Moody's affirms Medco's B1 rating; changes outlook to negative

(Singapore, March 24, 2020) -- Moody's Investors Service has affirmed the B1 corporate family rating (CFR) of Medco Energi Internasional Tbk (P.T.) (Medco).

Moody's has also affirmed the B1 ratings on the backed senior unsecured bonds issued by Medco Strait Services Pte. Ltd., Medco Platinum Road Pte. Ltd., Medco Oak Tree Pte. Ltd. and Medco Bell Pte.Ltd. These bonds are unconditionally and irrevocably guaranteed by Medco.

The outlook on all ratings has changed to negative from stable.

RATINGS RATIONALE

"The rating affirmation reflects our expectation that Medco's credit profile will remain resilient amid the volatile oil price environment, per our base case scenario of a price recovery in the second half of 2020 and through 2021. The affirmation also reflects the company's strong liquidity profile, fixed price gas contracts and plans to defer some of its capital expenditure to conserve cash," says Vikas Halan, a Moody's Senior Vice President.

"That said, Medco's credit profile will likely deteriorate if oil prices remain low for a prolonged period, underpinning our negative outlook, " says Halan, who is also Moody's Lead Analyst for Medco.

In Moody's base case scenario, the effects from the virus will persist into the second quarter of 2020, with improving economic fundamentals in the second half of the year. Under this scenario, Moody's expects oil prices to average $40-$45 per barrel in 2020, returning to $50-$55 per barrel in 2021. However, in a downside scenario where economic weakness persists longer, oil would average $30-$35 per barrel in 2020 and $35-$40 in 2021.

Specifically, Moody's expects Medco's adjusted RCF/adjusted net debt to fall below 10%, and its adjusted net debt/EBITDA to increases above 4x in 2020. These metrics will position Medco weakly for B1 ratings.

However, per Moody's base case scenario of a price recovery in the second half of 2020 through 2021, Moody's expects Medco's credit metrics to improve to levels more appropriately positioned for its B1 ratings.

The company has also announced measures to reduce its capital spending by about $100 million and its operating expenditure by about 15% over the next two years.

The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The oil & gas exploration and production sector has been one of the sectors most significantly affected by the shock given its sensitivity to demand and oil prices. More specifically, the weaknesses in Medco's credit profile have left it vulnerable to shifts in market sentiment in these unprecedented operating conditions, and Medco remains vulnerable to the outbreak continuing to spread and oil prices remaining weak. We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety. Today's action reflects the impact on Medco of the breadth and severity of the oil demand and supply shocks, and the broad deterioration in credit quality it has triggered.

Medco's B1 CFR reflects (1) the scale and geographic diversification of its reserves and production; and (2) the fact that nearly one-third of its total sales volume is natural gas sold at fixed prices, generating about $250 million of EBITDA that can cover its interest expense. At the same time, the B1 CFR remains constrained by Medco's exposure to the cyclicality of commodity prices, its acquisitive growth appetite, and the execution risk associated with its annual investment plan.

In addition, Medco's rating benefits from its proactive liquidity management with the company refinancing its upcoming debt maturities well in advance, increasing the average weighted debt maturity profile of its debt.

In terms of environmental, social and governance (ESG) factors, the ratings also consider the following:

For environmental factors, Medco's rating incorporates the environment risk that the company is exposed to through its oil & gas, power and mining businesses. However, the risk is somewhat mitigated by its high proportion of natural gas business that accounts for about 50% of its revenue, and by its long-term fixed price gas contracts that generate sufficient EBITDA to cover its interest expenses.

Further, the environmental risk for its power business is largely mitigated by the company's fuel mix, which is heavily weighted towards renewable sources like geothermal and hydro. Medco has only a minority interest in its copper mining business, which is an open pit mine and is well-positioned to benefit from higher EV penetration.

With regards to social factors, Medco's business mix includes sectors that are exposed to moderate to high social risks, especially around responsible production and health & safety issues. However, this risk is mitigated by the company's long track record of operating its businesses without any major incidents.

Lastly with regards to governance factors, the ratings incorporate Medco's strong appetite for growth as shown by its history of debt-funded acquisitions, and its concentrated ownership structure which could lead to increased potential for conflicts of interest. Nonetheless, these risks are partially mitigated by (1) Medco's public commitment to deleveraging and its target net debt/EBITDA of 3.0x; and (2) its listing on the Indonesian stock exchange, which requires the company to comply with listing rules.

Medco's liquidity profile is strong with cash and cash equivalents of $1.1 billion as of March 2020 (excluding Medco Power) and undrawn credit facilities of $250 million. The cash balance includes cash in escrow accounts for repayment of USD denominated bonds due in 2022, and for the partial repayment of the company's IDR bonds due in 2021, all totaling about $650 million. Excluding the cash in escrow accounts, Medco has cash and cash equivalents of about $420 million against $288 million of debt maturities over next two years (excluding debt which will be paid from cash in escrow account). As such, Medco does not have near-term liquidity issues as long as its cash flow operations is able to cover its capital spending.

A change in outlook to stable from negative will require a sustained improvement in the crude oil price environment, such that the annual average is above $45-$50 per barrel. Significant deleveraging through asset sales or proceeds from equity issue could also cushion the impact from low oil prices.

In addition, a stable outlook would also require the company to maintain strong liquidity with its cash and cash equivalents covering at least the amount of debt maturing over the next 12 months.

Moody's could downgrade Medco's ratings if oil prices drop below Moody's expectation, causing Medco's credit metrics to weaken to level inappropriate for its ratings. Any further debt funded acquisition could also put downward pressure on the company's ratings.

Specific credit metrics indicative of downward pressure include Medco's adjusted net debt/EBITDA rising above 4.0x, RCF/adjusted net debt falling below 10%, and EBITDA/Interest expense falling below 3.5x.

The principal methodology used in these ratings was Independent Exploration and Production Industry published in May 2017. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Established in 1980 and headquartered in Jakarta, Medco Energi Internasional Tbk (P.T.) is a Southeast Asian integrated energy and natural resources company listed in Indonesia with three key business segments, oil and gas, power and mining.  (ends)