MOODY'S ASSIGNS Ba1 RATING TO CLARK REFINING & MARKETING'S SEC. BANK DEBT; B2 TO CLARK USA'S SR. UNSEC. NOTES; OUTLOOK CHANGED TO NEGATIVE.
New York, 11/21/1995 -- Moody's Investors Service assigned a Ba1 rating to the secured working capital facility of Clark Refining & Marketing, Inc. (R&M), and a B2 rating to the new senior unsecured notes of Clark USA, Inc. (USA), R&M's holding company. Moody's confirmed the Ba2 rating on R&M's $400 million of senior unsecured notes and the B1 rating on USA's $264 million face value of senior secured zero-coupon bonds, but changed the rating outlook to negative from stable.
These ratings are supported by USA's new equity and the diversifying of its ownership base through a pending transaction with subsidiaries of Occidental Petroleum (rated Baa3) and Gulf Resources (a non-rated private oil and gas investment company based in the Middle East). The transaction, which constitutes a six-year forward purchase of crude oil paid for half in stock and half in cash, will provide a new source of cash for USA, a non-operating holding company, as the oil is delivered. However, the equity gained from the Occidental transaction may be overvalued.
The ratings also factor in USA and R&M's recurrent losses reflecting their sensitivity to refining margins and substantial ongoing capital needs which exceed depreciation. Interest coverage after non-discretionary capital expenditures is very thin. These companies have very high leverage (USA's debt-to-book capital at September 30, 1995 was 72% pro forma for the offering and transaction), particularly relative to the volatility inherent in the refining business, and there is considerable layering of debt. Furthermore, the implicit support of USA's parent, Horsham Corporation (rated Ba2), which had previously enhanced the rating, is being gradually weakened as Horsham's stake is diluted by equity from other investors.
However, the ratings are also based on USA's conservative practice of keeping sizable cash balances and financing much of its major acquisitions with equity (approximately half of the Occidental/Gulf transaction is equity-financed) will prevent its already high leverage from climbing further. USA's expanded asset base, with its refining capacity more than doubled from its Port Arthur acquisition in February 1995, also strengthens its credit profile.
The one-notch rating difference between R&M's bank facility and public debt reflects the value of the collateral backing the bank borrowings. The $400 million commitment is secured by R&M's intangibles and current assets, primarily $107 million of cash and current investments, $148 million of accounts receivable, and $300 million of inventory.
The B2 rating on USA's new senior unsecured notes is based on the structural and effective subordination of the notes to considerable amount of senior debt, both at the operating and holding company levels. These new notes will be structurally subordinated to about $740 million of R&M's obligations, including any borrowings under its bank facility, $400 million of public debt, $280 million of trade payables, and $61 million of leases. They are also effectively subordinated to $264 million face value ($165 million accreted value) of USA's zero-coupon notes, which are secured by the common stock of R&M, which is USA's principal asset.
In the pending transaction, USA will acquire for $247 million the right to receive 21 million barrels of crude oil from subsidiaries of Occidental and Gulf Resources. USA will pay $100 million in cash upfront (using the proceeds from this senior note offering) and will issue $147 million of its common stock to Occidental and Gulf. Over the next six years, Occidental and Gulf will deliver crude oil to USA on a pre-determined schedule. USA will then sell all of that crude back to Occidental and Gulf, who will arrange for their sale on the open market. USA expects to generate about $50 million a year in cash from those sales. To mitigate the commodity price risk, USA plans to sell forward about $150 million (about three years' worth of projected cash flows).
The $26.9 million of equity that USA issues to Gulf will be recognized gradually as Gulf delivers the crude over the next six years. On the other hand, the full $120 million of equity issued to Occidental will be booked at the close of the transaction. The Occidental transaction mutually benefits USA and Occidental. It enables USA to bolster its weak equity immediately and gives Occidental the cash to use in its debt reduction program.
If a flat oil price scenario is assumed based on WTI prices of $17 per barrel, the $220 million purchase price set for the Occidental transaction would result in a low discount rate of 5%, as compared to the 10% discount rate used in the standard SEC-10 calculation. At the 10% rate, the purchase price would be less, thus the value of equity issued to Occidental would be reduced. If the forward price curve is used, as Clark did, the discount rate would be in excess of 10%. Clark has indicated its intention to forward sell a significant portion of the production to be received at prices approximating the forward curve.
Occidental has provided a guarantee to meet its obligations under its agreements with USA. However, a material deterioration in Occidental's credit and its Baa3 credit rating, which may result in Occidental's failing to perform on its obligations to deliver the crude oil, would diminish the value of equity attributable to Occidental that is reflected in USA's balance sheet.
USA is about 60% owned by Horsham and 40% by Tiger. Equity investments by Occidental and Gulf would decrease Horsham's stake to 46%. Tiger will own 31% of USA, Occidental 19%, and Gulf 4%. This dilution would allow Horsham to deconsolidate USA on its financial statements, although it retains significant control over the company. Horsham intends to let its stake continue to be diluted gradually through equity issuances and eventually a long-planned initial public offering of USA stock. (Two prior attempts for such an offering failed due to unfavorable market conditions.)
Although R&M's value (and the value of the stock securing the zero coupon notes) has grown from the Port Arthur and the Occidental/Gulf transactions and additional equity, Clark has yet to realize the full benefits from them. The impact of depressed refining margins this year well exceeded its cost-cutting efforts, particularly in its midwest refining segment. Also, there is yet very little integration of Port Arthur, which is located on the Gulf Coast, with Clark's core midwestern operations. In its midwestern markets, R&M had sold 75% of its refinery output at its retail outlets, almost all of which it operated. Since the Port Arthur acquisition, this internalization rate had fallen to 39%. R&M has begun to market Port Arthur products in Texas to jobbers under the Clark name. Eventually, it may acquire outlets in the area to sell directly to retail customers at higher margins.
Although the Port Arthur refinery posted a modest profit this year, much of this is attributable to a low rate of depreciation due to the low purchase price of these assets. At a higher purchase price based on refining margins that are more normal than recent depressed levels, Port Arthur would have been breakeven at best. Furthermore, the cash flow retained by R&M will likely be limited because of ongoing capital expenditures. Mandatory capital expenditures at Port Arthur would be roughly three times the $6 million in annual depreciation. Discretionary projects to upgrade its capabilities and to stay competitive could result in outlays that are ten times depreciation.
R&M's bank facility has a $50 million sublimit for cash advances and $45 million for standby letters of credit to secure bonding and other requirements. Availability under the facility is the lesser of $400 million committed or the borrowing base, which is based on percentages of cash, investments, accounts receivable, and inventory. This borrowing base was $425 million as of September 1995. R&M utilizes this primarily for commercial letters of credit ($235 million outstanding as of September 1995) to procure crude oil and to maintain its inventory of crude and refined products. It rarely uses the facility for cash advances, relying instead on the cash it keeps onhand.
USA's new senior notes are being placed in privately negotiated transactions without registration under the Securities Act of 1933 under circumstances reasonably designed to preclude a distribution in violation of the Act. The issuance has been designed to permit resale under SEC Rule 144A.
Clark USA, Inc., headquartered in St. Louis, Missouri, is a non-operating holding company, an affiliate of the Horsham Corporation, a diversified holding company based in Toronto, Canada. Clark USA's chief operating subsidiary, Clark Refining & Marketing, Inc., refines and markets petroleum products.
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