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Rating Action:

Moody's downgrades Repsol to Baa2, outlook stable

14 Mar 2012

London, 14 March 2012 -- Moody's Investors Service has today downgraded the long-term issuer rating of Repsol YPF S.A.("Repsol") and the senior unsecured debt ratings of Repsol International Finance B.V. to Baa2 from Baa1. Moody's has also downgraded the preferred stock rating of Repsol International Capital Limited to Ba1 from Baa3. The Prime-2 commercial paper and short-term ratings are affirmed. The rating outlook is stable.

RATINGS RATIONALE

The rating downgrade reflects the marked increase in indebtedness and deterioration in financial metrics reported by Repsol in 2011 as a result of the group's weaker than expected operating performance in parallel with a significant increase in investments required to finance key growth projects.

While recognising the non-recurring nature of some of the factors, which constrained the group's operating cash flow generation in 2011, Moody's believes that in the context of the sizeable capital expenditure programme undertaken by the group to enhance its upstream reserve base and production profile, Repsol will be particularly challenged to cut debt in the next 2-3 years, beyond the reduction expected to result from the divestment and/or the use through a scrip dividend, of the stake in its own shares acquired from Sacyr in December 2011.

In 2011, despite higher oil and gas realization prices benefiting upstream activities and an increased contribution from the LNG business, Repsol's operating profitability and cash flow generation have been constrained by a number of factors. These included the loss of hydrocarbon production due to civil unrest in Libya but also labour strikes at 57%-owned YPF Sociedad Anónima ("YPF", Ba2 review for downgrade), a significant squeeze on refining margins reflecting the very challenging operating environment prevailing in Europe, as well as the effect on YPF's results of heightened cost inflation in Argentina and the suspension of the Petroleo Plus subsidy.

Combined with a significant increase in investments, which were 24% higher than in the previous year (excluding Gas Natural Fenosa), and the acquisition of a 10% stake in its own shares from Sacyr, this resulted in a marked increase in Repsol's indebtedness, despite the further reduction of the group's interest in YPF to 57.4% from 79.8%, which raised EUR1.9 billion (excluding a EUR438 million vendor loan granted to Grupo Petersen) during 2011. Based on the group's recent earnings announcement, Moody's estimates that Retained Cash Flow to Net Debt (based on the equity accounting of Gas Natural) has declined to 18% (pro-forma the placement of a 5% stake in own shares completed in January 2012) v. 33% in 2010.

At the same time, Moody's acknowledges the progress made by Repsol in recent years in enhancing its hydrocarbon resource base (mainly through exploration discoveries) and developing a pipeline of upstream projects, which should allow the group to meet its medium and long-term production growth targets. Moody's also notes the improvement in reinvestment risk factors (e.g. reserve replacement rates, finding and development costs) reported by Repsol's core upstream business as well as, to a lesser extent, by YPF in recent years.

Looking ahead, Moody's expects that Repsol's cash flow generation will benefit in the near term from the resumption of production in Libya and start-ups such as Margarita in Bolivia and Kinteroni in Peru. The recent expansion of the group's conversion capacity in Spain, should also give a fillip to Repsol's refining margins and help mitigate the pressures weighing on its downstream business in the context of the challenging operating conditions affecting the European refining sector and the weakening Spanish economy. However, free cash flow generation is likely to remain constrained by the high investments required to convert into reserves and bring to market the significant resources added to the group's portfolio in the past few years. In addition, the increased government interference and pressure faced by YPF to boost production and investment in Argentina may restrain Repsol's ability to upstream dividends from its 57%-owned subsidiary in the future. Moody's believes that all these factors will combine to limit Repsol's capacity to reduce debt in the next 2-3 years and restrain the pace of any recovery in its credit metrics.

The stable outlook reflects Moody's expectation that Repsol's future operating cash flow generation will improve against 2011, underpinned by a return to more normalized production levels in Libya, the positive effect of the capacity upgrade on the group's refining margins and the continuing delivery of its major upstream projects. In turn, this should help Repsol return to positive net cash flow (post divestments) and strengthen its credit metrics relative to the 2011 year-end, including Retained Cash Flow to Net Debt (based on the equity accounting of Gas Natural) of around 30% on a three-year average basis.

Moody's would consider downgrading Repsol's rating further in the event that renewed weakness in financial performance and/or any major delay/setback in the execution of key growth projects (i) result in further negative cash flow and leave the group's credit metrics weakly positioned for a sustained period of time including Retained Cash Flow to Net Debt (based on the equity accounting of Gas Natural) below 25% on average through-the-cycle and (ii) prevent Repsol from maintaining operating metrics in line with the Baa2 rating including a reserve replacement ratio consistently in excess of 100%.

Conversely, while unlikely at this juncture, upward pressure may develop on Repsol's rating should the successful execution of the group's upstream growth projects lead to some substantial improvement in cash flow generation allowing some meaningful deleveraging and marked strengthening in financial metrics, including Retained Cash Flow to Net Debt (based on the equity accounting of Gas Natural) consistently above 35%.

The principal methodology used in rating Repsol YPF S.A. was the Global Integrated Oil & Gas Industry Methodology published in November 2009. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Headquartered in Madrid, Spain, Repsol YPF, is a major integrated oil and gas company with consolidated total proved hydrocarbon reserves of 2.1 billion barrels of oil equivalent and a strong downstream presence in the Iberian peninsular. In 2011, the group reported consolidated operating revenue of EUR63.7 billion and hydrocarbon production of 290 million barrels of oil equivalent (including YPF's contribution of 181 million boe).

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Francois Lauras
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Olivier Beroud
Managing Director
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's downgrades Repsol to Baa2, outlook stable
No Related Data.
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