment until the issuer provides a response to the rating outcome. Longer term, Glencore’s actions around its contract renewal in 2020 will be pivotal to the credit profile
On the 14 March, Moody’s downgraded Adani Abbot Point Terminal’s (AAPT) senior secured credit rating to sub investment grade. Moody’s cites the ongoing severe pressure facing the coal sector has weakened the creditworthiness of AAPT’s coal mining counterparties which are the sole source of the terminal’s cashflows. In its rating decision, Moody’s sees an increased likelihood of AAPT's counterparty contracts either not being renewed or subject to early termination. We note S&P continues to rate the terminal at an investment grade rating.
The issuer advised that they were committed to maintaining an investment grade credit rating, and proposed a series of debt reduction measures to Moody’s including some holding back of dividends. The measures which the issuer presented to the rating agency to reduce debt were clearly insufficient to maintain an investment grade status and the two notch downgrade is material.
As a result of the downgrade, a coupon step up regime will take effect from the next interest period. For the 2020 bond, the next semi annual interest period runs from 29 May to 29 November. Based on AAPT’s current credit ratings, the step up in the coupon of 1.00% translates to a total coupon of 7.10% on the 2020 bond. We understand the 2018 bond has the same step up coupon regime in place.
Key credit considerations - Glencore contract renewal and asset utilisation
Adani Abbot Point’s credit profile hinges on a number of factors, however we believe the most important factor is the renewal of the Glencore take or pay contract which expires in June 2020.
Glencore must provide three years prior notice to the company of its renewal intentions that is by June 2017. If Glencore provides notice in 2017 that it does not intend to renew its contract with the terminal, or that it is looking to significantly lower the contracted throughput on rollover, then this will create major concerns around the capacity of AAPT to refinance the AUD1.08bn of debt due in November 2018. There will be a heightened perception of stranded asset risk. This debt is roughly split 50/50 between a bank debt tranche and a bond tranche.
AAPT’s actual terminal utilisation levels have not picked up as was previously anticipated. Actual throughput for the half year to September 2015 was 14.2m tonnes, which is about in line with the annual run rate in the previous year of 28.4mt. The recent throughput level translates to a terminal utilisation rate of around 60%. Previously, we were advised that Qcoal and Byerwen were due to start in the accounting year but were delayed due to non completion of the mine. The continued low utilisation rate has been attributed to the following factors:
- We understand the lower than expected utilisation rate is mostly due to lower than estimated exports by Glencore. On a year to date basis (Jul 2015 to Jan 2016), we understand that Glencore Coal Queensland’s actual exports were running at around 60% utilisation. Essentially, Glencore’s less than budgeted performance has resulted in muted export growth.
- Byerwen’s development and first coal continues to be delayed and it is now expected to export its first coal around Nov 2016. We see Byerwen as a moderate to high default risk given the continued delays in commencing production. Byerwen’s contract is for 5 million tonnes per annum or roughly 10% of total terminal capacity. Byerwen is owned by a number of joint venture partners including the Japanese Steel Corporation, however these entities do not provide an explicit guarantee of the obligations. If Byerwen were to default, we expect this would need to be captured in the socialisation mechanism as part of the next reset of the take or pay contracts in 2017. Each of the remaining users would have to pick up the lost charges from Byerwen, unless replacement capacity can be found prior to then
Below we set out the key considerations for bondholders:
Considerations for bondholders - the case for holding AAPT bonds
- Increased coupon to 7.10% and associated running yield
- Incentive for issuer to regain investment grade credit rating and reduce interest costs
- Potential for issuer to take further action to address credit concerns, including equity capital injection, noting 29 May is when the higher coupon kicks in
The case for selling AAPT bonds
- Concerns around the low utilisation rate, Glencore’s reduced throughput, as well as the ongoing dispute between AAPT and Glencore in relation to Glencore’s operations and maintenance contract with the terminal, highlighting the potential risk for Glencore’s non renewal of the contract
- Heightened refinancing risk of AUD1.08bn of debt in 2018 maturing ahead of 2020 bond, driven by coal divestment strategies, sub investment grade credit rating and Glencore renewal risk
- Company not delivering on its commitment to maintain investment grade rating (although AAPT can still provide a further response to address its credit rating)
The case for a buying AAPT bonds
- Potential entry point into the earlier maturing 2018 bond, particularly if forced selling by institutional investors with an investment grade mandate generates a value proposition. We note some institutional investors may point to the S&P investment grade credit rating as being sufficient for their mandate and may be able to hold onto the investment
- More than 50% of coal throughput is metallurgical coal, used in the production of steel (rather than thermal coal which is burned for energy)
- Incentive for issuer to return to investment grade credit rating, reducing interest costs and associated likely increased confidence in the 2018 refinancing
- Continued appetite from Chinese and Indian lenders to fund coal projects, in particular Adani relationship banks such as State Bank of India who may be prepared to refinance the terminal’s debt in 2018
- Longer term take or pay contracts (outside of Glencore) from a variety of counterparties
Conclusion
Firstly, price and trading action over the next few days will be an important consideration in assessing the risk/reward equation for AAPT. We expect there to be some forced selling in the 2018 bond, but this may take time as incoming bidders evaluate the credit opportunity. At this stage, it is not fruitful to quote pricing until a revised level is set following the rating action. We note the 1% pa step up in the coupon may provide partial support to the capital price following the downgrade as well as attracting running yield seeking investors. The bond is still rated investment grade by S&P but we believe S&P has been slow to update its credit re-evaluation of AAPT and may take action following Moody’s downgrade (which could trigger further forced selling).
From a research perspective, we believe patience is key before setting a course of action but we are leaning towards the seller camp, particularly if the coupon step up can hold up the capital price to a level which still delivers a moderate discount to par on exit. However our base expectation at the moment is that the bonds will trade lower as a result of forced selling. We could be wrong if new bidders get attracted to the increased coupon.
We were surprised by the two notch downgrade and disappointed that the company’s previously announced commitment to an investment grade rating has not been backed up with a sufficient and appropriate deleveraging. Stepping away from verbal commitments, on the facts we have at the moment, we see a continued and increasing pathway to uncertainty and reduced cashflow when the take or pay contracts are reset to a lower rate in 2017.
We would obtain more confidence in the credit if the company were to back up its statements and respond with a more concerted debt reduction plan. This would probably require an even greater equity capital injection from the Adani Group. We have not yet received a response from the issuer which is why we would be advocating patience until we have the opportunity to hear from them. We expect to be able to provide further details following discussion with the issuer.
Glencore has displayed a penchant for reducing production where it is unprofitable to them. We are concerned that the expiry of the take or pay contract at 2020 provides Glencore a pathway to reduce its coal production and not incur hefty infrastructure take or pay costs. Recent signals of lower production at its Collinsville and Newlands mines provide some justification to this concern and Glencore is currently utilising around 60% of contracted capacity. In addition, we continue to see a 60% utilisation rate at the terminal when we were expecting an increase in utilisation.
- Wholesale clients can access a full version of this article, including rating information. Click here
(note you will be required to login to your FIIG account)
Please contact your FIIG representative for further more information and current pricing levels on the Adani Abbot Point bonds.