Solar Tariffs have Room to Fall Further; Debt Viability Remains Intact : Ind-Ra

Solar tariffs are likely to fall further on a reduction in capital costs and solar power companies’ access to competitive funding, says India Ratings and Research (Ind-Ra). Despite aggressive bidding, debt viability of projects with low execution and counterparty risks (especially those under the Jawaharlal Nehru National Solar Mission scheme and Solar Park scheme), is likely to remain intact. 

However, creditors will have to avoid the pitfalls of thermal power where aggressive assumptions and leverage build up at the holding company level to fund equity contributions in underlying special purpose vehicles resulted in significant stress. The solar sector has huge potential and if developed responsibly, it could transform the structure of India’s power sector. 

Ind-Ra expects that the developers will favour projects under the Jawaharlal Nehru National Solar Mission scheme state projects on account of healthy credit profiles of the off-taker i.e. NTPC Ltd (‘IND AAA’/ Stable/‘IND A1+’) compared to weak credit profile of the state distribution companies. We expect that the projects floated under the viability gap funding (VGF) scheme will attract larger participation provided the tariffs remain above INR5/kWh. Ind-Ra believes that with the increase in competition, a scenario of developers paying premiums instead of availing VGF funding (similar to the road project tenders back in 2012) cannot be ruled out. 

The internal rate of return (IRR) for the recently awarded solar projects is likely to shrink to 12%-14% from the over 20% registered by projects awarded over the past few years. Despite this, Ind-Ra believes that the credit profile of the projects will remain comfortable with an average debt service coverage ratio of 1.3x. The capital cost could fall in the medium term and as a result lower bids to, or below, INR4/kWh by FY17. Ind-Ra expects capacity additions to remain robust with 12.5GW to be added by FY18, taking the cumulative capacity to 17GW in FY18 from 4.9GW in December 2015. However, it will still fall short of achieving the government of India’s target of 19GW by FY18. The government plans to increase renewable energy capacity to 175GW by 2022 including 100GW of solar capacity (60GW from ground mounted and 40GW from rooftop installations). 

Ind-Ra’s analysis of recently bid solar projects indicates that a 1% improvement in the capacity utilisation factor will result in a 2% increase in the IRR. Our analysis also indicates that the capital cost and tariff prices go hand in hand. For example, a project at a tariff of INR4.64/kWh and a capital cost of INR46.4m/MW will generate an IRR of 12%. Additionally, cheaper debt at 9% (typically in foreign currency with a hedging cost of 4%) will improve the IRR to 14%. Ind-Ra’s sensitivity analysis indicates that if the capital cost were to remain at INR55m/MW, a project with a tariff of INR4.64/kWh will fetch an IRR of 7% with a weak-to-moderate average debt service coverage ratio of 1.15 xs. 

Ind-Ra believes that the module prices have bottomed out; however they would increase in 1H2016 due to increasing demand from China and the US. Despite this, the capital cost could reduce further on contracting balance of system costs, indicating that commodity prices especially the price of steel would remain benign and competitive intensity between suppliers would stay high. The decline in the cost of inverters coupled with technological advancements and higher efficiency will further reduce capital costs. 

The weak credit profiles of the state distribution companies, except those in Punjab and Gujarat, remain an area of concern for the power sector resulting in risk of delay in receivables. This would be a major concern as most of the capacity additions are expected from the southern Indian states, which have weak distribution companies. This coupled with the double leverage adopted by developers could put further pressure on the project cash flows and could build up additional leverage at the holding company, limiting the flexibility available in the group to absorb any downside risks on cash flows. 

Solar generation contributes 13% to the total renewable energy source, second only to wind which contributes 65%. Capacity installations in solar power generation have grown at a CAGR of 50% between FY12 and December 2015. Rajasthan and Gujarat have been at the forefront with cumulative installed capacities of 1.26GW and 1.0GW respectively. However, going by the present pace of project awarding by different states, we believe that Andhra Pradesh and Telangana are likely to outpace Rajasthan and Gujarat by FY18. This is primarily due to the high land cost in Gujarat, saturation of solar generation and delay in project awarding by the state authority coupled with robust awarding activity by Telangana and Andhra Pradesh at state as well as central level. 

Ind-Ra believes that operational projects with power purchase agreements at higher tariff levels will remain exposed to the risks of renegotiation at some stage. While contractual arrangements provide protection, a consistent decline in tariffs and the perilous position of the sate distribution companies may resist them to honor their offtake obligations. This will affect debt serviceability of existing projects as they were built with higher capital costs cost and consequently with larger debt.