Fitch affirms ratings of National Company KazMunayGas and KazMunaiGaz Finance Sub B.V., outlook stable
July 1. KASE. Fitch Ratings. Moscow
Fitch Ratings has affirmed JSC National Company KazMunayGas’s (NC KMG or the group) Long-term foreign currency Issuer Default Rating (IDR) at ‘BBB’ with a Stable Outlook. Fitch has also affirmed KazMunaiGaz Finance Sub B.V.’s foreign currency senior unsecured rating at ‘BBB’. A full list of rating actions is at the end of this release.
Wholly state-owned NC KMG is a holding company for Kazakhstan’s (BBB+/Stable) interests in the oil & gas sector, including upstream, transportation and refining operations. Its ratings are notched down one notch from the sovereign’s. The rating approach is based on our expectation that the state will provide sufficient and timely tangible support to the group when needed. We view the proposed purchase of part of NC KMG’s stake in Kashagan by its parent, JSC Sovereign Wealth Fund Samruk-Kazyna (BBB+/Stable), as a clear reflection of this support.
However, the current weak credit metrics, if sustained, would point to a ‘B’ range standalone credit profile, compared with our historical assessment of NC KMG’s standalone profile as in the ‘BB’ range. Were the state to allow such weak credit metrics to persist indefinitely, this may cause us reassess our expectation of state support and to widen the notching between Kazakhstan and NC KMG.
We forecast that NC KMG’s funds from operations (FFO) adjusted gross leverage may deteriorate further in 2015 but will gradually revert to end-2013 levels of around 3.5x by end-2017. NC KMG’s ability to generate FFO will deteriorate in 2015-2016 on lower EBITDA from its main upstream subsidiary and lower dividends from the group’s joint ventures (JVs). At end-2014, the group’s FFO fixed charge coverage declined to 3.7x, down from 6x at end-2013, while its FFO adjusted gross leverage was 6.3x, up from 3.4x a year ago..
KEY RATING DRIVERS
Ratings Notched Down from Sovereign
The absence of an explicit state guarantee for a significant portion of NC KMG’s debt prevents full rating alignment between Kazakhstan and NC KMG, despite their strong links. We notch the group’s ratings down one notch from the sovereign ratings. The rating approach is based on our expectation that the state will provide sufficient and timely tangible support to the group when needed.
Samruk-Kazyna’s Deal Provides Support
NC KMG has announced its intention to sell half of KMG Kashagan B.V., which holds 16.88% stake in Kashagan, to Samruk-Kazyna, its immediate parent, for around USD4.7bn in cash and to use the cash proceeds to repay a portion of its debt. We believe that if completed, this deal would help NC KMG improve its financial profile over the medium term. We also view this transaction as evidence of continued state support for NC KMG, and the Stable Outlook factors in the expectation that the deal will be concluded as proposed.
We do not consider the potential breach of the 3.5x net debt:EBITDA covenant in NC KMG’s Eurobond documents, which the transaction seeks to cure, as an imminent liquidity risk, since it is incurrence only and would not trigger acceleration of the bonds, which make up the bulk of NC KMG’s debt. Some of the company’s loan agreements include maintenance covenants but given looser definitions therein we believe it unlikely these covenants would be breached in the near term, even in the absence of the Kashagan stake sale.
Weaker 2015 Upstream Results
NC KMG’s upstream is an important contributor to its EBITDA and cash flows. We expect upstream to contribute less to the group’s FFO in 2015 due to lower oil prices. We view a successful launch of Kazakhstan’s new oil and gas projects operated by JVs in which NC KMG has a stake as a pre-requisite for the country’s hydrocarbons production growth in the medium to long term. This is in contrast to JSC KazMunaiGas Exploration Production (KMG EP), NC KMG’s majority-owned subsidiary, whose primary goal is to manage production decline from its mature oilfields.
In 2014, KMG EP’s average export netback exceeded USD50 per barrel (bbl) and export sales were 5.6m tonnes, while domestic sales and supply volumes to Russia amounted to 2.4m tonnes with average netbacks of USD25/bbl-USD35/bbl. We expect the profitability of KMG EP to deteriorate due to a declining share of oil exports in 2015-2018 and a higher share of domestic sales.
The failed launch of the colossal Kashagan oilfield in October 2013, in which NC KMG has a stake, highlights the project execution risks inherent in the oil and gas industry, particularly when operating in environmentally sensitive areas and working with high-pressure, high-sulphur reservoirs. As a project partner, NC KMG is responsible for its share of project costs to re-launch Kashagan. According to the company, the linepipe replacement and other remedial works in Kashagan are on schedule and the production re-launch is expected in 2017.
