Fitch Affirms NCIG's Senior Debt at 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) Fitch Ratings-Sydney-September 23: Fitch Ratings has affirmed the ratings of Newcastle Coal Infrastructure Group Pty Ltd's (NCIG) senior secured debt at 'BBB-'. The Outlook is Stable. KEY RATING DRIVERS Summary: The rating is based on the coal export terminal's highly concentrated exposure to the volatile thermal coal market and small number of terminal users, which are only partly offset by its robust ship-or-pay agreements (SoPA) that feature fully contracted capacity and pricing flexibility. Fitch's breakeven analysis highlights the flexibility provided by NCIG's contractual cost pass-through framework to withstand substantial stress from higher debt costs or user defaults, although the pass-through also increases counterparty risk. Exposure to Volatile Coal Market: Volume Risk - Weaker NCIG benefits from its close proximity and rail connection to the Hunter Valley coal mining region in Australia and strong long-term contracts with users. However, it is highly exposed to the volatility and longer-term uncertainty in the market for thermal coal, which makes up around 85% of exports from the Port of Newcastle. A number of NCIG's users are owned by larger corporations, but their obligations are not guaranteed by their parent companies, creating substantial counterparty risk for NCIG. NCIG also faces potential competition from an adjacent terminal, Port Waratah Coal Services (PWCS), which charges substantially lower fees, although both facilities are fully contracted and NCIG provides customers with certain operational advantages. NCIG's capacity is fully contracted to nine shippers under rolling 10-year SoPAs. If a user defaults, the other users would fund the resulting revenue shortfall on a pro rata basis, insulating the terminal from a single user default. A protracted thermal coal-sector downturn could pressure the margins of port users and their ability to comply with the SoPAs. Default by one or more users or lower coal production at the source mines, and the consequent reduction in actual throughput would raise terminal fees per tonne of coal shipped for the remaining users, increasing any financial stress. This risk, combined with NCIG's high cargo and customer concentration and nearby competition, negatively affects the volume risk assessment and, ultimately, the issuer's overall credit profile. Full Cost Pass-Through: Price Risk - Stronger NCIG benefits from a strong ability to modify tariffs, including full pass-through to users, with only financing costs subject to a cap. Monthly user fees are based on budgeted costs, but NCIG is able to revise tariffs if costs are higher than it expected. User-Funded Capital Programme: Infra-Renewal Risk - Midrange NCIG, established in 2010, is well-maintained and completed its latest expansion in 2013, during which capacity increased to 66 million tonnes per annum (mtpa), with actual throughput of 53 million tonnes in the financial year ended June 2019 (FY19). The terminal completed a programme in 2017 that increased its ability to operate at a higher capacity rate of 75mtpa, although this would only be used for short periods to accommodate customer requirements, as an increase above 66mtpa on an annual basis would require license revisions and environmental approvals. Users are contractually required to fund NCIG's capital programme costs on an uncapped basis, including capital expenditure, repairs and maintenance. The infra-renewal attribute assessment is constrained to 'Midrange' due to the terminal's dependence on the uncertain long-term economic performance of the source mines, which are exposed to the volatile thermal coal market. Well-Managed Refinancing Risk: Debt Structure - Midrange NCIG's debt structure benefits from a substantial interest-rate hedging programme, which limits the current floating-rate exposure to an average of 20% over the next five years. The risk of rising interest rates is largely mitigated by the financing cost pass-through, subject to a cap. The senior debt benefits from a USD85 million debt-service reserve account, which is sufficient to cover six months of senior debt service, as well as from distribution lockup covenants and default debt-service coverage ratio (DSCR) covenants. However, the ratio levels are set lower than for similar assets. The debt structure entails a variety of bullet and partially amortising instruments, which must be refinanced on an ongoing basis and will fully amortise by 2038. This is mitigated by NCIG's broad borrowing base - including bank debt, US private placements, the Rule 144A and Regulation S market, and the syndicated Japanese debt market - and by the issuer's well-laddered debt maturity profile. NCIG's management has consistently demonstrated its ability to refinance debt well in advance of maturity. Overall, we assess debt structure risk as 'Midrange'. Financial Profile