Fitch Ratings has assigned India-based HPCL-Mittal Energy Limited (HMEL) a Long-Term Issuer Default Rating (IDR) of 'BB'. The Outlook is Stable. The agency has also assigned HMEL's proposed senior unsecured US dollar notes an expected rating of 'BB-(EXP)'.
The final ratings on the notes are contingent upon the receipt of documents conforming to information already received.
Fitch assesses HMEL's standalone credit profile at 'BB-', reflecting its robust refining operations supported by its highly complex refinery, strong profitability and expectations of high leverage on account of the large capex plans for its proposed petrochemical expansion. The IDR of 'BB' benefits from a one-notch uplift for its parent - Hindustan Petroleum Corporation Limited (HPCL, BBB-/Stable) - given the moderate linkages. HMEL's IDR will benefit from an additional notch uplift in the case of any weakening of its standalone credit profile below the current level of 'BB-', provided its linkages with HPCL remain intact.
KEY RATING DRIVERS
Strong Refining Operations: HMEL's refining operations are supported by its robust asset quality. Its refinery is highly complex (Nelson Complexity Index of 12.6), which enables the company to optimise its crude diet and supports strong margins. HMEL's utilisation rate has also been high (year ending March 2016 (FY16): 119%) with a throughput of 10.7 million metric tonnes per annum (mmtpa) - given the strong demand-supply dynamics in north India, where the refinery is located.
HMEL expects to complete its refinery expansion to 11.3 mmtpa (from 9 mmtpa) during 1HFY18. We expect margins to benefit from higher volumes, an improved product slate, ability to process acidic crude oils, and cheaper fuel alternatives in the near to medium term. HMEL also benefits from its take-or-pay agreement with HPCL for its liquid hydrocarbon production (about 75% of total), and also incentives from the state of Punjab.
Locational Benefit, Strong Profitability: HMEL's refinery-utilisation rate benefits from the strong demand for petroleum products in India - and particularly in the north. HMEL's land-locked refinery benefits from the favourable demand-supply dynamics in the region and minimal competition. This is likely to result in utilisation rates remaining high (FY16: 119%) over the medium term. The off-take agreement with HPCL for its liquid hydrocarbon further minimises the off-take risk and supports the high utilisation rates. The company also has a strong marketing infrastructure for its solid products, including polypropylene, which is likely to support its enhanced downstream operations following completion of its planned petrochemical expansion.
Large Capex Plans: HMEL plans to improve its downstream integration by setting up a petrochemical plant. The company estimates to spend around INR215 billion over the next five years starting in FY18. Increasing downstream integration should benefit HMEL in the long-term as a result of the petrochemical expansion. However, we expect HMEL's FCF to be negative over the medium term on account of the high capex; HMEL is likely to fund its capex partly from its operating cash flows and balance with debt.
Leverage to Rise: FCF turning negative after FY18 and the long lead time to revenue generation (after FY22) leads us to expect net leverage (net adjusted debt/ operating EBITDAR) to rise and remain between 4x-5x over the medium term. This may stay temporarily above our downward net leverage guideline of 5x over FY21-FY22 just before the completion of the petrochemical capex. Fitch takes a positive view of the take-or-pay off-take agreement with HPCL, which provides minimum payments to cover HMEL's debt obligations and ensures that the debt service coverage ratio (DSCR) is always maintained at or above 1.0x.
However, net leverage is likely to improve once the petrochemical project starts operations, expected in FY23.
Uplift for Parent Support: HMEL benefits from a two-notch uplift from its standalone credit profile, to reflect moderate linkages with its 49% parent - HPCL - as assessed under Fitch's Parent Subsidiary Rating Linkage Criteria. HMEL's IDR of 'BB' includes a one-notch uplift, while its IDR will benefit from one more notch in the case of any weakening of its standalone credit profile below the current level of 'BB-' - provided these linkages with HPCL remain intact. Similarly, HMEL's IDR will also benefit from one more notch in the case of any improvement in HPCL's standalone profile - again, provided the linkages with HPCL remain intact.
