Rating outlook stays negative: Moody’s downgrades Wapda’s CFR & BCA to Caa1

ISLAMABAD: The Moody's Investors Service has downgraded Pakistan Water and Power Development Authority’s (Wapda) Corporate Family Rating (CFR) and Baseline Credit Assessment (BCA) to Caa1 from B3. The outlook remains negative.

This rating action follows Moody's downgrade of Pakistan's ratings to Caa1 with a negative outlook on 6 October 2022.

"The rating action on Wapda reflects the close linkage of its credit quality with that of the government of Pakistan, given the government's full ownership and direct supervision of the company, as well as the fact that Wapda operates solely in Pakistan," says Yong Kang, a Moody's analyst.

The rating agency stated that Wapda's Caa1 CFR is primarily driven by its Caa1 BCA and Moody's assessment of a high likelihood of support from, and a very high level of dependence on, the Government of Pakistan (Caa1 negative) when needed, under Moody's Joint Default Analysis (JDA) for government-related issuers.

Wapda's BCA reflects its position in Pakistan's power sector as a dominant hydropower supplier, as well as the recurring financial support it receives from the government. At the same time, the BCA is constrained by the company's weak financial profile due to its sizeable hydropower capacity expansion plan, the long receivables cycle and delayed tariff decision. The adverse impact of recent floods and the technical fault at Neelum-Jhelum hydropower plant will further weigh on its credit quality, at least over the next couple of quarters.

Moody's expectation of a high likelihood of government support for Wapda considers the Pakistani government's full ownership and direct supervision of the company. It also reflects the company's strategic importance to the government, as it is an important platform that constructs and operates hydropower assets to supply affordable electricity in Pakistan, and builds water storage facilities to help address the country's acute water challenges.

However, such considerations are offset by the risks stemming from the government's low policy predictability and transparency. In addition, the financial challenges faced by the government, as reflected in its Caa1 ratings, indicate its limited capacity to provide support to Wapda.

Although there is no explicit uplift incorporated in the rating, the high likelihood of extraordinary support indicates some degree of stability in Wapda's credit quality even if its BCA were to be lowered, assuming there is no material change in the relationship between Wapda and the government.

The company's delays in collecting revenue are mainly driven by the significant cash shortfall at the Central Power Purchasing Agency (CPPA), the state-owned agency that purchases power from generation companies on behalf of the nation's distribution companies.

This shortfall mainly stems from, the gap between low end-user electricity tariffs and high thermal power-generation costs, high transmission losses, and the low recovery from end-users on electricity tariff payments, which increases CPPA's leverage and constrains its repayment capabilities.

Moody's projects Wapda's funds from operations (FFO) to debt ratio will remain weak at the low-single-digit percentage over the next one to two years, mainly driven by, the technical fault at Neelum Jhelum hydropower plant; the company's sizeable capital spending plans to expand its hydropower capacity; and the continued delay in collecting electricity revenue, which will pressure the company's working capital.

In terms of environmental, social and governance (ESG) factors, Moody's has considered that Wapda is exposed to environmental risks mainly because of physical climate risks in the form of extreme weather patterns. Such risks are partly offset by its positive carbon transition exposure as a hydropower generator.

As for social risk considerations, Moody's has factored in the weak track record of timely tariff adjustments, driven by affordability concerns. Moody's has also considered WAPDA's high financial leverage stemming from its aggressive capital spending plan, relatively weak risk management as shown by its technical fault and cost overrun, and concentrated ownership in its assessment of the company's governance risk.

The negative outlook on the rating mirrors the negative outlook on Pakistan's sovereign ratings, given the close linkage of Wapda's credit quality with that of the government.

Moody's could change the outlook to stable or upgrade WAPDA's rating if the agency takes a positive rating action on the sovereign and there is no material change in the relationship between Wapda and the government.

Moody's could downgrade Wapda's rating if Pakistan's sovereign rating is downgraded or the company's BCA weakens significantly.

The BCA could be lowered if Wapda's profitability or financial position further weakens because of, changes in Pakistan's regulatory environment, the company's aggressive debt-funded investments, without timely tariff adjustments, and/or further delays in its collection of electricity revenue.

However, a moderate weakening in Wapda's BCA is unlikely to immediately lead to a downgrade of its rating, because of the high likelihood of extraordinary support from the Pakistan government.

Copyright Business Recorder, 2022