| A key development within the capital markets in the Middle East is the increased use of Standard & Poor’s credit ratings. Infrastructure companies, mostly utilities within the area are looking to capitalise and harness investors growing appetite for their assets. Jan Willem Plantagie, a director in the Infrastructure Finance Group, discusses the recent ratings Standard & Poor’s has assigned to infrastructure credits in the Middle East and the current market trends
We at Standard & Poor’s have recently assigned our first corporate rating in the United Arab Emirates (UAE) to the district cooling company – National Central Cooling Co. PJSC (Tabreed). This represents our first public corporate infrastructure credit rating in the Middle East. The rating is ‘BBB-’ with a stable outlook. We have also rated Tabreed’s $200 million sukuk trust certificates at ‘BBB-’, being issued by special-purpose entity (SPE) – Tabreed 06 Financing Corp. These assignments follow the preliminary ‘AAA’ insured and ‘BBB’ underlying ratings allocated in April to the bank loan of a Middle Eastern sewerage project based in Ajman. This was not only the first publicly rated project finance transaction in the UAE by Standard & Poor’s but also the first rated project bank loan in the UAE.
These rating assignments illustrate the growing trend towards the use of credit ratings in the Middle East including for Islamic financing. Ratings are increasingly used as a tool to support diversifying the investor base, attract capital from outside the Middle East and improve transparency. Given the extraordinary levels of investments that are anticipated in the region to improve the countries’ infrastructure, at Standard & Poor’s we expect to see a significant increase in the use of Islamic financing, with credit ratings helping companies place this debt among domestic and international investors. The growing use of credit ratings, as exemplified by Tabreed and the Ajman Sewerage project, will ensure the Middle East harnesses investor interest and maintains market discipline.
Credit strengths of Tabreed
The assignment of ‘BBB-’ long-term corporate credit rating to UAE-based Tabreed took place on June 13, 2006. Several key strengths are reflected in this rating – significantly the utility’s dominant position in district cooling in the UAE. Tabreed is one of the world’s largest district cooling companies – designing, engineering, financing and operating district cooling facilities, and providing chilled water for air conditioning.
The low operating risk associated with Tabreed’s plants is another support for its credit quality. The plants have a high level of redundancy in operation and very high levels of reliability. Also, a high proportion of Tabreed’s business is contracted, with its revenue stream based upon these stable, long-term contracts, which further supports credit quality. These contracts are characterised by a fixed capacity rate based on availability, and a variable rate on top. This allows Tabreed to hedge against inflation and fuel cost increases, by passing cost increases onto customers.
Offtakers typically include army units, big infrastructure or commercial and residential properties.
At Standard & Poor’s we recognise the strong economic rationale for Tabreed’s products, which are a credit positive for the company. The high temperatures deem the product offering almost an “essential” service and the strong ongoing growth in large apartment block construction and public transport projects in the UAE is likely to fuel continued demand. Further to this, the lower long-term costs of district cooling compared to traditional air conditioning units – aided by the economies of scale the large, centralized plants are achieving – has been a strong factor in the UAE government’s support for this type of product. Contractual ties with the UAE government, as well as a cash flow that is resistant to downside, boost Tabreed’s credit strengths.
The UAE Offsets Group – established by the government as an independent body with the aim of supporting private sector bids for commercial projects – is a significant shareholder in Tabreed
Tabreed’s credit weaknesses
The above credit strengths are offset by several weaknesses at the BBB- rating level. Primarily, we see Tabreed’s aggressive financial structure acting as credit negative – with free cash flows expected to be significantly negative until 2010, reflecting the very high levels of forecast capital expenditure when compared to its existing asset base. In this time frame, we expect cooling capacity to more than quadruple, with projects representing capital expenditures of approximately UAE dirham (AED) 4 billion ($1.1 billion). This will largely be funded via an AED 2.38 billion ($650 million) increase in debt between now and 2010.
Tabreed recently asked Standard & Poor’s to rate its issuance of $200 million sukuk trust certificates which will go towards its expansion programme. We assigned a ‘BBB-’ senior secured debt rating on June 15, 2006, the same as the corporate credit rating on Tabreed – illustrating that the certificates benefit from the similar security structure to the utility’s other senior debt.
Within its expansion programme, Tabreed intends to increase its portfolio of district cooling plants to more than 35 by 2008, from the 17 currently in operation. The company intends to widen its focus not only on contracts in Abu Dhabi, but other markets in the region as well, such as Dubai, Qatar, and Saudi Arabia. We find that the company has good prospects in successfully operating in these markets.