These linkages factor in HMEL's strategic importance and operational linkages with HPCL. HPCL has a product off-take agreement with HMEL (valid until 2026) to buy all liquid products of HMEL, which also supports its debt-servicing capacity. Liquid products constituted over 75% of HMEL total output and about 80% of HMEL's revenues in FY16. HMEL's capacity will constitute over 40% of HPCL's total refining capacity, after expansion, to 11.3 mtpa. HMEL is also accorded first priority by HPCL for sourcing its product requirement in north India - where it is its only refinery.
Notching for Secured Debt: Fitch has rated HMEL's proposed senior unsecured debt one notch below its IDR, due to the high proportion of secured debt in its capital structure. Secured debt comprised nearly 88% of HMEL's total consolidated debt as of FYE16. The proportion of HMEL's secured debt is likely to come down after the proposed US dollar note issuance. However, we expect HMEL's secured debt/EBITDA to remain above 2.5x over the medium term, resulting in the notching.
[HMEL's IDR of 'BB' includes one notch uplift for linkages with its parent - Hindustan Petroleum Corporation Limited (HPCL, BBB-/ Stable). HMEL ratings will benefit from one more notch in the case of any weakening in its standalone credit profile - provided the linkages with HPCL remain intact. HMEL's standalone credit profile of 'BB-' reflects its strong refining asset quality which is likely to drive its strong cash flows and expectations of high leverage, in light of its large capex. HMEL's standalone credit profile of 'BB-' is one notch higher than that of Sweden's Corral Petroleum Holdings AB (CPH, B+/ Stable), due to HMEL's better asset quality, stronger profitability and presence in the high-growth Indian market. CPH has larger scale and some integration into fuel retailing, while its ratings are constrained by its presence in the mature European market with expected excess refining capacity, a structural decline in fuel consumption, stiff competition and high leverage despite manageable capex. Indian Oil Corporation Ltd's (IOC, BBB-/ Stable) large scale, dominant position as the largest refiner and fuel retailer in India, integration into fuel-retailing and petrochemicals, average asset quality and relatively better financial profile explain the two-notch differential with IOC's standalone credit profile of 'BB+'. IOC's IDR is equalised with that of the sovereign (BBB-/ Stable), die to the strong linkages.]
Fitch's key assumptions within our rating case for the issuer include:
- Crude oil price (Brent) of USD52.5 per barrel (bbl) in FY18, USD55/ bbl in FY19 and USD60/ bbl in FY20, in line with Fitch's crude oil price deck
- Moderation in the industry-wide gross refining margins, though remaining strong.
- Refinery throughput of 11 mmtpa in FY18, 12.3 mmtpa in FY19 and 11.7 mmtpa in FY20.
- Capex of over INR80 billion during the next three years starting FY18.
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
- Any improvement in HPCL's standalone credit profile, provided the linkages remain intact
- We do not expect any positive action on HMEL's standalone rating over the next medium term, given the expectations of increasing leverage on account of the large capex.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
- Any weakening of linkages between HPCL and HMEL
- Higher-than-expected capex or weak profitability resulting in net leverage (net adjusted debt/ operating EBITDAR) of over 5x on a sustained basis may result in a downgrade of the standalone credit profile to 'B+'. However, in the case of a one-notch downgrade of HMEL's standalone credit profile, its IDR will remain unchanged at 'BB' on account of an additional notch of support given its linkages with HPCL, provided the linkages remain intact.
Comfortable Liquidity: HMEL's cash balance was around INR2.4 billion as of end-December 2016 compared with long-term debt maturities of INR1.7 billion. The company also has a large unutilised undrawn working-capital facilities and access to the domestic debt market, given its strong relationship with banks in India. As detailed above, liquidity also benefits from the provision for minimum payments under its off-take agreement with HPCL.
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