October 20 (SeeNews) - Fitch Ratings said it has affirmed the long-term issuer default rating (IDR) of Turkish petrochemical company Petkim Petrokimya Holdings A.S. at 'B', with a stable outlook.
The stable outlook reflects Fitch's expectations of positive free cash flow (FCF) generation and moderate deleveraging over 2020-2023, whereas the rating reflects Petkim's credit metrics similar to that of peers rated in the 'B' category, its small scale, and high product concentration relative to larger, more diversified global peers, Fitch said in a statement on Monday.
Fitch also said in the statement:
"The Stable Outlook reflects Fitch's expectations of positive free cash flow (FCF) generation and moderate deleveraging over 2020-2023. We forecast funds from operations (FFO) net leverage to reduce to 3.5x by 2023, supported by a petrochemicals sector recovery, and after payment of the last USD240 million instalment in 2021 for the stake acquisition in SOCAR Turkey Aegean Refinery (STAR). The current, weaker-than-previously-expected credit metrics are driven by low petrochemical prices reducing earnings and higher capex plan, which should maintain FFO net leverage above our negative sensitivity of 4x in 2020-2021.
The rating of Petkim reflects its credit metrics similar to that of peers rated in the 'B' category, its small scale, and high product concentration relative to larger, more diversified global peers. In particular, Petkim owns a single-site petrochemical complex and is exposed to cyclical commodity polymers, which results in inherent earnings volatility. Its business profile benefits from a well-invested asset base, a strong market position in the domestic petrochemical market, and some resilience to foreign exchange volatility.
KEY RATING DRIVERS
Deleverage from 2021: The petrochemical market environment was already challenging in 2019, which affected the company's credit metrics. We forecast FFO net leverage to remain close to 5x in 2020, but expect a downward trend from 2021 with a reduction to 3.5x by 2023. Earnings in 2020 will be affected by lower demand and we expect the post-pandemic recovery in 2021 to be offset by a USD240 million payment of Petkim's third and last instalment for the purchase of 18% interest in the STAR Refinery. In order to cushion excessive growth in leverage, Petkim suspended payments of dividends in 2019 and in 2020. We don't expect distributions to shareholders over the rating horizon which supports the forecast positive FCF over 2020-2023.
Low Naphtha Prices Support Spreads: Petkim's earning reflects the spread of its products to naphtha, its major feedstock. Spread for thermoplastics, a segment representing nearly half of Petkim's non-trading revenue, improved in 2Q20 by 12% from 1Q20 and helped to mitigate a decline in market prices. The pressure from oversupply in polyethylene (PE; 60%-65% of Petkim's plastics sales) and the recovery in oil prices could, however, slow the pace of improvements in Petkim's earnings in 2H20. The new, global production capacity of PE is expected to increase in 2020 and 2021, although a recovery in demand in 2021 can improve supply/demand balance.
High Plant Use Despite Pandemic: Petkim maintained average use of its capacity at 95% in 1H20 and operations at its facilities have not been significantly affected by the pandemic. Weaker demand for plastics in domestic market was partly counterbalanced by an increase in export of about 5%. Sales volumes were modestly affected in 2Q20, with less than a 4% reduction yoy.
Turkish Lira Impact Manageable: Petkim has almost 90% of its plant production costs, or 80%-85% of total cash costs, denominated in US dollars because its major feedstock, naphtha, is purchased at US dollar price. Simultaneously, the majority of sales is directly denominated in US dollar and euros, or indirectly driven by lira price indexation to the global US dollar benchmarks. This supports Petkim's EBITDA during the periods of lira devaluation, thus largely offsetting the company's hard-currency debt revaluation. Foreign exchange volatility could also have indirect implications, such as weaker domestic demand, although Petkim could re-route its products to export markets.
STAR Launch Adds to Cost Savings: STAR Refinery now operates at almost full capacity. In late 2018 Petkim's ultimate corporate parent, State Oil Company of the Azerbaijan Republic (SOCAR; BB+/Negative), launched a new STAR Refinery located next to Petkim's plants in Turkey, with an annual oil refinery capacity of 10 million tonnes (mt). As a result, Petkim could expect around USD40 million annual savings on logistic costs after the full ramp-up of STAR Refinery. The refinery can supply up to 1.6mt of naphtha and 270 thousand tonnes of mixed xylene or reformate feedstock to Petkim annually.
STAR Stake Purchase Delayed: Petkim delayed the last of three equal USD240 million instalments for its 18% stake in STAR until June 2021. We assume this payment will be made if there is no severe downturn in Petkim's performance in 2021. The first two instalments were paid in 2018, funded by a USD500 million bond placement. We add the outstanding USD240 million payment to Petkim's adjusted debt and we do not factor dividends from STAR into our forecasts.
Small-Scale Commodity Producer: Petkim is a Turkish commodity chemical producer, making plastics and intermediates from naphtha. Petkim's profitability reduced at the end of 2019 when the naphtha-ethylene spread reduced as petrochemicals prices continued to decline. We expect petrochemicals prices to gradually recover from late 2020 as demand progressively returns to pre-crisis levels and absorbs added capacity that has oversupplied the market since 2019. Petkim's small scale and single-site operations with limited integration are key factors driving the company's rating in the 'B' category.
