The company has maintenance covenants under its debt. Under our standard oil
price scenario of $90 per barrel (bbl) for Brent in 2013 and $80 perbbl in
2014 and beyond, those covenants could be breached and annual maturities may
exceed the amount of free cash flow generated. Compared with other rated
Russian companies, Russneft's asset quality is somewhat lower, as the company
operates relatively mature fields with lower economies of scale and its
operating costs are slightly above average for Russia. Like its peers,
Russneft is exposed to oil price fluctuations and faces a heavy tax burden, so
that the majority of all-in costs are effectively set by the government.
These constraints are partly offset by the adequate profitability of
Russneft's upstream operations and by our expectation of positive free cash
flow. Russneft enjoys an imperfect natural hedge because the majority of
Russneft's taxes are linked to the Urals price and the Russian ruble
negatively correlates with the oil price. Russneft's assets are fairly
diversified across Russian oil-producing regions. We understand that capital
spending is relatively modest as Russneft's production growth mainly comes
from efficiency gains, as the company is catching up after the difficult
period of 2008-2009 and does not have any large costly new projects.
The company's financial policy is aimed at deleveraging, as highlighted by the
absence of dividends and by gradual deleveraging in recent years, as
illustrated by Russneft's sale of its refining and marketing assets to reduce
debt by $1.1 billion in 2011. Still, we see some long-term uncertainty over
how Russneft's shareholding structure and financial policy will evolve in
coming years. Currently, Russneft's shareholders are Russian company Sistema
(JSFC) (BB/Stable/--; 49%), CEO and founder Mikhail Gutseriev (49%), and the
Russian state-owned Sberbank (not rated; 2%). Significant minority stakes in
operating subsidiaries are held by the international trader Glencore
International PLC (BBB/Stable/A-2).
S&P base-case operating scenario
We expect Russneft to generate about $1.5 billion EBITDA in 2012. Under our
standardized price assumptions of $80 per bbl for Brent in the long term, we
expect Russneft's EBITDA to be about $1.1 billion.
We expect Russneft's oil production to grow as the company catches up after
the difficult 2008-2009 period, when it faced a decline in production on the
back of underinvestment and shareholding uncertainties. After the company's
shareholding structure was settled in 2010, Russneft demonstrated impressive
production growth thanks to efficiency gains, which we expect to continue.
S&P base-case cash flow and capital-structure scenario
Russneft's credit measures have improved markedly in 2009-2012, and we expect
the positive trend to continue. Under our standard price assumptions, we
expect Russneft to generate positive free operating cash flow (FOCF) of about
$300-500 million and gradually reduce debt. This should translate into funds
from operations (FFO) to adjusted debt of about 15%-20% and adjusted debt to
EBITDA of 3.5x-4.5x, in our view.
We view Russneft's liquidity as "less than adequate". Although the company's
ratio of liquidity sources to liquidity needs is above 1.2x, covenant
headroom is tight and the company is still in the process of establishing its
standing in the credit markets.
At June 30, 2012, the key sources of liquidity for the next 12 months included
expected FFO of about $1.1 billion. We believe that cash balances ($108
million) were largely tied to operations and hardly available to repay debt.
In addition, the company has some flexibility thanks to a $300 million unused
short-term revolving trade finance facility from Glencore. The key liquidity
needs included $367 million debt amortization in 2012 and about $0.5 billion
in capital spending. In addition, the company faces relatively sizable
maturities of $257 million in 2013 and $364 million in 2014, which we believe
carry refinancing risks. Essentially all Russneft's debt comes from only two
lenders, Sberbank and Glencore, and we view reliance on those key lenders as a
Russneft faces tight maintenance covenants under its existing debt facilities.
Under our price scenario, we see the risk of a covenant breach. Our base-case
expectation is that Russneft should be able to obtain a waiver, as it did
before, or to refinance.
We believe that Russneft's current efforts to optimize its debt structure and
diversify borrowing sources should be positive for liquidity and possibly
provide for ratings upside potential after they are implemented.
The positive outlook reflects some upside potential for the rating if Russneft
improves its liquidity by addressing potential covenant issues, extending its
maturity profile, and diversifying its funding sources. It also reflects our
expectation that Russneft will continue to generate positive FOCF and use it
for deleveraging. We expect Russneft to refrain from any sizable acquisitions
or dividends, at least as long as its adjusted debt to EBITDA is above 3x.
Under our price scenario, we expect adjusted debt to EBITDA to be about
3.5x-4.5x and FFO to adjusted debt to be about 15%-20%. In the event of any
shifts in the shareholding structure, we will evaluate the impact on the
company's financial policy.
Downside pressure could stem from a further increase in liquidity pressures.
Downside pressure could also materialize if the company's leverage were to
increase, for instance in the event of very low oil prices,
higher-than-expected capital expenditures, or in the event of any unforeseen
acquisitions, which are not part of our base-case scenario.