The substantial amount of planned construction creates contracting and construction risk for Tabreed. However, construction risk is somewhat mitigated as Tabreed does not take on speculative construction plans, instead signing offtake contracts covering the base output of a proposed plant prior to commencing construction. Much of the risk of construction costs overruns is similarly mitigated, with the risk being passed on to investment grade construction entities with whom Tabreed enters into fixed price and EPC turnkey contracts. The relative standardization of design, lack of complexity and proven technology further offsets construction risks.
We see as a negative credit factor Tabreed’s high, but reducing exposure of revenues to a single counterparty – the UAE military which accounted for 85%-95% of total Tabreed cooling revenue over the last three years. Tabreed’s contract with the military carries relatively loose termination provisions. However, we at Standard & Poor’s expect that termination is unlikely mainly due to Tabreed’s good track record and the limited alternatives of experienced providers to army zones.
We view the threat of greater competition is another weakness for Tabreed. Lack of direct government regulation in the industry means competition can come in at any stage. Yet, the significant barriers to entry from the high capital costs mitigate this risk – with traditional cooling methods representing the greatest competition going forward.
Islamic financing on the up
We at Standard & Poor’s expect the ratio of secured debt to assets at Tabreed to be more than 20% by the end of 2006. If this is the case, we will rate any unsecured debt one notch below the ‘BBB-’ corporate credit rating on Tabreed.
At present, Tabreed is roadshowing the $200 million sukuk trust certificates and the credit rating we assigned is proving a big support, placing Tabreed on the map with international investors. It shows that Standard & Poor’s credit ratings are also a valuable tool in Islamic Finance.
Indeed, this recent issue by SPE Tabreed 06 Financing Corp highlights the trend towards getting Islamic financing rated be it for a corporate, project, financial institution or sovereign entity. We expect that utilities in the Middle East will increasingly look towards Standard & Poor’s credit ratings to support widening the investor base, develop and deepen local capital markets and enhancing transparency.
Ajman Sewerage Bank Loan
Prior to the debut private corporate credit rating in the Middle East assigned to Tabreed, we had previously rated a UAE project’s debt issuance. Important to note was that the debt was a bank loan and benefited from a monoline insurance policy.
On April 7, 2006 we assigned our preliminary ‘AAA’ guaranteed rating to Ajman Sewerage (Private) Co. Ltd’s $100 million senior secured bank loan – due in 2025. The outlook on the debt is stable. We simultaneously assigned a preliminary underlying rating of ‘BBB’ to the loan. In addition to this, we assigned a recovery rating of ‘3’ to underlying debt, indicating our belief that there will be meaningful recovery of principal, in the range of 50%-80%, in the event of a default.
The ‘AAA’ rating reflects the monoline guarantee being provided by Ambac Assurance UK Ltd. This transaction therefore represents the notable reappearance of monoline insurance in the Middle East.
The underlying investment grade rating accounts for the significant project strengths. Importantly, there is a strong level of explicit support from the Emirate of Ajman, having revised its long-term concession agreement – allowing for tariffs to be adjusted for inflation and exchange rates changes between the U.S. dollar and the UAE dirham. The government has also increased its shareholding in the project, and provides specified minimum payments. It also helps collect connection fees that underpin about 40% of the revenue flows to the project during its construction phase.
This is significant as the project had previously defaulted, bringing construction to a halt in 2004, due to collection rates substantially behind those necessary to support the initial funding of the project.
Other strengths include the monopoly position of the sewage utility throughout the UAE once operational, as underpinned by the enactment of the Sewer Law requiring all sewage to be treated by Ajman. This also supports the bank loan’s credit quality, along with the project’s strong economic and environmental rationales.
The strengths we have acknowledged are offset by several weaknesses. These include the reluctance of some property owners in the Emirate of Ajman to pay connection fees, and the resulting exposure of revenues to potentially slow collection rates that lead revenues to fall short of the total billed. Construction risk exists as both the network and the treatment plant is only partly constructed, having been started in 2002, providing a credit negative. Similarly, the moderately weak covenants and evolving legal framework for projects in the Emirate of Ajman add to the weaknesses in the project.
It is our belief that further infrastructure projects will follow Ajman Sewerage and seek Standard & Poor’s credit ratings. Further boosting the demand for ratings in the Middle East.
Further information is available on Ratings Direct in the research updates entitled: “UAE-Based National Central Cooling Co. Assigned ‘BBB-’ Long-Term Rating; Outlook Stable”, “Ajman Sewerage Bank Loan Assigned Prelim ‘AAA’ And ‘BBB’ Ratings; Outlook Stable”, and research entitled “Tabreed 06 Financing Corp. $200 Million Sukuk Trust Certificates Rated ‘BBB-’; Outlook Stable”
|
