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June 30 (The following statement was released by the rating agency)
Fitch Ratings has assigned ORLEN Capital AB (publ)'s EUR500m bonds due 2021 a final senior unsecured rating of 'BBB-'. The bonds are unconditionally and irrevocably guaranteed by Polski Koncern Naftowy Orlen S.A. (PKN; BBB-/Stable).
The bonds are rated at the same level as PKN's Issuer Default Rating (IDR) to reflect the guarantee and their ranking as senior unsecured obligations of the company.
PKN's ratings reflect the company's business diversification with operations in the refining, petrochemical and fuel retail sectors, its strong position in the Polish market and an improved financial profile with funds from operations (FFO) net adjusted leverage of 2.5x in 2013 (including adjustments for inventory-holding losses and sales of obligatory reserves of crude oil). The ratings are mainly constrained by the cyclicality of the refining and petrochemical operations. Reported EBITDA under LIFO in 1Q14 was PLN1bn, representing a 5% yoy increase, mainly on the back of strong results in the retail and petrochemical segments.
KEY RATING DRIVERS
Improved Financial Profile
The ratings reflect PKN's improved financial profile following several measures taken by management to reduce leverage, including the disposal of Polkomtel S.A. in 2011 and a slowdown in capex in 2011-2013, after a capex-intensive period in 2007-2010. Fitch believes that PKN has much greater flexibility to reduce its capex in 2014-2017 than in 2007-2010, when it made some major committed investments. These factors help support PKN's creditworthiness amid still difficult conditions in the European oil refining sector. The recently completed acquisition of Canadian upstream company Birchill Exploration Limited Partnership for PLN0.7bn was part of PKN's planned capex for 2014.
Refining Margins under Pressure
The European refining sector remains under pressure, mainly due to overcapacity, muted demand and competition from US, Russian and Middle Eastern refineries. Fitch expects difficult market conditions to continue in 2014 with average refining margins similar to levels in 2013. Fitch expects that the fuel retail and petrochemical segments will be the main contributors to PKN's EBITDA in 2014. These two business lines accounted for 88% of EBITDA under LIFO standards in 2013 (58% in 2012; excluding upstream and corporate functions).
Sound Credit Targets
The company's credit profile is supported by sound credit ratio targets, including a gearing ratio below 30% and net debt-to-EBITDA below 1.5x. In line with its updated strategy, PKN reinstated dividend payments in 2013 following a period of no dividend payment in 2009-2012. The company is planning a gradual increase in dividends so that each payout will be up to 5% of average market capitalisation in the preceding year. However, dividend payouts will depend on the company's financial position and the economic environment, which Fitch views as positive for the ratings.
Compulsory Stock of Oil and Oil Products
In January 2014, the Polish government enacted a draft bill, which will serve to reduce PKN's obligatory crude oil and oil products stock between 2015 and 2017 from an equivalent of 76 days of consumption to 53 days of imports. This could be positive for PKN's financial profile by reducing the company's inventory by approximately PLN2.2bn. However, it is too early to determine the exact impact on leverage ratios as the government has yet to agree on the charges oil processing and trading companies will need to pay to maintain obligatory oil and oil products stock at the Material Reserve Agency and whether those charges would be reflected in fuel prices.
Positive: Rating upside potential is currently limited by the cyclicality of the refining and petrochemical operations. However, positive rating action may result from a material improvement in the company's business profile resulting in lower cyclicality of operating cash flows, with FFO adjusted net leverage not exceeding 2.0x. This credit ratio is calculated by Fitch, excluding the effect of inventory holding gains/losses, and reversing the sale of compulsory crude oil inventory to third parties.
Negative: Future developments that could lead to negative rating actions include:
-Deterioration in cash flows and an increase in FFO adjusted net leverage (excluding inventory holding gains/losses and compulsory crude stock sales) to above 2.5x on a sustained basis, for example, due to substantially weaker-than-expected conditions for refining and petrochemicals operations.
- Capex substantially above FFO, resulting in heavy negative free cash flow in the medium term
- An aggressive dividend policy
LIQUIDITY AND DEBT STRUCTURE
At end-March 2014 short-term debt of PLN2bn was covered by cash of PLN0.8bn and unused credit lines of PLN9.2bn. At end-2013 PKN had sufficient headroom within its financial covenants.
In April 2014 the company contracted a EUR2bn loan available for a five-year period with two one-year extension options. The loan was mainly used to refinance a EUR2.6bn credit facility signed in 2011. The company in the same month also issued the last tranche under its PLN1bn domestic retail bond programme. The issue of EUR500m bonds further diversifies PKN's funding sources and extends its debt maturity profile.