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

(The following statement was released by the rating agency) Fitch Ratings-Sydney/Hong Kong-18 September 2020: Fitch Ratings has affirmed the ratings of Newcastle Coal Infrastructure Group Pty Ltd's (NCIG) senior secured debt at 'BBB-'. The Outlook is Stable. RATING RATIONALE 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. This exposure is mitigated 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. The coronavirus pandemic and government containment measures worldwide have created an uncertain global environment for the seaport sector. NCIG's most recently available issuer data may not have indicated an impairment in performance, but material changes in revenue and cost profile are occurring across the sector and will continue to evolve as economic activity and government restrictions respond to the ongoing situation. Fitch's ratings are forward-looking in nature, and we will monitor developments in the sector as a result of the pandemic's severity and duration, and incorporate revised base- and rating-case qualitative and quantitative inputs based on our expectations for future performance and assessment of key risks. KEY RATING DRIVERS 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 NCIG is fully contracted and 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 54.5 million tonnes in the financial year ended June 2020 (FY20). In August 2020, NCIG received approval from the Department of Planning, Industry and Environment to increase the maximum throughput of the NCIG terminal from 66mtpa to 79mtpa. NCIG does not intend to fully realise this increase immediately, rather the increase is simply aligning the approval limits with the capability of the infrastructure in place. 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 30% over the next five years. The risk of rising interest rates is 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 used 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 could withstand an increase in the average cost of senior debt over the next five years to at least 18% (from 4.5% 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: BB+/RWN) 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 Factors that could, individually or collectively, lead to positive rating action/upgrade: - 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. Factors that could, individually or collectively, lead to negative rating action/downgrade: - 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. Best/Worst Case Rating Scenario International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579]. TRANSACTION SUMMARY 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. CREDIT UPDATE Spot prices for thermal coal have continued to decline in 2020 to around USD50/tonne currently. The lower prices will affect the cash flows of NCIG's coal-mine customers, but they benefit from being mainly in the lower half of the global cost curve for seaborne coal exporters. NCIG's FY20 operating costs were broadly in line with FY19, and reflect ongoing 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. FINANCIAL ANALYSIS 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 at least 18% over the next five years, from 4.5% in FY21 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. 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. ESG Considerations NCIG has an ESG credit relevance score of 4 for Governance: Management Strategy. This is because the company's bullet-amortisation debt structure compounds the risk of limited refinancing options due to lenders' increasing concerns over coal assets. Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit neutral or have only a minimal credit impact on the entity(ies), either due to their nature or the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. Newcastle Coal Infrastructure Group Pty Ltd ----Newcastle Coal Infrastructure Group Pty Ltd/Debt/1 LT; Long Term Rating; Affirmed; BBB-; RO:Sta Contacts: Primary Rating Analyst James Hodges, Associate Director +61 2 8256 0377 Fitch Australia Pty Ltd Suite 15.01, Level 15 135 King Street Sydney 2000 Secondary Rating Analyst Louis Pang, FRM Associate Director +852 2263 9992 Committee Chairperson Sajal Kishore, Senior Director +65 6796 7095 Media Relations: Peter Hoflich, Singapore, Tel: +65 6796 7229, Email: peter.hoflich@thefitchgroup.com Alanis Ko, Hong Kong, Tel: +852 2263 9953, Email: alanis.ko@thefitchgroup.com Wai Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@thefitchgroup.com Additional information is available on www.fitchratings.com Applicable Criteria Infrastructure and Project Finance Rating Criteria (pub. 24 Mar 2020) (including rating assumption sensitivity) (https://www.fitchratings.com/site/re/10114533) Ports Rating Criteria (pub. 24 Mar 2020) (including rating assumption sensitivity) (https://www.fitchratings.com/site/re/10114315) Applicable Model Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s). 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