Fitch Affirms Medco Energi at 'B+'; Outlook Stable

(Fitch Ratings - Singapore - 23 March 2020)--Fitch has affirmed PT Medco Energi Internasional Tbk's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B+' with a Stable Outlook. Fitch has also affirmed the ratings of Medco's senior unsecured US dollar notes, at 'B+' with a Recovery Rating of 'RR4'.

The affirmation and Outlook reflect Fitch's expectation that Medco will sustain a credit profile commensurate with its ratings post 2020, after factoring in the downward revision of Fitch's oil-price assumptions (see "Fitch Ratings Cuts Oil, Gas Price Assumptions on Coronavirus, Price War", dated 19 March 2020). Fitch expects leverage, measured by adjusted debt/operating EBITDAR, to exceed its negative sensitivity of 4.0x in 2020, due to weaker oil prices and lower volume, but forecasts leverage to improve to around 3.0x by 2021 and remain at around this level over the medium term. We also believe Medco's adequate liquidity will cushion any additional short-term shocks, although its rating headroom has declined from our previous expectations.

Medco's ratings also reflect its larger scale, low-cost position and favourable earning mix via fixed-price contracts relative to most 'B' category upstream oil and gas producers.

Key Rating Drivers

Financial Profile to Weaken: Fitch expects Medco's leverage, as measured by adjusted debt/operating EBITDAR, to increase to around 4.3x in 2020. This is due to weaker EBITDA expectations in 2020 of around USD580 million compared with our previous estimate of over USD800 million, driven by weaker oil prices and a curtailment in expected production. Fitch expects Medco's production to decline to around 95 thousand barrels of oil equivalent per day (mboepd) in 2020 amid weaker demand, from 100 mboepd in 2019 after it acquired Ophir Energy PLC.

However, leverage should improve to about 3.0x through to 2024 on gradually increasing oil prices and volume. Medco also has flexibility to curtail capex by more than we previously expected, although we have not factored this in to our forecasts. We exclude Medco's fully owned subsidiary, PT Medco Power Indonesia (MPI), when calculating adjusted leverage.

Earning Mix Mitigates Low Prices: Medco's earnings are less sensitive to changing crude oil prices than those of most 'B' category upstream oil and gas peers. This is because around a third of Medco's production comprises gas sold via long-term fixed-price take-or-pay contracts, generating EBITDA of around USD250 million a year. This covers Medco's consolidated interest expense by more than 1x.

Gas accounts for around 60% of Medco's production volume and is sold through long-term contracts, about half of which have fixed prices. Most of these contracts are also with investment-grade national oil and gas companies, mitigating counterparty risk. Fitch does not expect major changes to Medco's contracts in light of lower energy prices. Any changes would be considered as an event risk.

Strong Operating Profile: Medco's operating profile benefits from low lifting costs of around USD9-10/barrel of oil equivalent (boe) and a diversified production base largely located within Indonesia with some presence abroad; Medco derives its production from 16 oil and gas fields, none of which contribute more than 20% to output, lowering its operating risks. Fitch expects the company to maintain its proved reserve life of nearly seven years as it invests in exploration and development.

High Regulatory Risk: Medco's main base of operation is concentrated in Indonesia, exposing the company to regulatory risks. The regulatory uncertainty was highlighted by instructions from Indonesia's Directorate General of Oil and Gas in mid-2018 to cut the selling price at the Block A gas development in Aceh from the originally agreed USD9.45/million British thermal unit.

Power Investment Neutral: Fitch considers the risk dynamics of MPI to be neutral to Medco's credit profile, as its investment in the power company falls outside the restricted group structure defined in Medco's bond documentation. Medco has a USD300 million limit on investments outside the restricted group, as stated in the documentation, the majority of which has been utilised. The structure 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.

Derivation Summary

Medco's ratings reflect its operating profile, which compares well against 'B' rated exploration and production peers in terms of the earnings mix generated through fixed-price take-or-pay contracts, and generally bigger scale.

Canacol Energy Ltd. (BB-/Stable) derives over 90% of sales through fixed-price long-term take-or-pay contracts, which results in a higher rating than for most 'B' rated oil and gas producers, including Medco, despite its smaller production scale of 32mboepd. We expect Canacol's leverage to be lower than that of Medco and its reserve life to be better at around 10 years.

We expect Medco's production to be larger than GeoPark Limited's (B+/Stable) 40mboepd, although its reserve life of less than seven years is weaker compared with the eight years at GeoPark. Medco's stronger operating profile is somewhat offset by our expectations of higher leverage than at GeoPark.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer

Brent prices to average USD41, USD48, USD53 and USD55 a barrel in 2020, 2021, 2022 and in the long term, respectively, as per Fitch's oil and gas price deck. Gas prices in line with the fixed-price contracts wherever applicable.

Total production volume falling to around 95mboepd in 2020 and 100mboepd until 2022 from existing assets. Gradual decline after 2022.

Cash production costs to remain at or below USD10/boe.

Capex of USD200 million-300 million a year through to 2023.

Key Recovery Rating Assumptions

The recovery analysis assumes that Medco would be reorganised as a going concern in bankruptcy rather than liquidated.

We assume a 10% administrative claim.

Medco's going-concern EBITDA, excluding MPI) is based on the average EBITDA we expect over 2020 to 2024, which is stressed by 30% to reflect the risks associated with oil-price volatility, potential challenges in maintaining output from its maturing fields and other factors.

An enterprise value multiple of 5.5x is used to calculate a post-reorganisation valuation and reflects a mid-cycle multiple for oil and gas, metals and mining companies globally, which is higher than the observed lowest multiple of 4.5x. The higher multiple reflects that the majority of Medco's production volume stems from long-term fixed-price and indexed take-or-pay gas contracts, which provide more cash flow visibility across economic cycles than the average global upstream oil and gas production company.

We assume prior-ranking debt of USD338 million will be repaid before Medco's senior unsecured creditors, including investors in its US dollar bonds. Prior-ranking debt includes project-finance debt at non-guarantor subsidiaries, PT Medco E&P Tomori Sulawesi and PT Medco E&P Malaka.

The payment waterfall results in a recovery rate corresponding to a 'RR1' Recovery Rating for the unsecured notes. However, we rate the senior unsecured bonds at 'B+'/'RR4' because Indonesia falls into Group D of creditor friendliness under our Country-Specific Treatment of Recovery Ratings Criteria, and the instrument ratings of issuers with assets in this group are subject to a soft cap at the issuer's IDR. (ends)