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Rating Action:

Moody's changes outlook to negative and affirms PKN ORLEN's Baa2 rating

13 Dec 2019

Frankfurt am Main, December 13, 2019 -- Moody's Investors Service ("Moodys") has today affirmed the issuer rating of Polski Koncern Naftowy ORLEN S.A. ("PKN ORLEN" or "company") at Baa2 and also affirmed the baseline credit assessment (BCA) at baa3. Concurrently, Moody's has also affirmed at Baa2 the rating of the EUR 500 million due 2021 and EUR 750 million due 2023 senior unsecured bonds issued by ORLEN Capital AB (publ) and guaranteed by PKN ORLEN. The outlook on all ratings has been changed to negative from stable.

"Today's outlook change reflects the uncertainty regarding PKN ORLEN's future growth strategy consisting of additional acquisitions and large capex investments, while the company's Moody's adjusted leverage is likely to increase to around 2.5x debt/EBITDA pro forma of the envisaged acquisitions of Energa S.A. and Grupa Lotos S.A. proforma based on combined EBITDA of the acquired companies and the increased debt/EBITDA level, from currently 1.1x. Furthermore, we note that so far no separate financing for both acquisitions has been announced and that Energa S.A. still intends to build the coal power plant Ostroleka C with an installed capacity of 1000MW, while also its financing has not yet been fully secured", says Janko Lukac, an AVP -- Analyst and Moody's lead analyst for PKN ORLEN.

RATINGS RATIONALE

The outlook on PKN ORLEN's rating has been changed to negative from stable, reflecting the company's intention to acquire 100% of the capital of one of the largest Polish utilities Energa S.A. (Baa1 ratings under review) for about PLN 2.9 billion (around EUR 680 million), while being in the process of taking over the second biggest Polish refiner Grupa Lotos S.A. with a market cap of around PLN 16 billion (EUR 3.7 billion). At the same time PKN ORLEN is committed to substantial capex investments in its petrochemical operations and plans to increase its exposure to power generation and renewables. Furthermore, until there is more clarity on PKN ORLEN's strategic direction, Moody's sees a risk of additional debt-financed acquisitions which further weaken the company's financial profile.

During the next 12-18 months Moody's will monitor the group's strategic direction, M&A activity as well as investment plans and its impact on the group's leverage which Moody's estimated to reach pro forma for both acquisitions 2.5x adj. debt/EBITDA, which is on the upper end of our expectations for PKN ORLEN's baa3 BCA. This also assumes the takeover of only 66% of Grupa Lotos' share capital. We will also monitor when, and how the contemplated acquisitions will be financed.

PKN ORLEN aims to close both transactions during the course of 2020 (Energa S.A. in H1 and Grupa Lotos S.A. in H2) subject to regulatory approval and certain deal-specific conditions. Both, Energa S.A. and Grupa Lotos S.A. are owned partially by the Government of Poland (A2 stable) by 51.5% and 53.2%, respectively. Energa S.A. operates an energy distribution network in North and Central Poland with access to around 2.8 million end customers and operates power plants with 1.34 GW of installed capacity. The potential acquisition would strengthen PKN ORLEN's position as the fourth largest producer of electricity in Poland and increases the share of EBITDA of its energy activities to 29% pro forma from 14% in 2019. Electricity distribution activities will help to offset the inherent volatility of PKN ORLEN's refining business, but we see limited strategic fit between both companies' activities and hence a limited potential for synergies.

The acquisition of the polish refiner Grupa Lotos S.A. was announced in November 2018 and is currently investigated by the European Union. So far no price to public shareholders has been offered but an agreement with the Polish State Treasury regarding its 51% share in Grupa Lotos S.A. was made in August 2019. This transaction would enhance the market position of PKN ORLEN in Poland and give it access to the complex refinery (Nelson complexity of around 10) in Gdansk, which is likely to yield significant production synergies.

The baa3 BCA also reflects (1) PKN ORLEN's strong presence in Central and Eastern Europe (CEE), with a dominant presence in the downstream segment; (2) the smaller scale of its upstream operations; (3) the above-average complexity of its refineries, which are able to process heavy crude oil; (4) the high level of integration among its refining, retail and petrochemical businesses; and (5) its leading presence in the Polish wholesale and retail fuel markets.

However, the baa3 BCA also reflects the inherent exposure of the group's operating performance and financial results to the volatility of refining margins. This is only partly mitigated by the stabilizing effect on its operating results from its retail division and the company's efforts to invest heavily in the construction of new petrochemical facilities to increase its margins and resilience.

