OREANDA-NEWS. Fitch Ratings has downgraded Malaysia-based Petroliam Nasional Berhad's (PETRONAS) Long-Term Foreign - and Local-Currency Issuer Default Ratings (IDRs) to 'A-' from 'A', and affirmed its Short-Term Foreign-Currency IDR at 'F1'. The Outlook on the Long-Term IDRs is Stable.

At the same time, Fitch has downgraded PETRONAS' foreign-currency senior unsecured rating and the ratings on debt issued by PETRONAS Capital Limited and guaranteed by PETRONAS to 'A-' from 'A'. However, PETRONAS continues to maintain a strong standalone credit profile, assessed by Fitch at 'AA-'.

The rating actions follow the downgrade of Malaysia's Long-Term Local-Currency (LTLC) IDR to 'A-' from 'A', in line with the updated guidance contained in Fitch's revised Sovereign Rating Criteria dated 18 July 2016 (see Fitch Applies Criteria Changes to Global Sovereign Ratings). Fitch concluded that Malaysia's credit profile no longer supports a notching up of the LTLC IDR above the Long-Term Foreign-Currency IDR. This reflects Fitch's view that neither of the two key factors cited in the criteria that support upward notching of the LTLC IDR are present for Malaysia. Those two key factors are: (i) strong public finance fundamentals relative to external finance fundamentals; and (ii) previous preferential treatment of local-currency creditors relative to foreign-currency creditors.

KEY RATING DRIVERS

Ratings Constrained by Sovereign: PETRONAS' IDRs are constrained by Malaysia's IDRs. The reasons in support of Malaysia's LTLC IDR downgrade also weaken the case for rating PETRONAS' foreign-currency obligations above the sovereign foreign-currency rating. PETRONAS is 100%-owned by Malaysia and the government can exert significant influence over its operating and financial policies.

Strong Standalone Profile, Lower Headroom: Despite weakened oil and gas prices, PETRONAS continues to maintain a strong 'AA-' standalone credit profile. The rating headroom for its standalone profile has, however, narrowed due to pressure on operating cash generation from sustained low oil prices, and the likely slow recovery of prices over the forecast period, despite a reduction in dividend payout. Malaysia has reduced its expectations for dividends from PETRONAS in the current low oil price environment which benefits the company's financial profile. PETRONAS' rating also benefits from significant capex and opex savings announced by the company totalling MYR50bn through 2020.

Lower Dividend Supports Rating: Fitch expects PETRONAS to pay a lower dividend of MYR16bn in 2016, down from MYR26bn in 2015 and MYR29bn in 2014. With this reduction in dividends, Fitch expects PETRONAS to meet a majority of its capex from internal cash generation, even though operating cash generation is likely to be weaker due to low commodity prices. However, in Fitch's view, PETRONAS will continue to make sizeable contributions to the government's revenue. Any sustained reduction in its dividend payments remains predicated on the government's policy and its financial requirements given the government's reliance on PETRONAS for state revenue.

Significant Medium-Term Capex: Fitch expects PETRONAS' capex programme to remain significant, including capex on the downstream Refinery and Petrochemical Integrated Development (RAPID) project in Malaysia and the liquefaction and production facilities associated with its Canadian joint venture, Pacific NorthWest LNG project.

The USD16bn RAPID project consists of a refinery, naphtha cracker plant and other petrochemical facilities; the commissioning of the refinery is expected in early 2019 with the associated petrochemical plants to be phased in. Other facilities associated with the RAPID project, covering electrical and water supplies, LNG import terminal and a regasification terminal, will require an additional capex of USD11bn. A conditional final investment decision on the Pacific NorthWest LNG project was made in May 2015, which is still pending the receipt of final environmental approval. PETRONAS and its project partners will review the final environmental report and evaluate conditions attached to determine their impact on the overall cost structure and project schedule. The outcome, as well as the LNG market outlook and project commerciality, will be considered for the final investment decision.

Near-Term Negative FCF: Fitch expects PETRONAS' free cash flows (FCF) to remain weak, reflecting the expected slow recovery of oil prices, high committed capex and dividend payments. PETRONAS' financial flexibility, however, remains strong as it benefits from lower dividend payments in 2015 and 2016, as well as lower funding costs for its USD5bn bond issuance in March 2015. The company also had substantial cash balances of MYR116bn at 31 March 2016, and was in a net cash position given its relatively low indebtedness of about MYR54bn. Its leverage, as measured by funds from operations (FFO)-adjusted net leverage, was negative at 0.7x (a net cash position), and its FFO interest coverage was at 27x for 2015.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Oil price based on Fitch's Brent price deck of USD33/barrel (bbl) in 2016, USD45/bbl in 2017 and USD55/bbl in 2018

- Dividend payment of MYR16bn in 2016

- Capex to average MYR50bn over 2016 to 2018

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

- Upgrade of Malaysia's Foreign - and Local-Currency IDRs.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- Downgrade of Malaysia's Foreign - and Local-Currency IDRs.

For the sovereign rating of Malaysia, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 23 February 2016:

The Stable Outlooks reflect Fitch's assessment that upside and downside risks to the ratings are current broadly balanced.

The main factors that could, individually or collectively, lead to a negative rating action are:

- A sustained deterioration in fiscal discipline and the public finances leading to a sharper rise in government debt ratios than Fitch currently expects

- Further weakening of the balance of payments that strains domestic economic and/or financial stability

- Deterioration in political stability or governance that lead to a weakening of credibility of policy-making institutions

The main factors that could, individually or collectively, lead to a positive rating action are:

- Sustained reductions in government debt ratios

- Narrowing of structural weaknesses relative to peers, including development indicators and governance

LIQUIDITY: PETRONAS' liquidity remains strong, as reflected in net cash balances against balance sheet debt as at 31 March 2016.