Fitch Assigns 'B+(EXP)' Rating to Medco Energi's Proposed Notes

(Fitch Ratings-Singapore-23 April 2019)-- Fitch Ratings has assigned an expected rating of 'B+(EXP)' and a Recovery Rating of 'RR4' to PT Medco Energi Internasional Tbk's (Medco; B+/Stable) proposed US dollar notes. The notes will be issued by Medco's wholly owned subsidiary, Medco Oak Tree Pte. Ltd.

The proposed US dollar notes would be guaranteed by Medco and some of its key subsidiaries only after Medco completes the acquisition of Ophir Energy Plc. Ophir's shareholders had approved Medco's acquisition plan in March 2019 and Medco is awaiting certain approvals to complete the acquisition. Proceeds raised via the proposed notes would be held in escrow until certain conditions (primarily the completion of the acquisition) are met. Medco would redeem the issued notes in full with a special redemption fee of 1% and accrued interest if the approvals pertaining to the acquisition of Ophir are not obtained prior to the acquisition deadline of 4 July 2019. Medco would prefund the escrow account to ensure a sufficient amount is available to redeem the notes in full including redemption fees and interest accrued until the acquisition deadline.

The expected rating on the notes is at the same level as Medco's Issuer Default Rating (IDR) as they would constitute direct, unsubordinated and unsecured obligations of the company upon the completion of the Ophir acquisition transaction. The final rating on the notes is contingent upon the completion of the acquisition and upon the receipt of final documents conforming to information already received. Medco plans to use the proceeds for the acquisition of Ophir and for debt repayment.

Fitch upgraded Medco's IDR on 22 April 2019 to 'B+' from 'B', reflecting the Indonesia-based company's improving financial profile, supported by its efforts to sell its non-core assets to reduce leverage. The rating action also reflects Fitch's expectations that Medco's acquisition of Ophir will be value accretive and is likely to further strengthen its financial and operating profile. The acquisition of the UK-based company, in our view, will increase Medco's cash flows, based on Fitch's oil price assumptions, relative to the additional debt required for financing the transaction. The acquisition, once completed, will also boost Medco's oil and gas production by about 30%, which will be higher than most other 'B' rated peers.

KEY RATING DRIVERS

Sale of Non-Core Assets: The company has sold part of its stake in one of its associate companies for USD252 million and received USD152 million so far with another USD100 million expected by end-June 2019. Medco also expects to receive net cash proceeds of USD90 million from the sale of part of one of its buildings by September 2019 and USD24 million from the sale of some of its smaller international businesses for which final sale agreements have been entered into. These asset sales will help reduce debt and support improvement in Medco's financial profile. Fitch foresees only minimal risks to the completion of these asset sales.

Ophir Acquisition Credit Positive: We expect Medco's ongoing acquisition of Ophir to be value accretive after weighing the acquisition costs against incremental cash flows, and an expanded and more diversified operation. We expect Ophir to generate EBITDA of USD200million-300million until 2021 based on Fitch's oil-price deck assumptions and support improvement in Medco's credit metrics relative to the net debt added as a result of the acquisition. Fitch expects Ophir to add about 25 million barrels of oil equivalent per day (mboepd) of production in 2019 (Medco 2018 production: 77mboepd) including over 12mboepd from non-domestic assets based in Thailand and Vietnam.

Gas sales make up about 44% of Ophir's sales, most of which are based on fixed-price take-or-pay contracts, and would help Medco maintain its healthy mix of earnings from fixed-price contract gas sales. Medco expects to acquire Ophir for an enterprise value of around USD585 million, including Ophir's net debt balance of USD35 million at end-December 2018. The transaction for the acquisition is set be finalised in May 2019, pending the few approvals.

Improving Financial Profile: We expect Medco's leverage (adjusted debt/operating EBITDAR) to fall below 4x by 2019 (2018: 4.8x), supported by net cash inflow of about USD366 million from the sale of non-core assets. The acquisition of Ophir, once completed, will also help to improve Medco's leverage marginally. We expect Medco's leverage to remain between 3x and 4x over the medium term in the absence of any material investments other than its current planned capex. We have not factored in any cash inflows from share warrants in our forecasts. Fitch excludes Medco's 88%-owned subsidiary, PT Medco Power Indonesia (MPI), when calculating its adjusted leverage.

Favourable Earnings Mix: We expect Medco to derive about 30% of its sales volume through fixed-price take-or-pay contracts. Fitch estimates the EBITDA generated from these contracts will cover its consolidated interest expense (excluding MPI) by more than 1x (2018: 0.65x), post the Ophir acquisition. 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 two-thirds of Medco's production volume and is sold through long-term contracts, mainly to investment-grade off-takers.

Strong Operating Profile: Fitch expects Medco's production volume to rise to about 100mboepd once it completes the Ophir acquisition. Medco's production was relatively stable in at 77mboepd in 2018 (79mboepd in 2017). Medco's proved reserve life, including Ophir, is around eight years (also eight years excluding Ophir) based on our expectations of production with a three-year average reserve replacement ratio of over 100%.

Geographic Concentration; Regulatory Risks: Medco's predominant base of operations in Indonesia exposes it to the associated country risks though diversified fields minimise operating risks. The geographical concentration of earnings remains a constraint to most 'B' rated oil and gas producers. Medco is exposed to the country's regulatory uncertainties, highlighted by the instructions from Indonesia's Directorate General of Oil and Gas in July 2018 to lower the selling price at the Block A gas development in Aceh from the originally agreed USD9.45 per million British thermal unit (mmbtu).

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 already been utilised. The structure limits potential cash outflows from Medco to MPI or any other investments outside the restricted group.

There are also no cross-default clauses linking MPI's debt to Medco. MPI could however be credit positive in the long term after it completes most of its growth and is able to upstream dividends. MPI's business profile is not a concern as it has a relatively diversified earnings mix between geothermal and gas-power generation as well as earnings from the provision of operations and maintenance services to other independent power producers. MPI also has a successful track record of raising funds on its own.

DERIVATION SUMMARY

Medco's ratings reflect its business and financial profile, which would be enhanced further by the proposed acquisition of Ophir. Medco's profile, including Ophir, compares well with other 'B' rated exploration and production peers in terms of the mix of earnings generated through fixed-price take-or-pay contracts, a bigger scale and our expectations of the improvement in leverage.

Medco's credit profile is well-placed relative to most of its peers in the 'B' category. Medco's production, including Ophir, of close to 100mboepd is more than Kosmos Energy Ltd.'s (B+/Stable) 69mboepd and part of Medco's gas is also being sold at long-term fixed-price contracts. Medco's reserve life is broadly similar at eight years compared with seven at Kosmos. 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 is largely similar to the nine years at GeoPark. Medco's stronger operating profile is offset to an extent by our expectations of higher leverage compared with GeoPark.

PT Saka Energi Indonesia's (BB+/Negative, standalone credit profile of b) ratings are linked to the 'bbb-' standalone credit profile of PT Perusahaan Gas Negara Tbk (PGN, BBB-/Stable). Medco's operating profile compares favourably with that of Saka as we expect Saka's reserve life of less than five years to continue weakening until further clarity emerges on its structure within the PGN group. Medco's Fitch-expected credit metrics are also stronger than those of Saka.

Canacol Energy Ltd. (BB-/Stable) derives over 90% of its 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 also expect Canacol's leverage to be lower than that of Medco. Canacol's reserve life and limited geographical concentration are comparable with those of Medco. (ends)