JVs’ Dividends Decline
Although dividends from NC KMG’s JVs and affiliates will remain one of its key sources of cash over the medium term, we expect the dividend stream to decline in 2015-2018. In 2014, NC KMG received KZT302bn in net dividends from JVs and associates, while it generated KZT268bn in net cash flows from its consolidated operations. In 2014, TengizChevroil LLP (TCO), NC KMG’s largest JV by dividend contribution, paid NC KMG dividends of KZT187bn, down from KZT254bn a year ago. In 2015-2016, we expect lower payouts from TCO due to weaker cash generation and its large expansion plans, while our total dividend forecast during this period stands at just over KZT300bn, significantly lower than recent payments.
Large Capex for Refinery Upgrades
Refining and marketing is an important segment for the group. Its downstream subsidiaries, KMG RM and KMG International, produced 14.9m tonnes of oil products in 2014, excluding the output of Shymkent refinery, a JV. The group is currently undertaking the upgrade of its Atyrau refinery, which is the country’s oldest. In 2014, it also started upgrading two other refineries in Shymkent and Pavlodar to be completed by end-2016 to ensure that all its oil products are compliant with Euro-4 and Euro-5 emission standards. NC KMG estimates its total investments in downstream at nearly USD2.6bn in 2015-2016. Although the refinery upgrade programme has limited flexibility in terms of size, we note the 2015-2016 downstream capex may end up lower that projected due to potential delays.
High Gross Leverage Expected
The group continues to rely on external debt financing for capex funding. Therefore, we continue to focus our analysis on NC KMG’s gross leverage metrics because we do not consider the group’s significant cash balance at 31 March 2015 of KZT1.1trn, including short-term deposits, fully offsets its high leverage.
NC KMG’s KZT1.3tn (USD6.9bn) capex programme in 2015-2016 will be partially debt-funded. We forecast that the group will continue generating negative free cash flow over this period and estimate that its FFO adjusted gross leverage may exceed 5x in 2015-2016, before returning to around 3.5x in 2017. NC KMG’s gross coverage and leverage ratios in 2015-2016 are commensurate with those of ‘B’ rated EMEA oil & gas companies on a standalone basis.
Positive: Future developments that may, individually or collectively, result in positive rating action include:
– A sovereign upgrade.
Negative: Future developments that may, individually or collectively, result in negative rating action include:
– Evidence of weakening state support, ie, the state’s failure to provide timely tangible financial support to the company.
– Failure to improve the standalone credit metrics to those commensurate with a mid ‘BB’ rating category oil & gas company, eg, FFO adjusted gross leverage of 3.8x and fixed charge cover ratio of 6x over the medium term.
LIQUIDITY AND DEBT STRUCTURE
The group’s short-term debt of KZT304bn (USD1.6bn) was covered by its cash of KZT383bn and short-term investments of KZT742bn at end-March 2015. We expect NC KMG to generate nearly KZT260bn in negative free cash flows in 2015-2017, owing to weak oil prices and high downstream capex. According to NC KMG, it had approximately KZT427bn (USD2.3bn) of unused credit lines at 31 March 2015, which supports its short-term liquidity.
Weaker Tenge Drives Leverage Up
At end-March 2015, NC KMG had gross balance sheet debt of nearly KZT3.2trn (USD17.3bn), about 63% of which was at the parent company’s level. Fitch also includes in the group’s leverage the full amount of KZT101bn (USD545m) loan guarantee provided to Beineu-Shymkent Pipeline LLP, a JV.
In our forecasts, we assume that a 20% devaluation of the tenge occurs later in 2015, in line with Fitch’s sovereign team assumptions. At end-March 2015, over 91% of the group’s borrowings were denominated in foreign currencies, primarily in US dollars. As NC KMG reports its results in tenge, a possible devaluation will immediately increase its leverage, while its US dollar-linked revenues and EBITDA will increase gradually over time, as 76% of the group’s revenues and 53% of its costs in 2014 were US dollar-denominated.
Fitch’s key assumptions within our rating case for the issuers include:
– Stagnant oil and gas production. We do not expect Kashagan to pay dividends to NC KMG in 2017-2018.
– Higher volumes of oil products sold in Kazakhstan in 2016-2018 and a modest increase in average prices of oil products sold following the ongoing upgrades of refineries.
– Average USD/KZT exchange rate of 203.7 in 2015 and 227.5 in 2016-2018.
– KZT1.7tn of total capex over 2015-2018.
– Dividend payout to JSC Sovereign Wealth Fund Samruk-Kazyna (BBB+/Stable) at 15% of net income in 2015 and thereafter.
– Tangible and timely financial support from the government of Kazakhstan.
– Brent oil price equal to USD55/bbl in 2015, USD65 in 2016, USD75 in 2017 and USD80 in 2018-19.
FULL LIST OF RATING ACTIONS
Long-term foreign currency IDR: affirmed at ‘BBB’; Outlook Stable
Long-term local currency IDR: affirmed at ‘BBB+’; Outlook Stable
Short-term foreign currency IDR: affirmed at ‘F3’
Foreign currency senior unsecured rating: affirmed at ‘BBB’
Local currency senior unsecured rating: affirmed at ‘BBB+’
KazMunaiGaz Finance Sub B.V.
Foreign currency senior unsecured rating: affirmed at ‘BBB’