Fitch Rating : Revises Outlook on HMEL to Stable; Affirms IDR at 'BB'

5 May 2022 , 04:08 PM

Fitch Ratings has revised the Outlook on India-based HPCL-Mittal Energy Limited’s (HMEL) Long-Term Issuer Default Rating (IDR) to Stable from Negative, and affirmed the IDR at ‘BB’. The agency has also affirmed the ratings on the USD375 million 5.25% senior unsecured notes due 2027, and USD300 million 5.45% senior unsecured notes due 2026 at ‘BB-‘.

The Outlook revision reflects recovery in HMEL’s credit metrics to levels adequate for its standalone credit profile (SCP) of ‘b+’ ahead of our expectations, and lower downside risks to our profitability estimates, given improved refining industry conditions and mechanical completion of HMEL’s petrochemical project.

HMEL’s IDR benefits from a two-notch uplift from its SCP of ‘b+’, based on our assessment that its parent Hindustan Petroleum Corporation Limited (HPCL, BBB-/Negative, SCP: ‘bb’) has a ‘medium’ incentive to support HMEL, in line with Fitch’s Parent and Subsidiary Rating Linkage (PSL) criteria.

We believe that should HMEL’s SCP improve, the two-notch uplift could drive its rating above HPCL’s SCP, while being capped a notch below HPCL’s IDR in line with our revised PSL criteria. This reflects our view that HMEL’s position within HPCL adds to its strategic importance for Oil and Natural Gas Corporation Limited’s (BBB-/Negative, HPCL’s majority owner) overall downstream integration, providing incentives to support.

KEY RATING DRIVERS

Improving Leverage: Fitch expects HMEL’s net leverage, as defined by net debt/EBITDA, to improve to 5.7x in FY22 from more than 10 times in FY21, and around 4x by FY24. This is supported by healthy profit from its refining and petrochemical operations, reducing capex intensity following completion of the petrochemical project, limited tax outflows due to accumulated losses for the next few years, and management commitment to not declare any major dividends until leverage improves to around 3x.

Favourable Refining Industry Conditions: Fitch expects rising global demand for refined products along with tightening supply to support strong refining margins in the near to medium term, though moderating from the current highs. Singapore gasoline and gasoil cracks have improved to above pre-Covid-19 levels, with gasoil cracks at their highest in more than a decade. Lower refined product exports from China, disruption in product flows from ongoing geopolitical tensions, and increased uptake of middle distillates for power generation are driving the tightness.

Petrochemical Project Mechanically Completed: HMEL’s new petrochemical project was completed in April 2022, following a six-to-nine month delay due to issues around availability of labour and travel restrictions on international consultants. Project commissioning is now underway, and we expect the plant to contribute around USD70 million of EBITDA in FY23 and USD300 million in FY24 as it stabilises and ramps up gradually. HMEL expects a faster stabilisation, with USD140 million EBITDA in FY23 and USD450 million in FY24.

Strong Asset Quality; Single Refinery: HMEL’s strong asset quality is driven by its high-complexity refinery, which has a Nelson complexity index of 12.6, one of the highest in APAC. This allows for the processing of heavy crude oil and optimisation of the company’s product slate, as reflected in HMEL’s wider gross refining margins (GRMs) against regional benchmarks. The benefits are counterbalanced by the single refinery’s higher exposure to cash-flow volatility from the cyclical nature of the international refining industry versus refiners with several plants.

Linkages with Parent: HMEL is 49%-owned each by HPCL and Mittal Energy Investment Pte Ltd, but we believe HPCL has medium operational and strategic incentives to support HMEL, driving a two-notch uplift in HMEL’s rating from its SCP.

HMEL represents over 26% of HPCL’s refining capacity. HMEL is the sole refinery catering to HPCL’s product needs in the north Indian market, and helps reduce the gap between HPCL’s marketing volumes and refining volumes, with the two having a take-or-pay offtake agreement for all of HMEL’s liquid products (except naphtha). HMEL also adds to the parent’s diversification in petrochemicals from FY23.

Bond Ratings Notched Down: Fitch has rated HMEL’s bonds one notch below its IDR due to a high proportion of secured debt (around 80%) in its capital structure. We expect secured debt/EBITDA to stay above 3x over FY23-FY24, as borrowing for the petrochemical expansion is mostly on a secured basis. We may remove the notching impact if and when the proportion of secured debt declines in a sustainable manner as the company continues to deleverage.

DERIVATION SUMMARY

HMEL’s IDR includes a two-notch uplift due to the ‘medium’ incentive of support from its parent HPCL. HMEL’s output is sold entirely to HPCL and makes up 26% of HPCL’s refining capacity after expansion, supports HPCL fuel sales in the north Indian market, and adds to the parent’s diversification in petchem from FY23, driving medium operational and strategic incentive for the parent to support.

HMEL’s SCP of ‘b+’ is two notches lower than that of HPCL, which is one of India’s largest fuel-marketing companies, with around 11% of India’s refining capacity and 24% market share in fuel retail outlets, and a better financial profile than HMEL.

PT Saka Energi Indonesia’s (Saka, B+/ Negative) IDR also benefits from a two-notch uplift from its SCP of ‘b-‘ due to the ‘medium’ incentive of support from its parent PT Perusahaan Gas Negara Tbk (PGN, BBB-/Stable). The support is driven by the ‘medium’ legal incentive due to the presence of a cross-default provision between PGN and Saka, and medium ‘operational’ incentive with the parent having control over appointment of Saka’s board and management.

KEY ASSUMPTIONS

Brent crude oil prices of USD95 a barrel in FY23 and USD75 a barrel from FY24.

GRMs to average around USD14 per barrel over FY22-FY23, and then settle at mid-cycle levels of USD12 per barrel from FY24 (USD9 per barrel over FY20-FY21), supported by a demand recovery and improving product spreads.

Refinery utilisation rate of around 110% over the rating horizon, except 98% in FY25 on account of maintenance shutdown.

Capex of INR23 billion in FY23, falling to INR12 billion in FY24 as the petrochemical project is completed.

No dividend payments until net debt/EBITDA improves to around 3x by FY25

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Decrease in HMEL’s net leverage to below 5.0x on a sustained basis leading to an upward revision of its SCP and consequently an upgrade of its IDR.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Weakening of linkages between HPCL and HMEL.

Increase in HMEL’s net leverage to over 6.0x for a prolonged period may lead to a downward revision of its SCP, and consequently a downgrade of its IDR.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Comfortable Liquidity: HMEL’s liquidity is comfortable, with a cash balance of INR18 billion, petchem capex-related undrawn committed facilities of INR34 billion, and undrawn secured working-capital facilities of INR80 billion as of end-March 2022. This is against INR18 billion of debt maturities (including supplier’s credit and factoring arrangements) in FY23. In addition, HMEL has access to the domestic debt market where it has strong relationships with Indian banks, and the offshore market where it raised US dollar bonds in 2017 and 2019.

ISSUER PROFILE

HMEL, a joint venture between HPCL and Mittal Energy Investment Pte Ltd, operates a highly complex refinery with capacity of 11.3mt per year in north India, where it is currently commissioning an integrated petrochemical plant with capacity of around 2mt per year.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS

HMEL’s rating incorporates a two-notch uplift from its SCP, reflecting our view that its parent HPCL has medium operational and strategic incentives to support it.

ESG CONSIDERATIONS

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.