Moody's affirms Medco's B1 rating and revises outlook to stable following acquisition announcement

(Singapore, December 10, 2021) -- 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 Platinum Road Pte. Ltd., Medco Oak Tree Pte. Ltd., Medco Bell Pte. Ltd. and Medco Laurel Tree Pte. Ltd. These bonds are unconditionally and irrevocably guaranteed by Medco.

At the same time, Moody's has revised the rating outlook to stable from negative.

The rating actions follow Medco's announcement on 8 December that it will acquire ConocoPhillips Indonesia Holding Ltd (CIHL) from a subsidiary of ConocoPhillips (A3 positive) for purchase consideration of $1.355 billion. CIHL indirectly owns a 54% interest in the Corridor Production Sharing Contract (PSC) in Indonesia (Baa2 stable) and a 35% interest in Transasia Pipeline Company Pvt Ltd. The transaction is expected to close in the first quarter of 2022 and completion is subject to conditions such as securing shareholder and customary approvals.

"The rating affirmation reflects the greater clarity on Medco's growth plans and consequently its credit profile following the acquisition announcement. The transaction will enhance Medco's business profile by boosting its production scale, increasing the proportion of gas production in its energy mix and strengthening its protection against oil price volatility as most gas sales at Corridor PSC are underpinned by long-term fixed price contracts with quality counterparties," says Hui Ting Sim, a Moody's Analyst.

"The change in rating outlook to stable reflects our expectation that Medco will maintain very good liquidity and that its credit metrics will improve in 2022-23 because of strong earnings accretion from Corridor PSC, despite the debt-funded nature of the acquisition," adds Sim.

RATINGS RATIONALE

Moody's estimates the acquisition will increase Medco's production volume by 60-70 thousand barrels of oil equivalent per day (kboepd) from 93 kboepd in the nine months of this year. Proved reserves will also increase by 80-90 million barrels of oil equivalent (mmboe) from 207 mmboe at Medco as of June 2021. The Corridor PSC primarily produces gas, which are sold via long-term offtake contracts with fixed pricing to mostly high quality counterparties. Cash costs at the target assets are also low at $4-$5 per barrel of oil equivalent.

Moody's forecasts that the acquisition will increase Medco's proportion of gas in its production mix to 70%-75% from its current 60%-65%. The fixed-price portion of its production mix will also rise to 50%-55% from its current 33%-37%. However, Medco's exposure to geographic concentration risk will also increase as over 85% of its production will be from Indonesia post-acquisition, compared with around 77% in the first half of 2021.

Medco plans to fund the acquisition using proceeds from the $400 million US dollar bond that it issued in November this year, and another $450 million from an amortizing bank loan facility. Based on Moody's medium-term Brent crude price assumption of $50-$70 per barrel, Moody's estimates that Medco's debt/EBITDA will improve to 2.5x-3.0x over 2022-23 following the acquisition, from 4.4x as of the 12 months ended June 2021.

Post-acquisition, Medco will take over as operator of Corridor PSC, which is located onshore at South Sumatera with two producing oil fields and seven producing gas fields. Moody's views that Medco is likely able to manage the execution risks arising from the acquisition, given its familiarity with the area since its existing operations at South Sumatera are located near Corridor PSC. The company plans for limited capital spending to develop reserves in 2022-23 at Corridor PSC given its current high proportion of proved developed reserves.

However, Moody's expects execution risk will grow in 2024 as Corridor PSC will transition to the gross split scheme at the end of 2023 from its current cost-recovery scheme. The gross split scheme will require operators to manage all costs within their share of revenue to make a profit, as costs associated with investment and production are wholly borne by PSC holders and not shared with the government.

Pro forma for the $450 million bank loan facility and acquisition, Medco's liquidity is very good over the next 18 months. As of 30 June 2021, there were unrestricted cash and cash equivalents of $253 million, cash in escrow for debt and interest repayment of $116 million and undrawn credit facilities of close to $500 million at Medco, excluding Medco Power. Moody's expects the company's cash holdings, proceeds from its issued bonds, its $450 million amortizing bank loan facility, cash flow from operations of around $700-$750 million and asset divestment of around $100 million will be sufficient to address its acquisition payment for Corridor PSC, debt maturities of around $600 million and spending of close to $340 million over the next 18 months.

ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) CONSIDERATIONS

Medco's ESG Credit Impact Score is Moderately Negative (CIS-3). This reflects Moody's assessment that ESG attributes are overall considered to have limited impact on Medco's current rating, with greater potential for future negative impact over time. This is mainly driven by the company's highly negative environmental risks and highly negative social risks, but mitigated partially by its governance practices of proactive financial management.

Medco has a highly negative exposure to environmental risk (E-4 Issuer Profile Score) primarily because of its high exposure to carbon transition risk, physical climate risk and natural capital risk. The company has a sizeable power arm with renewable operations that are not within the restricted group of its US dollar bonds. However, at present, most of Medco's earnings are still generated through its oil and gas operations, reflecting its elevated exposure to environmental risk.

Medco has a highly negative exposure to social risk (S-4 Issuer Profile Score), because of high responsible production risks inherent to the nature of upstream operations and the need to develop relationships with local communities.

Medco's moderately negative governance risk score (G-3 Issuer Profile Score) reflects its growth appetite as shown by its history of debt-funded acquisitions, complex organizational structure and concentrated ownership. But this is balanced by the company's track record of proactive financial management to refinance debt maturities in advance and increase the average weighted maturity profile of its debt.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

An upgrade of Medco's rating will require an increase in the company's scale and a further improvement in its credit metrics while maintaining very good liquidity. Credit metrics supportive of a higher rating include adjusted net debt/EBITDA falling below 3.0x, retained cash flow (RCF)/adjusted net debt rising above 20% and EBITDA/interest expense increasing above 4.5x.

Downward pressure on Medco's rating could build if the company's credit metrics are weak for its rating level or its liquidity deteriorates. Debt-funded acquisitions could also exert downward pressure on the company's rating.

Quantitative metrics indicative of downward pressure include adjusted net debt/EBITDA rising above 4.0x, adjusted RCF/adjusted net debt falling below 10%, or adjusted EBITDA/interest expense falling below 3.5x.

The principal methodology used in these ratings was Independent Exploration and Production published in August 2021 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1284973. Alternatively, 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 resource company listed in Indonesia with three key business segments -- oil and gas, power and mining. (ends)