Fitch Rates Gazprom's LPNs 'BBB-(EXP)'
28 Nov 2016 10:50 AM
Fitch Ratings-London-28 November 2016: Fitch Ratings has assigned Gaz Capital S.A.'s (Gaz Capital) loan participation notes (LPNs) an expected senior unsecured 'BBB-(EXP)' rating. The planned notes are the 40th series to be issued under Gaz Capital's USD40bn debt issuance programme rated 'BBB-' by Fitch. The final rating is contingent upon the receipt of final documentation conforming materially to information already received and details regarding the amount and tenor.
The LPNs will be issued on a limited recourse basis for the sole purpose of funding a loan by Gaz Capital to PJSC Gazprom (BBB-/Stable). The proceeds from the loan are expected to be used by Gazprom for general corporate purposes. The noteholders will rely solely on Gazprom's credit and financial standing for the payment of obligations under the notes.
The LPNs are rated at the same level as Gazprom's Issuer Default Rating (IDR) on the basis that the loan will represent an unsecured and unsubordinated obligation of the company.
Gazprom is Russia's largest state-owned energy company, engaged in natural gas production, transportation and distribution, as well as crude oil production and refining, heat and electricity generation. In 2015, Gazprom produced 445 billion cubic metres (bcm) of natural gas, including its share of associates, and generated RUB1,874bn (USD31bn) of EBITDA. Its end-2015 funds from operations (FFO) adjusted net leverage was 1.3x, one of the lowest among global oil and gas companies.
KEY RATING DRIVERS
Rising European Volumes, Falling Prices
In 9M16, Gazprom's gas export volumes to Europe rose 9% yoy. Gazprom's average gas prices in Europe, including trading operations, fell to USD182.2 per thousand cubic metres (mcm) in 1H16, from USD269.5/mcm in 1H15 and USD366/mcm in 1H14 on falling oil prices.
Gazprom is well placed to maintain its market share in Europe because of its low cash production costs relative to peers. Gazprom's prices in Europe will start to recover, but the recovery will be slow - we assume its realised prices to average USD180/mcm in 2016, and to remain below USD190-USD200/mcm in 2017.
Weak FSU and Domestic Markets
Gazprom's gas sales volumes to former Soviet Union (FSU) countries and in Russia continue to fall, reflecting an on-going gas conflict with Ukraine, which almost entirely stopped buying Russian gas in mid-2015, a weakening Russian economy and intensifying competition from domestic producers. In 1H16, FSU and Russian volumes fell 22% and 9%, respectively. FSU gas prices collapsed in line with Europe's, while domestic gas sales prices increased 8% yoy in rouble in 1H16 and fell 12% in dollar terms to USD55/mcm, the lowest in years.
At the same time, sales in Russia should become a more important profit driver for Gazprom on the back of falling export prices. We estimate that in 2015 its domestic prices were 2.2x lower than the average export netback (export prices minus export duty and transportation) and that this figure should reduce to 1.5x in 2016.
Moderate Tax Increase
Based on the preliminary federal budget parameters, we expect Gazprom's mineral extraction tax to increase by around 15%, which will decrease the company's EBITDA by around 5% compared to our previous forecasts. We assess this tax hike as moderate, though it will put further pressure on Gazprom's free cash flow (FCF) in 2017. Oil taxes, which affect Gazprom Neft's financial performance, will remain broadly at the 2016 level.
We believe that a major tax hike remains the key risk for the Russian oil and gas sector. Our base case, however, is that taxes will remain broadly at the 2017 level; though a major tax hike is more likely if oil prices fall sustainably below USD40/bbl.
Moderate Leverage, Negative FCF
We estimate Gazprom's FFO adjusted net leverage will increase to 2.0x at end-2016 and to 2.1x at end-2017, from 1.3x at end-2015, due to weak forecast oil and gas prices, an additional RUB100bn tax charge, and high, but falling, capex. In addition, the metrics will be negatively affected by Gazprom's buyout of a 3.59% stake from Vnesheconombank (BBB-/Stable) for around RUB130bn and RUB85bn equity injection into JSC Gazprombank (BB+/Stable). Nevertheless, we expect Gazprom's leverage to be below our negative rating action trigger of 2.5x.