With 27.5% of its share capital held by the Polish state, PKN ORLEN falls within the scope of Moody's rating methodology for Government-Related Issuers (GRIs). Under this methodology, Moody's assumes moderate dependence and moderate support from the Government of Poland (A2 stable). This reflects PKN ORLEN's strategic importance to the Polish state as a market leader in the petroleum retail sector, its contribution to GDP, and its status as a major employer within Poland. Hence, PKN ORLEN's Baa2 rating benefits from a one-notch uplift relative to the baa3 BCA.

LIQUIDITY

Moody's deems PKN ORLEN's liquidity as adequate. The group has PLN 6.750 million cash on its balance by the end of Q3 2019 and access to an undrawn PLN 4,300 million multicurrency revolving facility maturing in April 2021, which is more than sufficient to cover working capital swings and in combination with operational cash flows to fund the CAPEX program. However, we note that the acquisitions will require additional external funding, which we expect to be secured timely.

OUTLOOK

The outlook on PKN ORLEN's rating is negative, reflecting the uncertainty regarding future acquisitions and already significant investment plans at a time when the announced acquisitions will increase the group's leverage towards the upper end of our guidance at 2.5x adj. debt/EBITDA for PKN ORLEN's baa3 BCA. Furthermore, the 50% stake of Energa S.A. in the Ostroleka C coal power plant with an estimated total construction cost of PLN 6 billion included in Energa S.A.'s large PLN 21 billion investment plan (2016-25) might increase PKN ORLEN's leverage further. It also takes into account the uncertainty of the company's future growth strategy and the need to still obtain committed financing for the acquisitions.

WHAT CAN CHANGE THE RATING UP / DOWN

Moody's currently does not consider to upgrade PKN ORLENS Baa2 rating as a result of the expected weakening in its credit metrics and execution risks around the integration of the acquired companies. A positive rating action could be considered if (1) PKN ORLEN successfully increases its geographic diversification supported by a more balanced business profile, with its significant exposure to the inherent volatility of the business, 2) deleverage its balance sheet towards below 1.5x adjusted debt/EBITDA on a sustained basis, and (3) continues to show positive free cash flow (FCF) generation, combined with strong liquidity.

The Baa2 rating could be strained if adverse downstream conditions result in markedly weaker operating performance, or if leveraging related to its growth strategy hurts the company's credit metrics, resulting in adjusted debt/EBITDA exceeding 2.5x on a sustained basis. Negative FCF generation or pressure on PKN ORLEN's liquidity could also result in a downgrade. Reduced support assumptions from the Polish government could also result in a downgrade.

ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONCERNS

Environmental considerations for PKN ORLEN include the risk that environmental concerns, penetration of electric cars and regulation result in a declining demand for PKN ORLEN's main products gasoline, diesel and other derivatives of oil. Moody's monitors this closely and notes that PKN ORLEN is expanding its production of petrochemicals and plans to develop an 1.200 MW offshore wind park in the Baltic Sea by 2024. A successful acquisition of Energa would further increase PKN ORLEN's exposure to renewables and add a sizeable electricity distribution network, but at the same time exposes PKN ORLEN to the already ongoing construction of the coal power plant Ostroleka C (50% stake) with an installed capacity of 1.000 MW expected to be completed by 2023 for an estimated PLN 6 billion (EUR 1.4 billion). Furthermore, Energa holds a 15% stake in the largest Polish coal miner Polska Grupa Gornicza.

Governance considerations for PKN ORLEN include the dominant position and influence of the Polish government on PKN ORLEN, despite controlling only 27.5% of its share capital. The Polish Government has a track of actively shaping the group's strategy and exchanging top management frequently. Both ongoing acquisitions are likely to be influenced by the Governments strategy to create national champions in strategic industries such as the energy sector. Moody's will closely monitor the Polish Governance stance on PKN and notes that Government-induced capital investment plans could result in a deterioration in the financial profile of the group.

PRINCIPAL METHODOLOGIES

The methodologies used in these ratings were Refining and Marketing Industry published in November 2016, and Government-Related Issuers published in June 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.

COMPANY PROFILE

Polski Koncern Naftowy ORLEN S.A. (PKN ORLEN), with an annual revenue of PLN109.7 billion EUR25.3 billion) and 707,000 bpd refining capacity in 2018, is the largest oil refining and retail group with well-integrated petrochemical and chemical production and operates more than 2,800 gas stations in Poland, Germany, the Czech Republic, Lithuania and Slovakia. It was formed from state monopolies in 1999 and currently has a public float of 72.5%, with the State Treasury holding the remaining 27.5% stake. The Articles of Association entitle the State Treasury to appoint and recall one member of the supervisory board and one member of the management board, giving the government effective control over PKN ORLEN's strategy and operations. The Polish government has a long track record of interfering in PKN ORLEN's strategy and frequently changing management and supervisory board members.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Janko Lukac
Asst Vice President - Analyst
Corporate Finance Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Matthias Hellstern
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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