Singapore, February 25, 2020 -- Moody's Investors Service has downgraded the corporate family rating
(CFR) of HPCL-Mittal Energy Limited (HMEL) to Ba2 from Ba1.
Moody's has also downgraded HMEL's senior unsecured bond rating
to Ba3 from Ba2.
At the same time, Moody's has changed the outlook on the rating
to stable from negative.
RATINGS RATIONALE
"The downgrade to Ba2 CFR reflects the deterioration in HMEL's
credit metrics, driven by the weak refining environment in Asia
as well as the company's expansion into petrochemicals, which
has kept HMEL's borrowings at elevated levels "says,
Sweta Patodia, a Moody's Analyst.
The weak industry conditions are reflected in the Singapore benchmark
refining margins, which declined to around $3.7/barrel
(bbl) for 2019 compared to its historical average of $6-$7/bbl.
This decline in the benchmark was due to the extremely weak fuel oil spreads,
which in turn were driven by International Maritime Organization's new
regulation restricting the use of heavy fuel oil in marine transportation.
HMEL's credit metrics were also impacted by its ongoing expansion
into petrochemicals which has led to an increase in its borrowings.
The company is in the process of setting up a dual feed petrochemical
capacity of 1.2 million metrics tons per annum (mtpa). The
project, which commenced in October 2017, was originally planned
to be completed by March 2022. However, the company now intends
to complete it by April 2021, accelerating its capital spending
and keeping its borrowings at elevated levels. Nonetheless,
there have been no material cost over-runs so far and the total
project cost continues to largely remain within management's initial
estimates.
Consequently, HMEL's leverage, as measured by debt/EBITDA,
increased to around 6.9x for the last twelve months ended December
2019 compared to 5.3x for the last twelve months ended June 2019.
At the same time, its interest cover, as measured by EBIT/Interest,
declined to 1.4x from 2.9x over the same period.
Tightening regulations on the use of heavy fuel oil in the shipping industry,
which kicked off in January 2020, could lead to higher demand for
middle distillates and thus provide some support to refining margins,
particularly for complex refiners like HMEL.
Moody's expects HMEL's debt/EBITDA will improve to around 5.5x
by March 2022, while its EBIT/interest cover will improve to around
2.6x over the same period.
However, the industry environment continues to remain uncertain
and a sustained weakness in regional refining margins could delay an improvement
in HMEL's credit metrics. Moreover, the impact of the
coronavirus outbreak on the regional demand growth for petroleum products
remains uncertain.
Furthermore, HMEL's refinery will undergo 35 days of planned shutdown
during September-October 2020, which will constrain its earnings
and cash flow during the fiscal year ending 31 March 2021 (fiscal 2021).
The stable outlook reflects Moody's view that the company will maintain
a high utilization of its refinery resulting in strong operating cash
flow such that its credit metrics will continue to support its standalone
credit profile.
HMEL's Ba2 CFR is supported by the company's high complexity refinery
that generates strong refining margins, and by its 15-year
offtake agreement with Hindustan Petroleum Corporation Ltd. (HPCL,
Baa2 negative) that provides high visibility on sales volumes.
The rating, however, is constrained by the moderate scale
of the company's operations, with a single refinery and crude distillation
unit, and by its exposure to the cyclical nature of the refining
industry.
HMEL's Ba2 CFR incorporates a two-notch uplift based on Moody's
expectation that the company will receive extraordinary support from its
shareholder and key off-taker, HPCL. This reflects
HMEL's strategic importance to HPCL, its 49% ownership by
HPCL, as well as HPCL's management oversight and track record of
providing financial and operational assistance to HMEL.
On 31 March 2019, 73% of the total debt in HMEL's capital
structure was secured. As such, the claims of bondholders
are subordinated to those of secured lenders. Consequently,
Moody's rates the company's senior unsecured bonds one notch below its
CFR.
HMEL's ratings also consider the following environmental, social
and governance (ESG) factors.
First, HMEL is exposed to increasing environmental regulations and
safety risks associated with its refining business, which is among
the 11 sectors that Moody's has identified as having elevated environmental
risk. However, these risks are somewhat mitigated by the
company's track record of environmental compliance and its high refining
complexity with increasing downstream integration.
Second, the ratings consider HMEL's aggressive financial strategy,
as evidenced by its largely debt funded and ongoing petrochemicals capacity
expansion. This is mitigated by the company's low shareholder returns,
long dated debt maturity profile and an undertaking from its sponsors
to cover certain shortfalls in internal cash generation and cost overruns.
The ratings also take into consideration HMEL's limited public disclosure
of its financial and operating performance given its status as a private
company in India.
Third, HMEL is privately owned and its ownership is concentrated
in HPCL and Mittal Energy Investments, which each hold a 49%
stake. HMEL's board consists of nine directors, out of which
only two are independent. HPCL is in turn 51.1% owned
by Oil and Natural Gas Corporation Ltd. (Baa1 negative),
which is 67.7% owned by the Government of India (Baa2 negative).
Mittal Energy Investments is a 100% subsidiary of Mittal Investments
SARL. The indirect, partial ownership by the Government of
India mitigates some of the risks arising from its concentrated ownership
structure.
As of 31 December 2019, HMEL had cash and cash equivalents of INR7.9
billion which along with expected cash flow from operations of around
INR26-27 billion will be sufficient to cover routine capital expenditures
of around INR10.6 billion and INR9.3 billion of debt maturities
over the next 12 months.
Moody's is unlikely to upgrade the ratings until HMEL completes
its ongoing expansion and successfully ramps-up its petrochemical
plant. A sustained improvement in the regional refining margin
environment leading to a material increase in earnings and cash flow would
also be beneficial for the ratings. Specific metrics that would
indicate upward ratings pressure include adjusted debt/EBITDA staying
below 4.0x and debt/capitalization remaining below 60% on
a sustained basis.
Moody's could downgrade the ratings if there is a sustained decline
in either refining margins or operational efficiency, which results
in a significant deterioration in HMEL's earnings and cash flow.
At the same time, any material cost overruns that necessitate higher
borrowings or delays in construction and/or ramp-up after physical
construction that defer the earnings contribution from the project,
will also exert negative ratings pressure.
Specifics metrics that would indicate downward ratings pressure during
the project construction phase include adjusted debt/EBITDA staying above
6.0x and debt/capitalization staying above 70% beyond March
2021.
Moody's could also downgrade the ratings if HMEL's credit metrics fail
to recover after project completion and stabilization, such that
debt/EBITDA stays above 5.0x and debt/capitalization stays above
65%.
HMEL's ratings could face further downward pressure if (1) Moody's downgrades
HPCL's ratings, or (2) there is a change in the relationship between
HPCL and HMEL that lowers Moody's assessment of the level of support incorporated
into HMEL's ratings.
The principal methodology used in these ratings was Refining and Marketing
Industry published in November 2016. Please see the Rating Methodologies
page on www.moodys.com for a copy of this methodology.
HPCL-Mittal Energy Limited, which commenced operations in
2011, owns an 11.3 million metric tons per annum (mmtpa)
refinery in Bathinda, Punjab, with a Nelson Complexity Index
of 12.6, making it one of the highest complex refineries
in Asia.
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.
Sweta Patodia
Analyst
Corporate Finance Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077
Laura Acres
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077
Releasing Office:
Moody's Investors Service Singapore Pte. Ltd.
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