Moody's Investors Service on Tuesday downgraded state-owned Oil and Natural Gas Corporation's (ONGC) rating in view of the uncertain oil price environment, depleting cash reserves of the government and government guidelines constraining its ability to lower dividends.
The rating agency downgraded ONGC's local and foreign currency issuer ratings to Baa2 from Baa1. It also downgraded the ratings of the unsecured bonds issued by ONGC and those issued by its subsidiary ONGC Videsh Ltd.
The outlook on all ratings remains negative, it said.
"Given the increasingly uncertain oil price environment, ONGC's depleted cash reserves, and government guidelines that constrains state-owned enterprises' ability to lower dividends, ONGC's ratings are materially challenged at the previous rating level and its credit profile insufficient to remain above India's Baa2 sovereign rating. The rating outlook is negative in line with the outlook on India's sovereign rating," said Vikas Halan, senior vice-president, Moody's.
"Further, the downgrade reflects our expectation that ONGC's credit metrics will weaken beyond the tolerance level for its ratings, if oil prices remain low for a prolonged period," he said.
Against the backdrop of a significant deterioration in oil prices over the last month that is predicted to persist for most of 2020, ONGC decided to pay an interim dividend of Rs 5 per share last week, resulting in cash outflows of Rs 6,300 crore, which has reduced its cash reserves.
ONGC had consolidated cash and cash equivalents of Rs 6,700 crore as on September 30, 2019.
"ONGC's dividend policy is based on the guidelines issued by the Government of India in May 2016, which requires all government-owned companies to pay a minimum annual dividend equal to 5 per cent of their net worth even if they do not have sufficient profits," Moody's said.
Despite depleted cash reserves, ONGC is expected to meet its debt repayment obligations given its access to capital as a state-owned company. "However, its lower cash reserves have diminished the company's capacity to protect its credit profile from oil price shocks," Halan said.
ONGC's cash reserves, which provided protection against the oil price decline in 2016, have been depleting over the past three years because of high dividends, share buyback in 2019, and its acquisition of Hindustan Petroleum Corp Ltd (HPCL) in 2018.
Its cash and cash equivalents declined to Rs 6,700 crore at September 30, 2019, from Rs 24,700 crore on March 31, 2016. Over the same period, ONGC's net borrowings increased to about Rs 1 lakh crore from Rs 21,500 crore.
In Moody's base case scenario, the effects from the virus will persist into the second quarter of 2020, with improving economic fundamentals in the second half of the year. Under this scenario, Moody's expects oil prices to average USD 40-45 per barrel in 2020, returning to USD 50-55 per barrel in 2021.
However, in a downside scenario, where economic weakness persists longer, oil would average USD 30-35 per barrel in 2020 and USD 35-40 in 2021.
"Moody's expects ONGC's (retained cash flow) RCF/net debt to decline below 30 per cent under its base case scenario and below 20 per cent under its downside case scenario, assuming there are no changes to the company's cost structure, shareholder returns or investment plans," the rating agency said.
The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented.
Oil and gas has been one of the sectors most significantly affected by the shock given its sensitivity to demand and oil prices.
More specifically, the weaknesses in ONGC's credit profile have left it vulnerable to shifts in market sentiment in these unprecedented operating conditions, and ONGC remains vulnerable to the outbreak continuing to spread and oil prices remaining weak, Moody's said.
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