Fitch Affirms Medco Energi at 'B+'; Outlook Positive

(Fitch Ratings - Singapore - 23 May 2023) -- Fitch Ratings has affirmed PT Medco Energi Internasional Tbk's Long-Term Issuer Default Rating (IDR) at 'B+' with a Positive Outlook. The agency has also affirmed the ratings on Medco's senior unsecured US-dollar notes at 'B+' with a Recovery Rating of 'RR4'.

The Positive Outlook reflects our expectation that Medco is on track to boost its reserve profile while maintaining an adequate financial profile. This is despite its proved (1P) reserve life dropping to around six years as of end-2022 (2021: 9.6 years) based on our calculation.

Medco's rating is underpinned by its improved scale after its acquisition of the Corridor block production sharing contract, low-cost position, earnings stability and healthy free cash flow generation, which support the company's strong financial profile under Fitch's oil and gas (O&G) price assumptions. We expect Medco's average EBITDA from fixed-price gas contracts to remain at around 2.3x of interest expense until 2027 (2022: 2.5x).

Key Rating Drivers

Reserves to Improve: Fitch estimates Medco's 1P reserve life to improve and stay above the positive trigger of seven years beyond 2023, based on average annual production of 145mboepd and likely additions in the next 6-12 months from investments in its Tanzania project and existing domestic blocks like Corridor and Natuna. Medco expects the Tanzania project, which is in the pre-front-end engineering design stage, to almost double its 1P reserves in the medium term. However, reserve accruals may be delayed, in our view, due to factors beyond Medco's control, including regulatory approvals.

Higher Capex; Strong Financial Profile: Medco has budgeted capex of around USD1.3 billion during 2023-2027 (2022: USD270 million, excluding acquisitions), mostly for its development programme. Fitch expects Medco's financial profile to remain strong for its rating, with EBITDA net leverage - excluding its fully owned subsidiary, PT Medco Power Indonesia (MPI) - remaining below 2x (2022: 1.4x) over the medium term. Robust cash flow from operations should support its large capex plans.

Strong Operating Profile: Medco's operating profile benefits from low cash costs of less than USD9 per barrel of oil equivalent (boe), countered partly by its production concentration in Indonesia. Its production scale is larger than that of most 'B' category O&G producers. Fitch expects average production to remain strong at 140 thousand barrels of oil equivalent per day (mboepd) from 2024 onwards (2022: 163mboepd), despite a drop in its working interest in the Corridor block after 2023 to 46%, from 54%.

Cash Flow Stability: The company's earnings are less sensitive to oil price changes than most similarly rated upstream O&G peers, as almost 80% of Medco's production is gas, of which 70% is sold via long-term fixed price take-or-pay contracts. These contracts mitigate price and volume risks, and support robust and predictable cash flow. Fitch estimates Medco to generate strong average annual EBITDA of above USD1 billion in 2023-2027, 45%-50% of which would be via fixed-price contracts.

Medco recently extended a gas sale and purchase agreement (GSA) with Singapore for part of its volumes from Corridor for five years until 2028. The remaining portion of Corridor gas is supplied domestically, and the GSAs are under discussion. We believe volume risk from renewals is low, considering Corridor's importance to Indonesia's domestic gas supply.

Acquisitions Treated as Event Risk: Fitch expects Medco to remain acquisitive, which we treat as an event risk. We view Medco's record of acquisitions, including its USD1.4 billion acquisition of Corridor in 2022 and USD550 million acquisition of Ophir Energy in 2019, to be credit accretive, improving the company's operating profile without affecting its financial profile. Medco has raised equity to partially fund its major investments in the past.

Power Business Neutral to Ratings: We assess MPI to be neutral to Medco's credit profile, as its investment in the power company falls outside the restricted group structure defined in its bond documentation. The documentation limits Medco's investments outside the restricted group to USD300 million, half of which has been utilised. It also limits cash outflow from Medco to MPI and other investments outside the restricted group. There are no cross-default clauses linking MPI's debt to Medco.

That said, Fitch believes Medco's increasing focus on energy transition can potentially lead to greater synergies with MPI over the medium to long term, and we will monitor Medco's ESG strategy and its impact on the restricted group.

Derivation Summary

Medco's production scale is comparable with that of exploration and production peers in the 'BB' rating category. The Positive Outlook reflects our expectation of improvement in its reserve profile over the next 6-12 months.

 

Around 80% of Canacol Energy Ltd.'s (BB/Stable) sales volume comes from long-term, fixed-price take-or-pay gas sales contracts, while the proportion of fixed-price contract sales in Medco's portfolio is around 55%. This gives Canacol a relatively stronger business profile, and explains its higher rating despite Medco's larger production scale and EBITDA generation. Both companies have a moderate 1P reserve life of around six years, and we view their financial profiles as being largely similar.

GeoPark Limited (B+/Stable) and Medco have limited geographic diversification and moderate reserve lives. Medco's profile, however, benefits from a larger production scale of 160mboepd, compared with GeoPark's 40mboepd, and the presence of fixed-price contracts. The Positive Outlook on Medco reflects our expectation that its reserve profile will improve, strengthening its business profile over that of GeoPark. Both entities have a strong financial profile, with GeoPark's being modestly stronger, as we expect it to be in a net cash position.

Key Assumptions

- Brent crude prices of USD85/barrel in 2023, USD75 in 2024, USD65 in 2025 and USD53 thereafter, according to Fitch's O&G price deck (see "Fitch Ratings Raises Mid-Term Oil and Cuts Near-Term Gas Price Assumptions", dated 13 March 2023)

- Gas prices in line with fixed-price contracts, where applicable

- Total production volume of around 160 mboepd in 2023, then dropping to around 140mboepd from 2024 due to a decline in working interest for the Corridor block

- Cash production costs of less than USD9/boe

- Average annual capex of USD270 million over the next five years

- Annual dividend pay-out of 15% of net income

RATING SENSITIVITIES

Factors that could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:

A sustained improvement in the 1P reserve life to seven years or above, while maintaining leverage (net debt/EBITDA, excluding MPI) below 2.5x.

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:

We will revise the Outlook to Stable if the positive rating guidelines are not met in the next 12 months.

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

Strong Liquidity: Medco, excluding MPI, had cash of around USD580 million at end-2022, which could cover the USD351 million of debt maturing within a year. Medco's liquidity profile benefits from USD487 million of committed undrawn facilities maturing beyond 12 months as of end-2022.

The company has significant annual debt maturities of USD500 million-700 million during 2026-2028, which is when its US dollar notes mature. Medco has a history of refinancing bond maturities well ahead of schedule. It bought back USD456 million of its 2025-2028 US dollar notes in 2022 through multiple tender offers. We expect it to generate sufficient cash flow from operations to cover its capex plan.

Issuer Profile

Medco is an Indonesian upstream O&G company, with some international presence. The company produced 163mboepd of O&G in 2022.

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.

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. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg . (ends)