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

(Fitch Ratings - Singapore - 19 Mar 2021)-- Fitch has affirmed 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'.

The affirmation and Outlook reflect Fitch's expectation that Medco's financial profile will remain commensurate with its ratings from 2021, after leverage in 2020 likely exceeded the level at which Fitch would take negative rating action due to weak energy prices and demand.

Medco's rating factors in its larger scale, low-cost position, and favourable earnings mix via fixed-price contracts relative to most 'B' category upstream oil and gas (O&G) producers. Medco also benefits from its ability to defer capex given a high proportion of developed reserves.

KEY RATING DRIVERS

Financial Profile to Improve: Fitch expects Medco's leverage, as measured by net debt/ EBITDA, to improve to around 2.3x in 2021, and remain at or less than 2.5x, from our expectation of 3.9x in 2020. The improvement factors our assumptions of improving crude prices as the sales of around two-thirds of its volumes were linked to crude prices in 2020. Its ratings could be upgraded if Medco manages to maintain a lower leverage. We exclude Medco's fully owned subsidiary, PT Medco Power Indonesia (MPI), when calculating leverage.

Steps to Aid Deleveraging: The company has taken steps to manage leverage, including raising around USD440 million since 2019 from the disposal of non-core assets and over USD300 million of equity since 2017. Medco also expects to receive USD192 million in 2021 from the sale of a stake in an associate.

Contracted Earnings: Medco's earnings are less sensitive to oil price changes than most 'B' category upstream O&G peers. Fitch estimates Medco's EBITDA at USD670 million-750 million a year in 2021-2025, of which at least USD220 million would be via fixed-price minimum take-or-pay volumes. Fitch expects the earnings from these contracts to cover Medco's interest expenses by more than 1x from 2021. EBITDA from take-or-pay contracts fell to USD193 million in 2020, as its off-takers cut volumes due to weak demand. However, Medco received USD27.5 million of contractual payments as off-takers' volumes fell below minimum agreed amounts. Around a third of Medco's production is gas sold via long-term fixed-price take-or-pay contracts.

Capex Flexibility: Fitch also thinks that Medco's financial flexibility is boosted by its relatively high proportion of developed reserves, which enabled the company to cut its oil and gas capex by around 40% to USD155 million from its expectations prior to the plunge in oil prices. Fitch assumes annual capex will range between USD200 million and USD250 million, which is 20% higher than the company's estimates over the forecast horizon until 2025.

Strong Reserve Profile: Medco's rating reflects its proved reserves (1P) of 216 million barrels of oil equivalent (mmboe) at end-September 2020 resulting in a reserve life of seven years on 2020 production. Fitch expects the company to maintain its 1P reserve life due to its expected investments in exploration and development, and moderate record of a three-year organic reserve replacement of 0.5x.

Medco's moderate 1P reserve life is supported by its proved developed reserves, which would allow around five to six years of production with minimal capex, and proved and probable reserves, which should allow nine years of production.

Strong Operating Profile: Medco's operating profile benefits from low lifting costs of USD9-10 per barrel of oil equivalent (boe) and a production base that is largely located in Indonesia with some international presence. Its production is derived from 16 oil and gas fields, none of which contribute more than 20% to output, lowering its operating risks. Fitch expects Medco's production to have declined to around 91 thousand barrels of oil equivalent per day (mboepd) in 2020 and remain at 90-95 mboepd till 2022, from 100mboepd in 2019 due to weaker expected demand.

Acquisitions Treated as Event Risk: Fitch expects Medco's growth to stem primarily from acquisitions and will consider these event risks. Fitch considers Medco's track record of oil and gas acquisitions over the past five years, including its USD550 million acquisition of Ophir Energy in 2019, to have been credit accretive, in terms of improving its long-term financial profile and operating profile. Fitch also thinks further equity inflows are possible if any large acquisitions are considered, given its track record.

Power Investment Neutral: Fitch considers the risk dynamics of MPI to be 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. The documents limit Medco's investments outside the restricted group to USD300million, most of which has been utilised. The structure 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.

