Fitch Assigns Medco Energi's Proposed Notes 'B+' Rating

(Fitch Ratings - Singapore - 01 Nov 2021)-- Fitch Ratings has assigned PT Medco Energi Internasional Tbk's (Medco; B+/Stable) proposed senior notes issued by its wholly owned subsidiary, Medco Laurel Tree Pte. Ltd., a rating of 'B+' and a Recovery Rating of 'RR4'.

The notes, which are guaranteed by Medco and some of its key subsidiaries, are rated at the same level as Medco's Issuer Default Rating (IDR), as the notes constitute its direct, unsubordinated and unsecured obligations. Medco will use the proceeds to complete its planned acquisitions or to refinance some of its existing US dollar notes coming due in 2025 and 2026.

Fitch continues to treat any potential acquisitions/investments as event risks given the uncertainties relating to them, and would reassess impact on Medco's credit profile upon conclusion of acquisitions. Medco has a record of credit accretive acquisitions that have improved its long-term financial and operating profile.

Medco's rating factors in its larger scale, low-cost position, adequate credit metrics 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

Acquisitions Treated as Event Risk: Fitch's rating case assumes Medco's proposed notes would be fully utilised to refinance some of its 2025 and 2026 US dollar notes. As a result, Fitch does not expect any material changes to Medco's gross debt-based leverage from the proposed notes. If Medco utilises the bond proceeds for acquisitions Fitch will assess the impact of the acquisition, along with its proposed funding strategy.

Financial Profile Adequate for Rating: In the absence of acquisitions Fitch expects Medco's leverage, as measured by net debt/EBITDA, to improve to around 3.1x in 2021 (2020: 4.8x), and remain at close to 3x till 2025. The improvement reflects the current strong crude prices and our expectation of a moderation in prices in 2022. Medco also expects to receive USD141 million in 2021 from the sale of a stake in an associate. We exclude Medco's fully owned subsidiary, PT Medco Power Indonesia (MPI), when calculating leverage.

Contracted Earnings: Medco's earnings are less sensitive to oil price changes than many upstream O&G peers, with about USD200 million of its expected EBITDA in 2021 being derived from fixed-price minimum take-or-pay volumes. Around a third of Medco's production is gas sold via long-term fixed-price take-or-pay contracts.

Reserve Profile Helps Capex Flexibility: Fitch also thinks that Medco's financial flexibility is boosted by its relatively high proportion of developed reserves, which would allow around five years of production with minimal capex. This enabled the company to cut its O&G capex by over 40% to USD144 million in 2020 compared to its pre-pandemic plans. Medco's proved reserves (1P) of 206 million barrels of oil equivalent (mmboe) at end-June 2021 result in a reserve life of about six years. Medco's proved reserves could increase meaningfully, if some of its production sharing contracts are extended.

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 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.

Production to Recover: Fitch expects Medco's production to fall to around 88 thousand barrels of oil equivalent per day (mboepd) in 2021 (2020: 93mboepd) as a result of maintenance, unplanned downtime in some of its fields and weak gas demand in the 9M21. However, we expect production to recover from 4Q21, with improving demand.

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 USD300 million, 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 a 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 small scale of production of 40mboepd, low reserve life and limited operational diversification. Frontera Energy Corporation's (B/Stable) ratings reflect its smaller production scale of around 45mboepd, somewhat higher reserve life of 7.6 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 of USD55 a barrel in 2022 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 15 June 2021.

- Total production volume in 2021 to decline to 88mboepd, and recover to 93mboepd in 2022 and to 98mboepd in 2023.

- Cash production costs of less than USD10 per boe

- Annual capex between USD200 million and USD250 million over the next five years, which is 20% higher than the company's estimates over the forecast horizon until 2025.

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 2021 to 2024, 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 USD189 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.

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-June 2021, Medco, excluding MPI, had unrestricted cash of USD306 million compared with debt maturities of USD61 million in 2H21. Its liquidity profile is comfortable with debt maturities of between USD100 million and USD200 million per year until 2024. It has US dollar bonds of between USD500 million and USD650 million falling due each year from 2025 to 2027. 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.

Issuer Profile

Medco is an Indonesian upstream oil and gas company, with some international presence. The company produces about 90mboepd of O&G.

Date of Relevant Committee

18 March 2021

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)