S&P: Viva Energy Holding Pty Ltd. Assigned 'BBB-' Rating; Outlook Stable
"The rating reflects Viva Energy's solid market position in Australian fuel retailing and commercial fuels, where the group holds about 25% market share in both segments by volume and has an integrated fuel-supply business throughout the supply chain," said S&P Global Ratings credit analyst Brenda Wardlaw.
In addition, the group generates stable rental income and fuel margin from its retail alliance with Coles. The latter operates the convenience stores and forecourt and Viva Energy supplies the fuel, maintains the fuel equipment, and controls the sites.
Viva Energy has sold its 425 freehold service-station portfolio into Viva REIT. The company will use the proceeds to repay its A$798 million term debt and A$285 million debt drawn from its borrowing base facility; fund a A$400 million capital return to shareholders; and for transaction expenses and working capital.
Viva Energy is the sole tenant of Viva REIT with a sublease to Coles (part of Wesfarmers Ltd. [A-/Negative/A-2]) and has retained a shareholding of about 40% in the REIT. Viva Energy acquired Royal Dutch Shell PLC's Australian (Shell Australia Ltd.) downstream assets in February 2014 and is owned by a Vitol-controlled investment vehicle, which includes Abu Dhabi Investment Council as a shareholder.
Viva Energy has exclusive rights to use the Shell brand in Australia under a long-term agreement for its retail and commercial fuels business. Furthermore, the group benefits from relatively high barriers to entry as a result of well-located supply and distribution infrastructure (including import terminals and a pipeline linking the Geelong refinery to Melbourne) and a national retail network that would be difficult and capital intensive to replicate.
Moderating these strengths is the group's exposure to a small single-site refinery in Geelong, Victoria, which we expect to generate 30% to 50% of earnings. The refining business is cyclical, capital-intensive, carries high operating risks, and has large working capital requirements. Viva Energy is also exposed to volatility in oil prices, refining margins, exchange rates, and macroeconomic cycles that can affect consumer demand for fuel in its retail business.
In addition, Viva Energy's commercial business has some customer concentration risk and exposure to the resources and mining sector. Viva Energy is also reliant on strategic alliances with Coles for its convenience store and retail business, Shell for its fuel brand, and its shareholder Vitol for sourcing its crude feedstock and refined products. While we view these alliances as strengths of the business, they may present a risk when the long-term contracts expire.
Our view of the group's financial risk profile reflects our forecast of Viva Energy's pro-forma adjusted debt to EBITDA for the financial year to Dec. 31, 2016, being in the low 2.0x range and funds from operations (FFO) to debt of about 35%-40%. Our financial risk profile assessment also reflects our expectation Viva Energy will generate solid free operating cash flow of about A$200 million, which it will use to repay drawings on the borrowing base facility and fund growth in the business. We forecast moderate deleveraging on an adjusted debt-to-EBITDA basis over the next two years.
Viva Energy's capital structure on the completed Viva REIT IPO includes a US$1.1 billion borrowing base facility that will be drawn down by about A$300 million (net of cash). The company will have no term debt. Further, we expect the company to fully repay the borrowing base facility within one-to-two years. Our analytical adjustments to debt include full consolidation of Viva REIT because of its high strategic importance to Viva Energy. We also make operating lease adjustments for leasehold service stations outside of Viva REIT; however, these lease commitments are net of Coles sublease income.
The rating also benefits from our view that the group's financial flexibility will support financial metrics at the stronger end of our expectations at most times in the cycle. We expect its debt to EBITDA to track in the 1.5x to 2.5x range. We also consider other credit characteristics in aggregate such as: Our forecast repayment of balance-sheet debt within one-to-two years; Stable earnings from rent and fuel margin, which account for about 35% of EBITDA; Commitment by the shareholders not to pay dividends over the medium term; and The fact that a high proportion of the adjusted debt relates to consolidation of the Viva REIT and operating leases. We also view Viva Energy's business risk profile is at the stronger end of the scoring category, supported in part by the favorable industry dynamics in the Australian retail fuel market on the back of steady GDP growth.
We believe that Viva will operate at the stronger end of both its financial and business risk assessments, which is supportive of the one-notch rating uplift.
Ms. Wardlwaw added: "The stable rating outlook reflects Viva Energy's financial flexibility to maintain leverage within the range of adjusted debt to EBITDA of 1.5x-2.5x, supported by sound cash flow generation and flexibility over management fees."
Viva Energy is benefiting from favorable refining margins, which is supporting earnings growth while also facilitating business investment to improve the operating performance and reliability of the refinery. The stable outlook also reflects good visibility of earnings from the Coles alliance from rental income and fuel marketing margin.
We could lower the ratings if Viva Energy's debt to EBITDA increases to more than 2.5x or FFO to debt reduces to less than 35% on a sustained basis. Downside ratings pressure could also occur if refining margins were to substantially decline, or an oil price shock were to occur. The latter scenario could materially reduce demand for fuel and increase the cost of inventory and drawings under the borrowing base facility. We could also lower the ratings if an unforeseen operational shutdown were to occur at the refinery that materially affected earnings.
We consider ratings upside is limited over the next two-to-three years because of the inherent volatility in the refining business; the group's financial policy objectives; and the company's limited track record under its current shareholders and management. However, we could raise the ratings if Viva Energy could reduce its exposure to volatile refining earnings that improves its business risk profile, while also maintaining adjusted debt to EBITDA less than 2.0x and FFO to debt more than 50%.