Fitch Ratings has affirmed Lonsdale Finance Pty Ltd’s Long-Term Issuer Default Rating (IDR) at ‘BBB’ with a Stable Outlook. Lonsdale Finance is the issuing entity for the Port of Melbourne.
The rating reflects the Port of Melbourne’s role as a primary port of call serving the Victorian and broader Australian market, with a diversified landlord port business model benefiting from a stable regulatory regime and a portfolio of long-term property leases governing the operation of its established port facilities. The company’s debt structure is senior, but the lack of strong covenants, a non-amortising profile, high gearing and considerable refinancing risk constrain its rating.
The coronavirus pandemic and related worldwide containment measures have created an uncertain global environment for the ports sector. Port of Melbourne’s performance data, through the most recently available issuer data, indicate limited impairment, however, revenue and cost changes are occurring across the port sector and will continue to evolve along with economic activity and government restrictions in response to the pandemic. Fitch’s ratings are forward-looking in nature; Fitch will monitor the severity and duration of pandemic-related developments in the sector and revise the qualitative and quantitative inputs in its base- and rating-cases in accordance with its performance expectations and key risk assessments.
KEY RATING DRIVERS
Primary Port of Call – Revenue Risk (Volume): Stronger
The Port of Melbourne is one of Australia’s largest container ports by throughput, handling 2.9 million twenty-foot equivalent units (TEU) in the financial year ended June 2020 (FY20). This accounted for around 37% of Australia’s mainland capital-city total container traffic. The facility has over 30 commercial berths with a diverse range of operations, including motor vehicles, dry bulk, break bulk and liquid bulk cargos, in addition to containers. However, some areas of the port have limited ability to accommodate the largest ships proposed for Australian shipping routes because the Yarra River and Westgate Bridge impose access constraints.
The port is in a strategic position in the heart of Melbourne, the state capital of Victoria and its largest city. It is a strong regional port with limited competition and the trade hub for Victoria, southern New South Wales, eastern South Australia and Tasmania. Victoria is Australia’s most densely populated state and relies less on mining than other states, limiting commodity-price exposure and insulating the economy from mining-sector volatility. The strategic location limits the ability of shipping lines to redirect cargo on an ongoing basis; therefore, it will remain a port of call to serve this region.
Supportive Regulatory Regime, Leases – Revenue Risk (Price): Stronger
The port’s trade-based tariff increases are set under a stable, transparent regulatory regime and monitored by an external independent body, providing high pricing certainty to the port and users. Tariff limits will be relaxed after 2037 at the latest, allowing faster increases than inflation to enable the port to earn a market return on its asset base and recover efficient costs.
The port has also secured long-term lease agreements, which provide unregulated and stable cash flow of around one-third of total revenue. Most of the leases have fixed increases at the greater of CPI+1.5% or 4.0% and some are in place for the length of the port’s concession. In October 2020, the Essential Services Commission (ESC) undertook the first market rent inquiry covering the period 1 November 2016 to 31 October 2019, which examined the port’s contractual arrangements and the extent to which the land rents paid are passed through to Victorian consumers. The commission has recommended changes to improve transparency in the negotiation process and for resolving disputes. We do not believe that these recommendations will affect the port’s financial profile in the medium-term.
Well-Developed Port Facilities – Infrastructure Development and Renewal: Stronger
One of the port’s major precincts, Webb Dock, benefits from recent redevelopment, including a third container terminal – one of the world’s most advanced with a high degree of automation. The port is not yet at full capacity, so we expect short-term capex requirements to average at around AUD100 million a year.
The harbour master has approved for the Swanson Dock container terminal on the Yarra River to cater for vessels up to 10,000 TEU. We expect Webb Dock to be able to accommodate vessels of up to 14,000 TEU, subject to infrastructure investment and operational improvements over time. Accordingly, Port of Melbourne does not expect ship size to affect the port’s competitive position.
