Moody's: ONGC's acquisition of HPCL will increase ONGC's leverage to upper limit of its Baa1 rating

Moody's Investors Service says that Oil and Natural Gas Corporation Ltd.'s (ONGC, LC: Baa1 stable, FC: Baa2 stable) planned acquisition of a majority stake in Hindustan Petroleum Corporation Ltd. (HPCL, Baa3 positive) will cause ONGC's leverage to approach the upper limit of its Baa1 rating.

ONGC's strategic importance to the Indian government (Baa3 positive) will also increase, given that the merger would create the country's first integrated oil & gas company with significant upstream and downstream operations.

Based on HPCL's average market capitalization over the three months to 24 October 2017, the stake to be acquired by ONGC is worth about INR350 billion. Assuming this amount as the purchase price, Moody's says that ONGC will likely fund the transaction with incremental borrowings of INR250 billion, with the remaining amount funded with cash on hand and the liquidation of investments.

 

"Using ONGC's pro-forma leverage for the fiscal year ended March 2017 as measured by retained cash flow/net debt and debt/EBITDA the acquisition would weaken these results to 33% from 68% and 1.9x from 1.1x," says Vikas Halan, a Moody's Vice President and Senior Credit Officer.

"Nevertheless, the increase in leverage will be partly offset by a qualitative improvement in ONGC's operations, as a vertically integrated company, such that its pro-forma financial metrics could still support its Baa1 rating," adds Halan.

Moody's analysis is based on the government of India and the board of directors of ONGC having given in principle approval for ONGC to purchase the government's 51.11% stake in HPCL.

Moody's report also says that post acquisition, ONGC's local currency rating will not be rated more than one notch above the Indian sovereign's local currency rating, because of the increase in ONGC's exposure to domestic revenues through HPCL's refining and marketing business.

In addition, Moody's views the increase in ONGC's leverage from the acquisition as an indication of stronger government influence on the company's financial profile. This level of influence will no longer support the current two-notch gap between the local currency ratings of ONGC and that of the government. And, the rating on ONGC's foreign currency bonds will remain constrained by the Baa2 country ceiling for foreign currency bonds in India.

On HPCL, Moody's says that after the merger, HPCL will continue to be of strategic importance to the government and will form ONGC's largest subsidiary. Specifically, HPCL will stay strategically important to the government, because of its large-scale refining and marketing operations. HPCL will also retain its status as a state-owned entity based on the government's 69% ownership in ONGC and the government will keep its ability to appoint all HPCL board directors.

Moody's also points out that while HPCL contributes significantly to the government's revenues through direct and indirect taxes, any support to the company if needed after the merger will be through ONGC.

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