Dec 10 -
Summary analysis -- Cheung Kong Infrastructure Holdings Ltd. ------ 10-Dec-2012
CREDIT RATING: A-/Stable/-- Country: Hong Kong
Primary SIC: Heavy
Mult. CUSIP6: 166745
Credit Rating History:
Local currency Foreign currency
02-Jul-1997 A-/-- A-/--
The rating on Hong Kong-based Cheung Kong Infrastructure Holdings Ltd. (CKI) reflects our view of the benefits the company derives as a core subsidiary of the wider Cheung Kong group. The rating on CKI is equalized with that on Hutchison Whampoa Ltd. (A-/Stable/--; cnAA/--), which owns 76.39% of CKI.
We assess CKI’s stand-alone credit profile (SACP) as ‘a-', reflecting the company’s “strong” business risk profile and “intermediate” financial risk profile. CKI has stable cash flows due to investments in regulated utilities in developed markets, a strong market position, and good portfolio diversity. The company’s above-average appetite for acquisitions and inherent subordinated equity cash flows moderate these strengths.
The regulated utilities in the developed markets in which CKI has invested have strong to excellent business risk profiles. These assets have a natural monopoly in their service areas. The transparent and established regulatory regimes in these markets are credit protective and result in steady and predictable cash flows for the utility companies within each regulatory period.
In our view, the periodic regulation review of tariffs on regulated utilities represents a major risk for CKI’s investments in these markets and the cash flows that the company derives from them. But CKI’s diverse portfolio partly mitigates such risk.
CKI’s portfolio diversity has improved since the company led a consortium to acquire and privatize the parent of the U.K. water utility company Northumbrian Water Ltd. (BBB+/Stable/--) in October 2011 and also the acquisition of Wales & West Utilities, a gas distributor in the U.K. CKI’s infrastructure investments have good diversity in terms of geography and sectors.
We believe CKI’s U.K. assets will become the largest contributor to the group’s income as well as cash flows over the next two years, due to significant contribution from UK Power Networks Holdings Ltd. (BBB/Stable/--and Northumbrian Water. Profit contributions from the U.K.-based assets rose 45% year-over-year for the first half of 2012. The U.K. assets have begun contributing more profits to CKI than Power Assets Holdings Ltd. (A+/Stable/--; cnAAA/--), which owns the electricity generation and distribution monopoly in Hong Kong Island.
CKI’s cash flow tends to be subordinated to third-party debt at the operating company level. Nevertheless, tempering these risks are the company’s management and operational control over these investments, its flexibility and willingness to divest when needed, and the size and diversity of its portfolio. We believe the company may provide capital for expansion and liquidity support to these projects when it sees it fit to continue to invest in them.
In our opinion, CKI’s above-average appetite for acquisitions and the financing of recent acquisitions primarily through debt have weakened its financial strength.
We expect CKI’s financial performance to improve in 2012 compared with a year ago following contribution from the Northumbrian Water acquisition. At the corporate level, we anticipate that CKI’s ratio of adjusted funds from operations (FFO) to debt will improve to about 25%-28% at the end of 2012 from 19.7% a year ago. Its FFO interest coverage may rise to about 7x from 5.6x. In the absence of large debt-funded acquisitions, we expect CKI’s adjusted FFO-to-debt ratio to improve to over 30% over the next two years due to the FFO contribution from Northumbrian Water and its other U.K. assets. We consider the US$1 billion in perpetual capital securities that CKI issued in September 2010 as having “intermediate” equity content, and treat 50% of the principal as equity and 50% as debt in our calculation of financial ratios.
We analyze CKI’s adjusted cash flow protection at both the corporate and the group level; when analyzing group-level metrics, we consolidate the company’s key investments in associates, which mostly have “significant” financial risk profiles.
We view CKI’s liquidity as “strong,” as defined in our criteria underpinned by recurring cash flows from dividends. The company’s liquidity sources should exceed its uses by more than 2x for the next 12 months. Our liquidity assessment is based on the following factors and assumptions:
-- The company’s near-term liquidity sources include cash and bank deposits of Hong Kong dollar (HK$) 8,711 million as of June 2012, and our FFO forecast of HK$5,900 million. In 2012, CKI raised HK$4.6 billion through share placements and US$300 million (about HK$2.3 billion) by issuing perpetual securities. We estimate the company’s current cash and bank deposits at about HK$7 billion.
-- Liquidity uses include estimated dividends of about HK$3,900 million and committed capital expenditure of around HK$350 million.
-- We believe CKI’s net sources should remain positive, and the company will be in compliance with its financial covenants even if EBITDA declines by 15%.
-- CKI has good banking relationships and access to the capital markets, which helps it to maintain strong financial flexibility.
We note that CKI’s investment portfolio mostly comprises listed equities and listed notes issued by corporate entities with investment-grade ratings. The portfolio has a fair market value of HK$5,509 million as of June 30, 2012. We do not include these securities in our liquidity calculation. Nevertheless, we believe these marketable securities can boost CKI’s liquidity, if needed.
The stable outlook reflects CKI’s business risk profile and the outlook on the company’s parent, Hutchison Whampoa. The stable outlook also reflects our expectation that CKI will carefully manage its debt leverage while contemplating new investments.
We may lower the rating on CKI if: (1) we downgrade the company’s parent; or (2) CKI’s SACP deteriorates materially, adversely affecting the parent’s credit profile.
We could lower CKI’s SACP if: (1) the credit profiles of the company’s major invested entities deteriorates substantially; or (2) CKI’s investment risk appetite increases with more debt-funded acquisitions, which will reduce the company’s credit strength by increasing leverage more than we expect. An adjusted FFO interest coverage at the corporate level of less than 5x or an adjusted FFO-to-debt ratio of less than 20% on an ongoing basis would indicate an increase in risk appetite.
We see only a limited potential to raise the rating on CKI unless we upgrade the parent. CKI’s debt-funded acquisition strategy currently caps the potential upside to the SACP.