We expect Gazprom's FCF after dividends to be negative at least in 2016 and 2017, financed by the company's vast cash reserves and possibly additional borrowings. Gazprom should be able to broadly balance its after-dividend cash inflows and outflows by 2018.
Fitch's key assumptions within our rating case for the issuer include:
- Fitch's Brent price deck: USD42/bbl in 2016, USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl in the long term
- National balancing point (NBP) gas price deck: USD5.0/mcf in 2016, USD5.5/mcf in 2017, USD6/mcf in 2018 and USD6.5/mcf in the long term
- USD/RUB exchange rate: RUB69 per 1 USD in 2016, RUB68 in 2017, RUB62 in 2018 and RUB57 in the long term
- Slightly higher gas exports to Europe; slightly lower Russian and FSU gas volumes in 2016-2019 compared with 2015
- Gazprom's average European gas price influenced by Brent with a six-month lag and spot natural gas prices
- Capex falling 15% yoy in 2016 and 5% yoy in 2017 in rouble terms
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Negative rating action on Russia, stemming from a weakening of the policy framework that undermines macroeconomic and fiscal performance, a sharp decline of international reserves or a rise in geopolitical tensions (for more details see ' Fitch Revises Outlook on Russia to Stable; Affirms at 'BBB-', dated 14 October 2016 at www.fitchratings.com).
- Material deterioration of credit metrics, e.g. FFO adjusted net leverage above 2.5x (2016E: 2.0x) and FFO interest cover of below 8x (2016E:8.7x) on a sustained basis due to a prolonged decline in oil and gas prices, aggressive capex or sizable acquisitions.
- Significantly falling gas sales to Europe.
- Prolonged interruptions in gas transit via Ukraine to Europe.
- Deteriorated liquidity.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Positive rating action on Russia, which is likely to trigger positive rating action on Gazprom, as the company's rating is constrained by that of the sovereign.
Positive rating action on Russia could result from the rebuilding of fiscal and external savings buffers, for example through a sustained recovery in oil prices; fiscal reforms and commitment to a credible medium-term fiscal framework or implementation of structural reforms that would boost potential growth.
At 30 June 2016, Gazprom had RUB1,424bn in cash and callable long-term deposits, sufficient to cover RUB564bn of short-term debt and projected annual negative FCF of RUB349bn, including dividends and the buyout of its shares from Vnesheconombank. However, without new borrowings Gazprom's strong liquidity position could worsen in 2017. Our base case scenario is for Gazprom to restore its strong liquidity in 2017-18 by attracting new loans from domestic and, possibly, Chinese banks, as well as occasionally issuing international bonds.
While Gazprom is exempt from US/EU financial sanctions, its oil subsidiary PJSC Gazprom
Neft (BBB-/Stable) is subject to US and EU financial and sectoral sanctions. We view stringent US and EU sanctions against Gazprom unlikely, as Gazprom is Europe's key gas supplier.
+7 495 956 9901
Dmitry Marinchenko, ACCA
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Fitch Ratings Limited
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Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: firstname.lastname@example.org; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: email@example.com.
Date of Relevant Rating Committee: 19 October 2016.
Summary of Financial Statement Adjustments
- Operating leases: Fitch adjusted Gazprom's debt by adding 6x the annual operating lease expense of RUB35.6bn in 2015.
- Financial guarantees: We included total end-2015 outstanding amount of financial guarantees provided by Gazprom in the company's debt.
- Not readily available cash: Fitch estimates that Gazprom will need to keep RUB150bn of cash on balance sheet for various corporate needs such as working capital funding and removes this amount from the company's readily available cash.
Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
National Scale Ratings Criteria (pub. 30 Oct 2013)
Parent and Subsidiary Rating Linkage (pub. 31 Aug 2016)
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