Contingent Liabilities of STEAS: Petkim is 51%-owned by SOCAR Turkey Enerji A.S. (STEAS), which in turn is 87%-owned by SOCAR and 13% by Goldman Sachs International. Petlim, a container terminal in the Aegean region operating since 4Q16, is 70%-owned by Petkim and 30%-owned by Goldman Sachs. Goldman Sachs has put options with STEAS and Sermaye Investments Limited (SIL, subsidiary of SOCAR) until 2021 protecting the value of its stakes in STEAS and Petlim. Should these options be exercised, STEAS would incur liabilities of up to USD1 billion with respect to STEAS, and USD300 million with respect to Petlim, with the remaining of USD300 million to be paid by SIL. While this is not our base case scenario, and the maturity of the option could be extended, this could result in pressure on Petkim to upstream additional cash to STEAS.
Rating on Standalone Basis: SOCAR's IDR is aligned with that of Azerbaijan (BB+/Negative), while its Standalone Credit Profile is 'b+'. Under Fitch's Parent and Subsidiary Linkage Rating Criteria, we have not factored in any uplift on Petkim's rating from SOCAR's ownership as we assess the overall links between SOCAR and Petkim as moderate. This assessment captures moderate legal ties between the two companies (which takes into account a lack of legal guarantees but also assumes Petkim being subject to cross-default provision in SOCAR's bond documentation) and moderate strategic and strong operational ties.
DERIVATION SUMMARY
Russia-based PJSC Kazanorgsintez (B+/Stable) is Petkim's closest rated peer based on product mix (basic polymers) and geographical concentration. Kazanorgsintez benefits from its more competitive cost position, higher EBITDA margins (on average over 25%) and from a stronger financial profile, with FFO net leverage of under 1x. Petkim benefits from wider product diversification while Kazanorgsintez's revenues are more concentrated towards polyethylene.
Other Fitch-rated, commodity-focused EMEA chemical companies include Roehm Holding GmbH (B-/Stable), PAO SIBUR Holding (BBB-/Stable), Ineos Group Holdings S.A. (BB+/Negative). Roehm has a leading position in the methacrylates business in Europe with better geographical diversification but is more leveraged than Petkim. Ineos has much stronger business profile with better product and geographical diversification and larger scale. SIBUR and US-based Westlake Chemical Corporation (BBB/Negative) have competitively priced petrochemical feedstock, placing them in a more advantageous position than less integrated producers, such as Petkim.
KEY ASSUMPTIONS
- Average USD/TRY rate at 6.97 in 2020, 7.76 in 2021, and 8.01 in 2022 and onwards. Year-end USD/TRY rate of 7.6 in 2020, 7.9 in 2021, 8.1 in 2022 and onwards.
- Petrochemical margins pressuring EBITDA towards USD200 million in 2020 (TRY1.4 billion) before a market-driven recovery towards USD255 million (TRY2.0 billion) by 2023.
- Neutral change in working capital in 2020, followed by annual working capital outflow of around TRY0.2 billion in 2021-2023.
- Capex-to-sales at around 6.5% over 2020-2023.
- No dividends paid to shareholders nor received from STAR Refinery over the rating horizon.
- The last USD240 million instalment related to the 18% stake purchase in the STAR Refinery to be paid in 2021.
Key Recovery Rating Assumptions
- The recovery analysis assumes that Petkim would be considered a going-concern in bankruptcy and that the company would be reorganised rather than liquidated.
- The going-concern (GC) EBITDA is estimated at USD220 million. It reflects Petkim's performance in a low cycle with benefits from synergies with the STAR Refinery in the future. An EV multiple of 4x was applied to the GC EBITDA, reflecting its single-site business with exposure to emerging markets.
- After deduction of 10% for administrative claims, our waterfall analysis generated a ranked recovery in the RR4 band, indicating a 'B' instrument rating. The waterfall analysis output percentage on current metrics and assumptions was 48%.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- Consistent implementation of conservative financial policy leading to FFO net leverage consistently below 3.0x (2019: 4.8x);
- Significant improvement in cash flow diversification - for instance, higher cash flow generation at Petlim and dividends from the STAR Refinery.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- FFO net leverage sustained above 4.0x;
- Support provided to the parent (such as cash outflows related to put options being called by Petlim and STEAS's minority shareholder) resulting in a deterioration of Petkim's credit metrics;
- Further material deterioration in the outlook for petrochemical margins;
- Aggressive financial policy, including resumption of dividend payments, in the absence of material improvements in earnings.
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.
LIQUIDITY AND DEBT STRUCTURE
Limited Liquidity: Petkim's liquidity was manageable at end-June 2020, with cash and deposits of TRY4.6 billion covering short-term debt of TRY3.7 billion. Petkim will also have to pay the last instalment of USD240 million (TRY1.6 billion equivalent) by June 2021 for the acquisition of an 18% stake in STAR Refinery. In the case of a lower performance than expected, we would expect the payment to be delayed, as was the case in 2020.
Current debt is mostly used to finance working capital, including TRY1.6 billion of liabilities resulting from letters of credit for naphtha procurement that we treat as debt. Petkim's liquidity profile reflects some reliance on uninterrupted access to domestic banks. As of June 2020, Petkim had access to about USD1.3 billion of undrawn, uncommitted debt facilities. This is not uncommon among Turkish corporates but exposes the company to systemic liquidity risk and results in a liquidity ratio of close to 1x. The rest of the total debt has remote maturity dates, including a USD500 million bond due in 2023.
SUMMARY OF FINANCIAL ADJUSTMENTS
-- In 2019 we treated TRY59 million (USD33.4 million of depreciation and amortisation on rights-of-use of assets, and USD25.6 million of lease interests) as operating expenses.
-- In 2019 TRY1.4 billion (equivalent USD240 million) residual commitment to pay for the 18% stake in STAR were treated as off-balance-sheet debt."