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

(Fitch Ratings - Singapore - 10 January 2020)--Fitch has affirmed Indonesia-based PT Medco Energi Internasional Tbk's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B+' with a Stable Outlook. Fitch has also affirmed the ratings of Medco's senior unsecured US dollar notes at 'B+' with a Recovery Rating of 'RR4'.

At the same time, Fitch has assigned a 'B+' with a Recovery Rating of 'RR4' to the proposed senior notes to be issued by its wholly owned subsidiary, Medco Bell Pte. Ltd. The rating on the notes, which are guaranteed by Medco and some of its key subsidiaries, is at the same level as Medco's IDR as the notes constitute its direct, unsubordinated and unsecured obligations. Medco will use some of the proceeds to refinance part of its existing debt.

Medco's ratings reflect its larger scale, low-cost position, and favourable mix of earnings via fixed-price contracts relative to most 'B' category upstream oil and gas producers. Fitch also expects Medco's leverage to continue to improve in the absence of any acquisitions.

Key Rating Drivers

Commitment to Deleverage: We estimate Medco's leverage, measured by adjusted debt/operating EBITDAR, fell to below 4.0x by end-2019 (2018: 4.8x), and will remain at or below 3.0x over the next three years. Fitch excludes Medco's fully owned subsidiary, PT Medco Power Indonesia (MPI), when calculating adjusted leverage. We also do not factor in the potential cash proceeds of around USD200 million from its in-the-money share warrants in 2020, which could further improve leverage compared with our expectations.

Medco's leverage and earnings profile has improved following the acquisition of Ophir Energy Plc in 2019, our revised expectations of higher production from some assets and proceeds of around USD420 million from the sale of some of its non-core assets. The company intends to maintain its net debt/EBITDA leverage at or below 3x over the long term.

Acquisitions an Event Risk: Fitch believes Medco will likely pursue acquisitions as part of its growth strategy in addition to its organic exploration and development plans. This could result in temporary spikes in Medco's leverage. Fitch considers any acquisition as an event risk and would reassess Medco's business and financial profile if it occurs.

Favourable Earnings Mix: We expect Medco to derive about 30% of EBITDA through fixed-price take-or-pay contracts. Fitch estimates the EBITDA generated from these contracts will cover the company's consolidated interest expense, excluding MPI, by more than 1.0x (2018: 0.7x). This is a key strength relative to most global oil and gas peers, lowering the commodity risks associated with the sector. Gas accounts for about 60% of Medco's production volume and is sold through long-term contracts, mainly to investment-grade off-takers.

Strong Operating Profile: Medco's operating profile benefits from its low lifting costs of around USD10/barrels of oil equivalent and relatively diversified production base largely within Indonesia with some presence abroad. The company's production volume rose to around 100 thousand barrels of oil equivalent per day (mboepd) (2018: 77 mboepd) after the Ophir acquisition. The company expects its production volume to be maintained around the current levels beyond its proved reserve life of less than seven years in light of its expected spending on exploration and development.

Geographic Concentration: Medco's predominant base of operations in Indonesia exposes it to regulatory risks, though its diversified fields minimise operating risk. Medco currently derives its production from 16 oil and gas fields, none of which contribute to over 20% of production. The country's regulatory uncertainties are highlighted by the instructions from Indonesia's Directorate General of Oil and Gas in mid-2018 to lower the selling price at the Block A gas development in Aceh from the originally agreed USD9.45/million British thermal unit.

Power Investment: Fitch considers the risk dynamics of MPI neutral to Medco's credit profile as its investment in the power company falls outside the restricted group structure defined in Medco's bond documentation. Medco has a USD300 million limit on investments outside the restricted group, as stated in the documentation, the majority of which has been utilised. The structure limits cash outflow from Medco to MPI and other investments outside the restricted group.

There are also no cross-default clauses linking MPI's debt to Medco. MPI's business profile has a diversified earnings mix between geothermal and gas-power generation as well as earnings from the provision of operation and maintenance services to other independent power producers. MPI also has a successful record of raising funds on its own.

Derivation Summary

Medco's ratings reflect its operating profile, which compares well against 'B' rated exploration and production peers in terms of the earnings mix generated through fixed-price take-or-pay contracts, generally bigger scale and an improving leverage profile.

Production of close to 100mboepd is more than Kosmos Energy Ltd.'s (B+/Stable) 69mboepd. Medco's reserve life is broadly similar at around seven years for both companies. Fitch expects Medco's leverage profile to be comparable with that of Kosmos.

We expect Medco's production to be larger than GeoPark Limited's (B+/Stable) 40mboepd, although its reserve life of less than seven years is weaker compared with the eight years at GeoPark. Medco's stronger operating profile is somewhat offset by our expectations of higher leverage than GeoPark.

Canacol Energy Ltd. (BB-/Stable) derives over 90% of sales through fixed-price long-term take-or-pay contracts, which results in higher ratings than most 'B' rated oil and gas producers, including Medco, despite its smaller production scale of 32mboepd. We expect Canacol's leverage to be lower than that of Medco and its reserve life to be better at around 10 years. (ends)