The cost-recovery nature of NCIG's revenue makes traditional debt metrics less relevant. Fitch has therefore utilised breakeven analysis to determine the stress level that can be sustained while maintaining a minimum 1.0x DSCR and staying within the finance cost recovery cap. For interest-rate stress, the analysis demonstrates that NCIG can withstand an increase in the average cost of senior debt over the next five years to at least 19% (from 5.1% at FYE20 in our rating case). For contracted-capacity stress, Fitch's analysis shows that NCIG can sustain a default of up to 60% of its currently contracted capacity or an annual 6% constant decline between now and debt maturity in 2038. We consider this credit positive. PEER GROUP Queensland-based DBCT Finance Pty Limited (senior secured rating: BBB-/Stable) and Adani Abbot Point Terminal Pty Ltd (AAPT, senior secured rating: BBB-/Stable) are NCIG's closest peers. All three coal export terminals have ship-or-pay contracts with users, but NCIG's rolling 10-year contract terms are longer than those of DBCT and AAPT, with much stronger termination provisions. All terminals have full operating cost pass-through frameworks. Some of NCIG's debt is partially amortising, but carries substantial refinancing risk, as does that of DBCT and AAPT. DBCT's and AAPT's concession terms, extending to 2100 and 2110, respectively, are substantially longer than that of NCIG, which terminates in 2053 (including a 10-year extension). NCIG mainly ships thermal coal, while DBCT's and AAPT's throughput is primarily metallurgical coal, which Fitch sees as a more stable commodity with greater predictability of price and long-term demand. RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action: - a sustained rise in coal prices that leads to substantial increases in coal production in the Hunter Valley region; and - amortisation of senior debt substantially faster than currently planned. Developments That May, Individually or Collectively, Lead to Negative Rating Action: - contracted capacity falling due to customer default or a coal-price downturn for a sustained period, making it substantially more likely that a default will occur; - NCIG failing to complete debt refinancing well in advance of scheduled maturities; and - any re-gearing, or debt amortisation slower than in NCIG's current plan. CREDIT UPDATE Performance Update Spot prices for both metallurgical and thermal coal declined considerably in 2019, with thermal coal dropping to below USD70/tonne and metallurgical coal at around USD150/tonne. While the lower prices will impact the cash flows of NCIG's coal-mine customers, they benefit from being mainly in the lower half of the global cost curve for seaborne coal exporters. NCIG's FY19 operating costs were higher than in FY18 due to increased investment in maintenance of long-term assets.. NCIG's margins are not affected by changes in its cost level, due to its ability to pass through operating costs to customers. NCIG remained active in the financing markets, completing a USD340 million partially amortising bank debt facility in June 2019 with seven banks. The proceeds are being used to refinance a US private placement due to mature in December 2019, and other debt facilities with maturities in 2020 and 2021. NCIG also entered into USD327 million of interest-rate swaps in June 2019, substantially hedging exposure to floating interest rates. Fitch Cases Fitch's base and rating cases assume the terminal's capacity is fully contracted over the life of the senior debt, which is rated based on its contractual framework, disregarding actual and projected terminal throughput. The average DSCR under Fitch's cases is 1.4x, in line with the current rating. However, the comparability of Fitch's average DSCR calculation is limited by NCIG's ability to adjust revenue to recover operating and financing costs, with the latter subject to a cap. Fitch focused on breakeven analysis, which highlights NCIG's ability to withstand an increase in the average cost of senior debt to 19% over the next five years, from 5.1% in FY20 in our rating case. The terminal's resilience to a loss of at least 60% of contracted capacity in Fitch's analysis is credit positive. Asset Description NCIG owns and operates a 66mtpa coal export terminal under a long-term lease that extends to 2053 (including a 10-year extension option). The terminal is located at the Port of Newcastle in New South Wales, Australia. Contact: Primary Analyst David Cook Director +61 2 8256 0363 Fitch Australia Pty Ltd Level 15, 77 King St Sydney NSW 2000 Secondary Analyst James Hodges Associate Director +61 2 8256 0377 Committee Chairperson Sajal Kishore Senior Director +65 6796 7095 Media Relations: Peter Hoflich, Singapore, Tel: +65 6796 7229, Email: peter.hoflich@thefitchgroup.com; Leslie Tan, Singapore, Tel: +65 6796 7234, Email: leslie.tan@thefitchgroup.com. 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