Staggered Bullet Maturities – Debt Structure: Midrange
Lonsdale Finance’s debt structure, while mostly senior in priority, is characterised by considerable refinancing risk, exclusive use of bullet maturities and a back-loaded profile with a debt balance that increases over time due to debt-funded capex requirements. A portion consists of deeply subordinated shareholder loans, but creditors are all equity partners and therefore Fitch considers this an equity instrument. The lack of structural features, such as a dedicated debt service reserve, also limits the debt structure assessment.
Fitch’s model assumes a majority of fixed-rate debt in the future. Fitch sees the treasury policies that lay out management’s debt structure and liquidity goals as positive, despite the limited covenants, but this does not fully mitigate the maturity profile or refinancing risk.
Fitch’s rating case, which assumes that volume will remain subdued in FY21 before returning to FY19 levels in FY22, results in average net debt/EBITDA of 8.5x over the next five years, dropping from 9.2x in FY21 to 7.7x in FY25 due to rising EBITDA, even while the net debt balance increases due to the non-amortising debt structure along with debt funding of certain capex amounts over time.
Fitch has also established a severe downside case that assumes a greater decline in volume and a slow recovery profile to achieve FY19 volume by FY25. This scenario results in an average net debt/EBITDA of 9.1x over the next five years, falling to under 8.5x by FY25.
Key peers include British port group ABP Finance Plc (senior note rating, A-/Stable) and the US-based Port of Houston Authority (TX) (bond rating, AA/Stable). Similarly to the Port of Melbourne, ABP has a diverse throughput mix and functions as the port landlord, albeit for multiple ports; this reduces operational risk significantly for both issuers. The Port of Melbourne has a rating case five-year average net debt/EBITDA of 8.5x, higher than ABP’s five-year average net debt/EBITDA of 7.2x.
The Port of Houston’s throughput is diverse, and we assess the port as ‘Stronger’ for volume, price and infrastructure renewal, similar to the Port of Melbourne. The ports differ in terms of debt structure, where the Port of Houston’s IDR reflects an absence of revenue-backed debt and capital improvements, as it has thus far been funded via ad-valorem taxes and excess cash flow from operations, which support its higher rating.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
-A resilient underlying performance over a number of years, especially demonstrated during the economic slowdown, in conjunction with a prudent financing strategy, leading to projected five-year average Fitch-adjusted net debt/EBITDA of below 7.5x.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
-Weak financial performance due to lower volume, credit erosion of terminal operators that results in payment delinquencies, increased costs, additional indebtedness for distribution or adverse regulatory rulings leading to a projected five-year average Fitch-adjusted net debt/EBITDA of above 9.5x.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance.
The Port of Melbourne is one of Australia’s largest container ports, located in the centre of Victoria’s capital city of Melbourne, the country’s second-most populous city. It handles more than a third of Australia’s capital-city container trade and has a diverse mix of import and export cargo, including general and containerised cargo, liquid bulk, dry bulk and motor vehicles.
FY20 normalised EBITDA was broadly in line with Fitch’s expectations, with a slight reduction in the margin relative to FY19. FY20 revenue was down on weaker trade volume, although this was partially offset by robust growth in property revenue. The small increase in operating costs was broadly in line with CPI. The operating cost base remains stable, supported by the largely fixed nature of the port’s operating expenses.
Fitch developed two scenarios that serve as the basis for its review of the Port of Melbourne. Our rating-case scenario conservatively assumes that port volumes will remain depressed in FY21 as a result of the ongoing pandemic-related slump in economic activity, with contractual minimum annual guarantees used as a floor for revenue. Our rating case contemplates a full recovery in volume to FY19 levels by FY22.
Fitch’s more severe downside case assumes a deeper volume decline in FY21, with a straight-line recovery path to achieve FY19 volumes by FY25, reflecting a prolonged period of subdued economic activity.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.
Source: Fitch Ratings