Moody's Investors Service has affirmed the Baa2 issuer ratings and senior unsecured bond ratings of Oil India Limited (OIL).
Moody's has also affirmed the Baa2 rating on the senior unsecured notes issued by Oil India International Pte. Ltd. and guaranteed by OIL.
At the same time, Moody's has lowered OIL's baseline credit assessment (BCA) to baa3 from baa2.
The outlook on all ratings is stable.
RATINGS RATIONALE
"The lowering of the BCA to baa3 from baa2 is driven by our expectation that the company's credit metrics, which have weakened on the back of acquisition and shareholder payments, are unlikely to recover to a level more appropriate for a baa2 BCA," says Vikas Halan, a Moody's Vice President and Senior Credit Officer.
"Furthermore, we expect OIL's retained cash flow (RCF) to debt will remain around 20%-22% in fiscal 2018 ending March 2018 and in fiscal 2019, which will be in line with the 22% (excluding the effect of one-time royalty payments) in fiscal 2017, but lower than 31% in fiscal 2016. Such a level of RCF to debt is lower than our threshold of 25% for a baa2 BCA," says Halan.
OIL acquired stakes in oil & gas fields in Russia for $1 billion in 2016 and also executed share buybacks of INR15,270 million in June 2017. These exercises resulted in an increase in its net borrowings to over INR80 billion as of September 2017, compared to a net cash position in March 2016.
Even though an improvement in oil prices will result in higher cash flows, OIL will continue to generate negative free cash flows as its dividend payments and capital expenditures will remain high.
The company may also need to make further buybacks under the guidelines issued by the government of India for the state-owned companies.
Consequently, Moody's expects OIL's borrowings to remain high over the next 2-3 years, unless the company decides to monetize some of its non-core investments, such as its stake in Indian Oil Corporation Ltd (IOC, Baa2 stable).
"The affirmation of OIL's Baa2 issuer rating reflects our expectation of the high likelihood of extraordinary support that results in a one-notch uplift from its baa3 BCA," says Halan.
OIL's BCA also reflects the company's strategically important position as India's second largest state-owned exploration and production (E&P) company. It is a significant contributor of the country's upstream production, accounting for about 8% of India's total crude oil (excluding condensate) and natural gas production, along with 8% of its proved crude oil reserves in fiscal 2017.
OIL also benefits from the competitive cost structure of its onshore operations, resulting in high profitability and solid operating cash flow generation.
At the same time, the ratings take into account OIL's small scale, level of asset concentration, moderate financial profile, exposure to the Indian government's (Baa2 stable) credit risk, and the execution risks associated with its inorganic growth strategy for overseas.
The ratings also incorporate OIL's strong financial flexibility, provided by its investment in Indian Oil Corporation, with a market value of approximately INR100 billion as of 26 December 2017. The company can monetize this investment to reduce its borrowings.
OIL also has a robust liquidity profile with cash and cash equivalents (including investments in liquid muutal funds) of INR44 billion as of 30 September 2017 against no short-term debt.
The outlook on the ratings is stable, reflecting the stable outlook of India's sovereign rating.
At the same time, Moody's expects OIL to manage its capital spending and shareholder distributions in such a way that its financial metrics will remain supportive of its ratings.
An upgrade of OIL's ratings to Baa1 will require an upgrade of India's sovereign rating to Baa1.
OIL's BCA could be raised to baa2 if the company demonstrates sustained improvements in its credit metrics and maintains financial discipline as it pursues growth. Specific indicators include retained cash flow to debt exceeding 25% on a consistent basis.
OIL's issuer rating could be downgraded to Baa3 if (a) its BCA falls to ba3; or (b) India's sovereign rating is downgraded; or (c) there is a change in the relationship between OIL and the Indian government, resulting in a lower expectation of extraordinary support.
The BCA could be lowered to ba1 if a) OIL makes any debt-funded acquisitions or shareholder returns, or b) its earnings and cash flow generation decline more than Moody's expects owing to an unexpectedly protracted or steep decline in oil prices.
Credit metrics indicative of such downward pressure include adjusted RCF to debt staying below 20%.
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