Fitch Assigns Medco Energi's USD650m Notes Final 'B+'

(Fitch Ratings-Singapore-23 May 2019)-- Fitch Ratings has assigned PT Medco Energi Internasional Tbk's (Medco; B+/Stable) USD650 million 7.375% senior notes due in 2026 issued by its wholly owned subsidiary, Medco Oak Tree Pte. Ltd., a final rating of 'B+' and a Recovery Rating of 'RR4'.

The rating on the notes, which are guaranteed by Medco and some of its key subsidiaries, is at the same level as Medco's Issuer Default Rating (IDR), as the notes constitute its direct, unsubordinated and unsecured obligations. The assignment of the final rating follows a review of final documents conforming to information already received. Medco will use some of the proceeds to complete the acquisition of UK-based Ophir in May 2019 and will use the remainder to repay debt.

Fitch upgraded Medco's IDR to 'B+' from 'B' on 22 April 2019, reflecting the Indonesia-based company's improving financial profile, supported by its efforts to sell non-core assets to reduce leverage. The rating action also reflects Fitch's expectations that Medco's acquisition of Ophir for an enterprise value of around USD585 million, including Ophir's net debt balance of USD35 million at end-2018, is value accretive and is likely to further strengthen its financial and operating profile. We believe the acquisition will increase Medco's cash flow, based on our oil-price assumptions, relative to the additional debt required to finance the transaction. It will also boost Medco's oil and gas production by about 30%, which will be higher than that of most 'B' rated peers.

KEY RATING DRIVERS

Sale of Non-Core Assets: The company has sold part of its stake in an associate company for USD252 million and has received USD152 million so far, with USD100 million to be received 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 smaller international businesses, for which final sale agreements have been entered into. These asset sales will help reduce debt and improve Medco's financial profile. Fitch foresees only minimal risk to the completion of these asset sales.

Ophir Acquisition Credit Positive: We expect the acquisition of Ophir to be value accretive after weighing acquisition costs against incremental cash flow. The transaction should result in an expanded and more diversified operation and we expect Ophir to generate EBITDA of USD200 million-300 million until 2021, based on our oil price-deck assumptions. It should also improve Medco's credit metrics relative to the net debt added by 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 will help Medco maintain its healthy mix of earnings from fixed-price contract gas sales.

Improving Financial Profile: We expect Medco's leverage, as measured by adjusted debt/operating EBITDAR, to fall below 4.0x by end-2019 (2018: 4.8x), supported by net cash inflow of about USD366 million from the sale of non-core assets. The acquisition of Ophir will also marginally improve Medco's leverage, which we expect to remain at between 3.0x-4.0x over the medium-term in the absence of large investments other than planned capex. We have not factored in any cash inflow from share warrants and exclude Medco's 88% owned subsidiary, PT Medco Power Indonesia (MPI), when calculating adjusted leverage.

Favourable Earning Mix: We expect Medco to derive about 30% of 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 1.0x (2018: 0.7x), including earnings at Ophir. 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, including Ophir. Medco's production was relatively stable at 77mboepd in 2018 (2017: 79mboepd). Its proved reserve life, both including and excluding Ophir, is around eight years based on our expectation of production with a three-year average reserve replacement ratio of over 100%.

Geographic Concentration; Regulatory Risk: Medco's predominant base of operations in Indonesia exposes it to associated country risks, though diversified fields minimise operating risk. The geographical concentration of earnings remains a constraint for most 'B' rated oil and gas producers. Medco is exposed to the country's regulatory uncertainties, highlighted by 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 could, however, be credit positive in the long-term once it matures and is able to upstream dividends. MPI's business profile has a diversified earning 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 business and financial profile, which has improved post the acquisition of Ophir. Including Ophir, Medco's profile compares well against 'B' rated exploration and production peers in terms of the earning mix generated through fixed-price take-or-pay contracts, bigger scale and our expectations of lower leverage.

Medco's credit profile is well-placed relative to most peers in the 'B' category. 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 similar to the nine years at GeoPark. Medco's stronger operating profile is somewhat offset by our expectations of higher leverage compared with GeoPark.

PT Saka Energi Indonesia's (BB+/Negative, standalone credit profile: 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 pending clarity 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 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, while Canacol's reserve life and limited geographical concentration are comparable with those of Medco. (ends)