S&P revises Zhaikmunai outlook to positive; affirms ‘B’ rating

Aug 10. Reuters


S&P revises Zhaikmunai outlook to positive; affirms 'B' ratingThe outlook revision follows Zhaikmunai’s strong operating performance in the first quarter of 2012, with production more than doubling following the successful ramp up of the company’s newly completed gas treatment facility (GTF). We anticipate that this strong performance will continue into 2013. Zhaikmunai’s strong cash flow also improved the company’s liquidity cushion, with on-balance-sheet unrestricted cash of $141 million on March 31, 2012. In addition, we recognize the company’s robust profitability, with a Standard & Poor’s-adjusted EBITDA margin of consistently more than 50% in the past three years.

We understand that management still has to decide whether to proceed with the second phase of investment in the new GTF, which would further increase production in the longer term. Such an expansion project, if approved by the board in the second half of 2012, could require total expenditure of about $365 million over 2013 and 2014. We currently understand that management aims to maintain a comfortable cash balance during the second investment phase.

Under our base-case scenario for 2012, we assume that Zhaikmunai will gradually increase production at the GTF to achieve average annual production of about 35,800 barrels of oil equivalent (boe) per day (first-quarter 2012 production was 33,552 boe per day, while April production was 37,000 boe per day). Under our base case, we anticipate further output growth in 2013, to 48,000 boe per day, assuming the GTF’s maximum capacity is reached.

Based on our volume forecasts, together with our oil price assumptions of $100 per barrel and $90 per barrel in 2012 and 2013 respectively, we anticipate that Zhaikmunai’s EBITDA will increase substantially to about $400 million in 2012 and $500 million in 2013 (versus about $180 million in 2011, and $109 million in the first quarter of 2012).

Under our base-case scenario, we forecast that Zhaikmunai will generate modest positive free operating cash flow in 2012, assuming capital spending of close to $200 million. For 2013 and 2014, free cash flow is more unpredictable, as it will depend on the likely rise in capital spending related to the GTF expansion as well as prevailing oil prices. Nevertheless, the company’s credit metrics should have substantial headroom for the rating, with adjusted debt to EBITDA of less than 1.0x in 2012, under our base case, compared with 2.1x in 2011.

We have revised upward Zhaikmunai’s business risk profile to “weak,” from “vulnerable” previously, owing to its increased production and strong profitability. Key business risk factors, in our view, continue to be the company’s concentrated asset base, and risks relating to the oil industry and operating in Kazakhstan. Business risk supports are the company’s very high profitability, helped by low cash lifting costs and a supportive tax regime under its production sharing agreement. Country risk is also mitigated by the company’s part-ownership of its local partner, Kazakhstan-based engineering company KazStroyService.

We classify Zhaikmunai’s financial risk profile as “aggressive.” This is owing to Zhaikmunai’s potentially significant capital expenditure (capex) plans and therefore its limited free cash flows under our base-case scenario, which assumes that the company proceeds with its GTF phase two investment. Our assessment also includes its limited track record in bank and capital market funding. Relative strengths are the company’s recently increased cash flow generation and liquidity, as well as its long-term debt maturity profile.


We assess Zhaikmunai’s liquidity as “adequate,” as defined in our criteria. We estimate that the company’s liquidity sources should exceed liquidity uses by about 1.5x in 2012, and by about 1.4x in 2013. The company does not have committed bank lines, but we understand that management’s policy is to ensure that the company can comfortably finance capex with cash in hand and projected cash flow.

Under our base-case credit scenario, we believe Zhaikmunai will benefit from the following liquidity sources over the next 12 months:

— Estimated surplus cash of $111 million as of March 31, 2012, as we treat $30 million of the reported $141 million of unrestricted cash as tied to operations. We view positively the fact that the majority of Zhaikmunai’s cash is held in dollars at various large banks in western Europe, while cash in Kazakhstani tenge is held at Sberbank, a Russian state-owned bank. We view this as an important support against the risk of banking industry instability or a currency devaluation in Kazakhstan.

— No committed bank lines, as the company relies principally on its cash balances and cash flow generation, as well as flexibility of capital spending to manage its minimum liquidity.

— Funds from operations of about $320 million.

We assume that liquidity needs over the next 12 months comprise:

— No short-term debt, with the $450 million senior secured notes falling due in October 2015.

— No acquisitions, dividends, or share buybacks.

— Working capital outflow of about $80 million.

— Substantial capital spending in the vicinity of $200 million in 2012, and potentially rising to $350 million in 2013 in our base-case scenario. We recognize, however, that the assumed rise in capex will be flexible, and will depend on management’s decision and timing on the GTF phase two development.

The $450 million notes’ documentation does not includes any maintenance covenants, and only one debt incurrence test, defined as the consolidated coverage ratio (EBITDA to interest expense) of 3x.

Recovery analysis

The issue rating on the 10.5% $450 million senior secured notes due 2015 issued by Zhaikmunai LLP is ‘B’. The recovery rating on these notes is ‘3’, reflecting our expectation of meaningful (50%-70%) recovery prospects in the event of a payment default.

In our view, Zhaikmunai’s senior notes have a weak security package comprising only share pledges. However, the notes benefit from guarantees from the majority of the company’s subsidiaries. Our issue and recovery ratings reflect our belief that in the event of a default, Zhaikmunai would be reorganized as a going concern owing to its significant oil and gas reserves.

In order to determine hypothetical recoveries, we simulate a default scenario. Based on a going-concern valuation, we estimate the company’s stressed enterprise value would be about $1 billion at our hypothetical point of default in 2015. This stressed value takes into account a combination of operational delays in the GTF phase two investment, weaker production rates, and a sustained period of low commodity prices, which are symptomatic of past defaults in this sector. Under our base-case assumptions, lower EBITDA growth than we forecast would lead to an inability to refinance the notes.

Although we expect recoveries to exceed 70%, we cap the recovery rating at ‘3’ (50%-70% recoveries) due to Zhaikmunai’s exposure to the Kazakh insolvency regime in a post-default scenario. Based on our assessments of insolvency regimes, we categorize Kazakhstan among the countries that we consider to be the least creditor-friendly jurisdictions, offering only limited formal protection to creditors.


The positive outlook reflects the possibility of a one-notch upgrade in the next six months if Zhaikmunai continues its strong operational track record and sustains current strong credit metrics and “adequate” liquidity. We assume in our base case that the company proceeds with phase two of its GTF investment, and we will seek to obtain further information about its timing and financing.

We could revise the outlook to stable if Zhaikmunai’s production levels were considerably lower than we currently envisage, in the event of what we perceive to be less prudent liquidity management, or due to material adverse country-related risks.