Last week, Moody’s Investors Service, a credit rating company, downgraded the corporate family rating (CFR) of UK-based Vedanta Resources (referred to as Vedanta), a holding company of India’s metal conglomerate Vedanta Ltd.

The rating downgrade is significant to the Indian entity as Moody’s CFRs, defined as the long-term ratings on a corporate family’s debt, normally applies to all connected organisations. Both the UK and Indian businesses of the Vedanta group are very closely related and are under the same management. Thus, the rating is also applicable to the debt of Vedanta Ltd and its subsidiaries.

According to Kaustubh Chaubal, Vice-President and Senior Credit Officer, Corporate Finance, Moody’s Investors Service, the downgrade of Vedanta’s ratings was triggered by a sustained deterioration in the company’s credit profile, and the expectation that its credit metrics would become weaker.

Also, Moody’s expectation that Vedanta will pay an additional dividend towards meeting Volcan’s (Vedanta’s parent company) upcoming debt maturity, and that this would further stress the credit metrics, contributed to the downgrade.

Reasons for the downgrade

Vedanta’s CFR was downgraded by one notch from Ba3 (speculative and subject to substantial credit risk category) to B1 (speculative and subject to high credit risk category).

Moody’s expects that, over the next 12 months, Vedanta Resources would breach the credit metrics benchmarked for the previous Ba3 rating. The credit metrics considered by the rating company include debt/EBITDA (indicator of debt serviceability), EBIT/interest (indicator of a company’s ability to pay interest and other fixed charges from its earnings) and cash flow from operations, less dividends/adjusted debt (indicator of a company’s ability to repay its debt). This is on the back of a low and volatile commodity price environment, which is unlikely to significantly improve Vedanta’s earnings.

Besides, Moody’s rating action also reflects its revised view on the treatment of the loan raised in 2018 by Vedanta sole shareholder, Volcan Investments, an investment company under Chairman Anil Agarwal’s family trust.

Vedanta, once a listed company, was delisted and privatised in October 2018, when Volcan Investments bought back the balance stake from the public (about 33 per cent) using debt funds.

Moody’s earlier approach for rating was based on the expectation that Volcan will not require Vedanta to service any of its debt obligations. However, they now expect Vedanta to pay an additional dividend, supposedly to aid Volcan’s upcoming debt maturity. The additional dividend, payable now, is expected to be adjusted towards reducing dividend payments in the next fiscal.

If this happens, Moody’s expects that the separation between the two companies — Vedanta and Volcan — will blur and exert pressure on Vedanta’s credit metrics.

Further, Vedanta’s liquidity is estimated to be weak at the holding company level. Moody’s believes that the holding company will raise debt to meet its cash needs in case of a shortfall in cash flows.

Triggers to ratings revision

Going ahead, Moody’s could upgrade the CFR back to Ba3 if commodity prices improve and support an expansion in Vedanta’s earnings and free cash-flow generation. This is expected to help the company reduce its debt levels and strengthen credit metrics.

Having said that, the rating company could also further downgrade the CFR if commodity prices remain weak or Vedanta is unable to sustain and improve its cost reduction initiatives. Such an environment will weaken the company’s profitability, with a potential impact on margins.

Moody’s notes that the rating could fall further if there is any additional payment of dividends by Vedanta to Volcan; large debt-financed acquisitions by Vedanta that could materially skew its financial profile; or if there is any adverse ruling with respect to Cairn India’s (part of Vedanta Ltd) disputed tax liability (over ₹10,000 crore).

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