Fitch Rates Medco Energi's Proposed Notes 'B+'

(Fitch Ratings - Singapore - 11 Oct 2023)-- Fitch Rating has assigned a 'B+' rating to PT Medco Energi Internasional Tbk's (Medco; B+/Positive) proposed senior notes issued by its wholly owned subsidiary, Medco Maple Tree Pte. Ltd. The Recovery Rating is '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 plans to use the proceeds to refinance part of its existing debt and might fund the potential acquisition of a Middle East oil and gas (O&G) asset.

The Positive Outlook on Medco's rating reflects our expectation that the company may boost its reserve life while maintaining an adequate financial profile; Medco's proved (1P) reserve life improved slightly to 6.5 years by end-June 2023, after dropping to around 6 years at end-2022 (end-2021: 9.6 years).

The ratings reflect Medco's larger scale, low-cost position and favourable earnings mix via fixed-price contracts relative to most 'B' category rated upstream O&G producers. Its earnings stability and healthy free cash flow generation supports a strong financial profile under Fitch's O&G price assumptions. We expect Medco's average EBITDA from fixed-price gas contracts to remain at above 2.5x of interest expenses until 2027 (2022: 2.5x).

Key Rating Drivers

Reserves to Improve: Fitch estimates Medco's 1P reserve life to remain above the positive trigger of seven years beyond 2023, based on average annual output of 145 thousand barrels of oil equivalent per day (mboepd). This is likely to be aided by reserves additions in the next 6-12 months from its Tanzania project and existing domestic blocks. Medco expects the Tanzania project, which is in the pre-front-end engineering design stage, to almost double 1P reserves in the medium term. However, reserve accruals can be delayed due to factors beyond Medco's control, including regulatory approvals.

Higher Capex; Strong Financial Profile: Medco has budgeted capex of around USD1.3 billion during 2023-2027 (1H23: USD99million, 2022: USD270 million, excluding acquisitions), mostly for its development programme. Fitch expects Medco's financial profile to remain strong for its rating, with EBITDA net leverage - excluding its fully owned subsidiary, PT Medco Power Indonesia (MPI) - remaining below 2x (2022: 1.6x) over the medium term. Robust cash flow from operations should support its large capex plans.

Strong Operating Profile: Medco's operating profile benefits from low cash costs of less than USD9 per barrel of oil equivalent (boe), countered partly by its production concentration in Indonesia. Fitch expects average production to remain strong at 145mboepd (1H23: 162mboepd, 2022: 163mboepd), despite a drop in Medco's working interest in the Corridor block in Indonesia after 2023 to 46%, from 54%.

Cash Flow Stability: The company's earnings are less sensitive to oil price changes than most similarly rated upstream O&G peers, as almost 80% of Medco's production is gas, of which 70% is sold via long-term fixed price take-or-pay contracts. These contracts mitigate price and volume risks, and support robust and predictable cash flow. Fitch estimates Medco to generate strong average annual EBITDA of above USD1 billion in 2023-2027, 45%-50% of which would be via fixed-price contracts.

Corridor GSAs: A major portion of Corridor's gas is supplied locally, and the gas sale and purchase agreements (GSA) are under discussion for renewal. We believe volume risk from renewals is low, considering Corridor's importance to Indonesia's domestic gas supply. The remaining portion of Corridor's gas is supplied to Singapore, where the GSA was extended in late-2022 for five years until 2028.

Acquisitions Remain in Focus: Fitch expects Medco to remain acquisitive and views its record of acquisitions, including its USD1.4 billion acquisition of Corridor in 2022 and USD550 million acquisition of Ophir Energy in 2019, to be credit accretive.

Medco has entered into an agreement to acquire a 20% non-operating stake in a Middle East O&G asset. The acquisition will add modestly to Medco's production (13mboepd) and reserves (proved and probable reserves of 56 mmboe) and in our view, is unlikely to alter Medco's operating profile significantly. Fitch believes Medco's financial profile has headroom for the proposed acquisition. Fitch will incorporate the acquisition in its base case once further details on the acquisition become available.

Power Business Neutral to Ratings: We assess MPI to be neutral to Medco's credit profile, as its investment in the power company falls outside the restricted group structure defined in its bond documentation. The documentation limits Medco's investments outside the restricted group to USD300 million, about half of which has been utilised. It also 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.

That said, Fitch believes Medco's increasing focus on energy transition can lead to greater synergies with MPI over the medium to long term as the company's energy transition gathers pace.

Derivation Summary

Medco's production scale is comparable with that of exploration and production peers in the 'BB' rating category. The Positive Outlook reflects our expectation of improvement in its reserve profile over the next 6-12 months.

Around 80% of Canacol Energy Ltd.'s (BB/Stable) sales volume comes from long-term, fixed-price take-or-pay gas sales contracts, while the proportion of fixed-price contract sales in Medco's portfolio is around 55%. This gives Canacol a stronger business profile, and explains its higher rating despite Medco's larger production scale and EBITDA generation. Both companies have a moderate 1P reserve life of around six years, and we view their financial profiles as being largely similar.

GeoPark Limited (B+/Negative) and Medco have limited geographic diversification and moderate reserve lives. Medco's profile, however, benefits from a larger production scale of 160mboepd currently, compared with GeoPark's 40mboepd, and the presence of fixed-price contracts. The Positive Outlook on Medco reflects our expectation that its reserve profile will improve, strengthening its business profile over that of GeoPark. The Negative Outlook on GeoPark reflects our expectation that its reserves life, which is weaker to Medco's, will continue to decline in the next 12-18 months. Both entities have a strong financial profile, with GeoPark's being modestly stronger, as we expect it to be in a net cash position.

Key Assumptions

- Brent crude prices of USD80/barrel in 2023, USD75 in 2024, USD70 in 2025, USD65 in 2026 and USD60 thereafter according to Fitch's O&G price deck (see Fitch Ratings Revises Near-Term Gas Price Assumptions, Oil Prices Unchanged, dated 13 September 2023)

- Gas prices in line with fixed-price contracts, where applicable

- Total production volume of around 160 mboepd in 2023, then dropping to around 140mboepd from 2024 due to a decline in working interest for the Corridor block

- Cash production costs of less than USD9/boe

- Average annual capex of USD270 million over the next five years

- Annual dividend pay-out of 15% of net income

RATING SENSITIVITIES

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

A sustained improvement in the 1P reserve life to seven years or above, while maintaining leverage (net debt/EBITDA, excluding MPI) below 2.5x.

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

We will revise the Outlook to Stable if the positive rating guidelines are not met in the next 12 months.

Liquidity and Debt Structure

Strong Liquidity: Medco, excluding MPI, had cash of around USD443 million at June 2023, against USD145 million of debt maturing in 2H23.

The company has significant annual debt maturities of above USD450 million during 2026-2028, which is when its US dollar notes mature. Medco has a history of refinancing bond maturities well ahead of schedule. It also bought back USD32 million and USD456 million of its US dollar notes due in 2025-2028 through multiple tender offers and open market purchases in 2023 and 2022. We expect it to generate sufficient cash flow from operations to cover its capex plan.

Issuer Profile

Medco is an Indonesian upstream O&G company, with some international presence. The company produced 162mboepd of O&G in 1H23.

Date of Relevant Committee

22 May 2023

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

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores. (ends)