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June 18 (The following statement was released by the rating agency)
Fitch Ratings has upgraded OAO Tatneft's (Tatneft) Long-term Issuer Default Rating (IDR) to 'BBB-' from 'BB+'. The Outlook is Stable. A full list of rating actions is at the end of this release.
The upgrade reflects Tatneft's improved business and financial profile following the commissioning and subsequent development of the OJSC Taneco (Taneco) refinery complex. Tatneft's credit profile is supported by low leverage with funds from operations (FFO) adjusted gross leverage of 0.4x in 2013, the lowest among Russian oil and gas peers. Fitch expects the company will maintain stable oil production and favourable leverage metrics, even if Tatneft decides to double Taneco's capacity to 14 million tonnes per annum (mtpa).
KEY RATING DRIVERS
Stable Production, Ample Financial Profile
Tatneft credit profile is supported by stable and predictable oil production, vast reserve base and favourable credit metrics. The company's five-year oil production compound annual growth rate has been 0.3% reaching 188.2 million barrels (516kbpd) in 2013. Proved reserves have been relatively flat over the past five years and amounted to 6 billion bbl as of 1 January 2014, implying a 32-year of oil reserve life, the longest among Russian peers. In 2012 and 2013 Tatneft repaid the majority of the debt it had raised for the construction of first phase of Taneco resulting in FFO adjusted gross leverage of 0.4x in 2013, a decrease from 0.8x in 2012.
Higher Vertical Integration Positive
Tatneft continues to implement operational upgrades to the Taneco refinery, which was commissioned in December 2011. A new 2.9mtpa hydrocracking unit completed in 1Q14 will improve the depth of refining and raise the output of light products such as jet fuel and EURO 5 diesel fuel. Taneco plans to start production of high-index Group III base oils this year. Fitch views the increasing complexity of the refinery as positive for the credit profile, especially in light of the potential taxation changes in Russia.
Taneco Further Development
Fitch's base case expectations do not include Tatneft's potential investment doubling Taneco's capacity to 14mtpa. Tatneft is yet to make a final decision with respect to this project, which would require capex of USD3.5bn according to the company's initial estimates. The potential investment would likely be spread over four to five years. Fitch assumes that if Tatneft decides to start the project, the company will maintain FFO adjusted gross leverage below 1.5x. . Our assumption is supported by the currently low debt level, sound financial results and stable dividend policy assuming pay-outs at 30% of net profit.
The change of the company's sales structure in favour of refined products and domestic market lowered the relative amount of export duties and improved its EBITDA per barrel of crude oil output in 2013 by 3% yoy to RUB657 from RUB637 in 2012 and RUB572 in 2011. Fitch understands that the tax regime changes currently being debated for Russian oil and gas producers may be positive for Tatneft if enacted in their current form due to Tatneft's inherent upstream focus.
Tax Regime Supports Extraction of Extra-Viscous Oil
Over 400 thousand tonnes (kt) of extra-viscous oil (EVO) have been produced at Ashalchinskoye field since the beginning of its development. Currently Ashalchinskoye field's average daily production amounts to 650t/day. Tatneft's management aims to produce 800kt of EVO per year. The development of EVO deposits is supported by the favourable tax regime, which provides a 90% reduction in export tax. We view the expected increase in EVO production as positive to the company's business and financial profile.
Limited Production Diversification Constrains Ratings
Tatneft's ratings are constrained by its production scale, mature oil reserves (hence higher lifting costs vs Russian peers) and limited production diversification as production is concentrated in the Republic of Tatarstan (BBB/Negative).
Positive FCF Supports Liquidity
At end-2013, short-term debt was RUB36.6bn (USD1.1bn) against a cash balance of RUB29.5bn and our expectation of positive free cash flow. Tatneft has a conservative capital structure, with FFO adjusted gross leverage of 0.4x at end-2013. Fitch expects Tatneft to show positive FCF in 2014-2015, which will contribute to further deleveraging in 2014. Fitch's base case expectations do not include Tatneft's possible investments in doubling Taneco's capacity.
At end-2013 Tatneft held approximately 50% of total cash at Bank Zenit (BB-/Stable) and AK BARS Bank (BB-/Stable), which Fitch considers as a constraint on the company's credit profile. We therefore place more emphasis on gross rather than net leverage ratios.
Headroom for positive rating action is currently limited. Fitch would consider an upgrade if higher oil and gas production is coupled with increased geographical diversification and FFO gross leverage remains consistently below 1.0x.
Negative: Future developments that could lead to negative rating action include:
- FFO adjusted gross leverage remaining above 1.5x.
- FFO interest coverage below 10.0x.
FULL LIST OF RATINGS
Foreign currency Long-Term IDR: upgraded to 'BBB-' from 'BB+'; Outlook Stable
Foreign currency Short-Term IDR: upgraded to 'F3' from 'B'