DERIVATION SUMMARY

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

Canacol Energy Ltd.'s (BB-/Positive) rating reflects the long-term, fixed-price take-or-pay gas sales contracts, which account for around 75% of its sales volumes. In addition, Fitch expects it to turn to a net cash position by 2024. As a result, its ratings are higher than most 'B' rated oil and gas producers, including Medco, despite Canacol's smaller production scale and moderate P1 reserve life of six years. The Positive Outlook on the rating reflects Fitch's expectation that Canacol's production scale would increase to around 40mboepd by 2022.

We expect Medco's credit profile to be comparable to that of GeoPark Limited (B+/Stable), as they have comparable forecast leverage and reserve life. GeoPark's ratings are constrained by its scale of production of 40mboepd, reserve life and limited operational diversification. Frontera Energy Corporation's (B/Stable) ratings reflect, its smaller production scale of around 45mboepd, comparable reserve life of 6.6 years and higher production costs than Medco. Medco's higher ratings reflect its stronger operating profile.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer

- Brent prices to average USD58 a barrel in 2021, and USD53 a barrel thereafter, as per Fitch's oil and gas price deck. Gas prices in line with the fixed price contracts where applicable. See Fitch Ratings Raises Short-Term Oil and Gas Price Assumptions, dated 17 March 2021, at https://www.fitchratings.com/site/pr/10155643

- Total production volume in 2021 and 2022 to increase marginally to 93mboepd from 91mboepd in 2020

- Cash production costs of less than USD10 per boe

- Annual capex between USD200 million and USD250 million over the next five years

KEY RECOVERY RATING ASSUMPTIONS

The recovery analysis assumes that Medco would be reorganised as a going concern in bankruptcy rather than liquidated.

We assume a 10% administrative claim.

Medco's going-concern EBITDA, excluding MPI, is based on the average EBITDA we expect over 2020 to 2023, which is stressed by 30% to reflect the risks associated with oil-price volatility, potential challenges in maintaining output from its maturing fields and other factors.

An enterprise value multiple of 5x is used to calculate a post-reorganisation valuation and reflects a mid-cycle multiple for oil and gas, metals and mining companies globally, which is higher than the observed lowest multiple of 4.5x. The higher multiple reflects that a sizeable proportion of Medco's production volume stems from long-term fixed-price and indexed take-or-pay gas contracts, which provide more cash flow visibility across economic cycles than the average global upstream oil and gas production company.

We assume prior-ranking debt of USD205 million will be repaid before Medco's senior unsecured creditors, including investors in its US dollar bonds. Prior-ranking debt includes project-finance debt at non-guarantor subsidiaries, PT Medco E&P Tomori Sulawesi and PT Medco E&P Malaka.

The payment waterfall results in a recovery rate corresponding to a 'RR2' Recovery Rating for the unsecured notes. However, we rate the senior unsecured bonds at 'B+'/'RR4' because Indonesia falls into Group D of creditor friendliness under our Country-Specific Treatment of Recovery Ratings Criteria, and the Recovery Rating on instruments of issuers with assets in this group are subject to a cap of 'RR4'.

RATING SENSITIVITIES

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

- Leverage (net debt/EBITDA excluding MPI) sustained below 2.5x, provided Medco is able to maintain production of around 100mboepd and a proved developed reserve life of 6 years

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

- Leverage above 3.5x for a sustained period.

- Significant weakening in Medco's operating-risk profile, including a material fall in production and weakening of its proved reserve life to less than seven years or significant weakening in the mix of earnings from fixed-price gas sales.

- Any significantly adverse regulatory developments

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: At end-September 2020, Medco, excluding MPI, had unrestricted cash of over USD500 million compared with debt maturities of USD253 million due by end-2021, and debt maturities of between USD50 million and USD170 million per year until 2024. Medco also has a recent history of refinancing bond maturities well ahead of schedule. Fitch expects Medco to broadly generate positive free cash flows, and have the flexibility to curtail capex meaningfully if needed, which would help its liquidity profile.

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)