Fitch Revises Outlook on Tupras to Negative; Affirms at 'BBB-'
The revision of the Outlook results from weaker than previously expected financial performance coupled with higher than expected dividend payment in 2016. This results in a higher risk that Tupras's forecast funds from operations adjusted net leverage (FFO net leverage) may be above 2.5x in 2016-2019, our threshold leverage metric for negative rating action. We recognise Tupras's ability to generate free cash flow (FCF) as a result of falling capital intensity, even in a weaker market environment, which partly offsets these negative pressures. Tupras is rated on a standalone basis, but the company's ratings would also be constrained by the sovereign rating. Fitch revised the Outlook on Turkey's sovereign rating to Negative from Stable on 19 August 2016 (see 'Fitch Affirms Turkey at 'BBB-'; Revises Outlook to Negative').
Turpas's ratings reflect the company's leading position in the Turkish oil refining and marketing sector, favourable crude oil purchase costs and product slate, as well as higher complexity of refining assets following the completion of the Izmit refinery upgrade and the growing Turkish fuel market. The ratings are constrained by refining sector cyclicality, the company's generous dividend policy and sales concentration in a single, albeit growing, market (Turkey, BBB-/Negative).
KEY RATING DRIVERS
Stronger Business, But Higher Leverage
In November 2014, Tupras completed the modernisation of the Izmit refinery with the residuum upgrading project (RUP) consisting of a vacuum distillation, delayed coker and hydrocracker units. New units became fully operational in 2015 and are expected to add 3.5 million tonnes of higher margin white products, which is positive for the company's credit profile. The completion of RUP also marks the end of a capex-intensive period.
We expect reduced investments of up to TRY800m annually from 2016 compared with over TRY2bn in 2012-2014, when RUP was being constructed. However, with generous dividend payouts and refining margins below our earlier forecasts, there is a risk that Tupras's net leverage metrics will be outside our guidance for the 'BBB-' rating, driving the Outlook revision. We also forecast leverage will be reduced gradually on the back of positive FCF, which drives the affirmation.
Negative Outlook on Sovereign Rating
Fitch revised the Outlook on Turkey's sovereign rating to Negative from Stable on 19 August 2016. Although the rating action on Tupras reflects our reassessment of the company's standalone financial profile, Tupras's ratings would also be constrained by the sovereign rating. The uncertainties related to the recent political situation in Turkey have had a limited direct impact on Tupras's operations so far, but at the same time the higher volatility of Turkish lira, potential decrease in tourist arrivals and pressure on GDP growth may weaken Tupras's financial profile and reduce growth in Turkish fuel demand.
Refining Margins Remain Volatile
Refining margins in Europe have retreated from the exceptionally high levels of 2015 and remain volatile. Higher refining throughput in 1Q16 resulted in higher inventory levels and lower margins. Margins started to recover in 2Q16 on the back unplanned shutdowns but dipped again in July-August as the market remained well supplied. Net refining margins will continue to be supported by depressed oil prices in the medium term, but the current market dynamics show that global refining overcapacity has not been addressed. We expect that refining asset maintenance and run rate adjustments will support refining margins towards the end of 3Q16 and 4Q16, although a return to the exceptionally high margins of 2015 currently seems unlikely.
Tupras's 1H16 figures reveal weaker than expected performance although we believe 2H16 will be stronger. In 1H16, Tupras's reported EBITDA decreased by 2% yoy to TRY1bn in TRY terms, but dropped 22% in USD terms to USD355m. The company's current cost of supplies-adjusted EBITDA showed even worse performance, falling by 43% to USD260m.
We expect Tupras's EBITDA to total TRY2.7bn in 2016 compared with our earlier expectation of TRY3.2bn. Dividends paid in 2016 totalled TRY1.6bn, around two times higher than we assumed earlier. We expect FFO net leverage to be 3.2x in 2016. With reduced capex requirements going forward and stronger business profile following RUP completion, the leverage metrics in the medium term will largely depend on refining margins in Turkey and the company's dividend payouts.
Growing Turkish Fuel Market
Tupras's ratings are supported by the growing Turkish fuel market. Sales of diesel, jet fuel and gasoline from January to May 2016 increased by 10%, 10% and 7% yoy, respectively. We expect that growing vehicle park and air traffic will further support fuel market growth in Turkey over the rating horizon, while a diesel shortage will remain in place. The growth rates are even more impressive when compared with European averages where gasoline and diesel consumption increased in 1H16 by 1%.
In 2015, net diesel imports to Turkey were 12.3 million tons. We believe the additional 5 million ton of diesel production coming from the new refinery currently being constructed in Turkey by the State Oil Company of the Azerbaijan Republic (SOCAR, BB+/Negative) post-2018 will not be enough to balance the market.
Competition in Crude to Benefit European Refiners
The lifting of the US ban on oil exports in December 2015 resulted in the Brent-WTI differential collapsing, which improved the competitiveness of European refining companies versus their US peers. Oil markets continue to be well supplied, which will allow refiners to capitalise on pricing differential between various crude types. We expect that the coastal location of two of its main refineries will allow Tupras to benefit from higher pricing differentials between various crude blends. This is reflected in our forecasts.
The company was a large buyer of Iranian crude in the past, but was forced to scale down purchases between 2012 and 2015. In addition, higher competition for lower-grade crudes has already resulted in higher differentials, with Urals to Brent discount averaging USD2.6/bbl in 1H16, compared with USD1-1.5/bbl over the past few years.
Fitch's key assumptions within our rating case for the issuer include:
- Mediterranean refining margins moderating from USD4.8/bbl in 2015 to USD3.0/bbl in 2016 and USD2.5/bbl in the long term.
- USD/TRY (annual average): 2.95 in 2016; 3.04 in 2017 and 3.15 in the long term.
- Low capital intensity in 2016 and thereafter following the completion of RUP modernisation.
Positive: Future developments that may, individually or collectively, lead to a revision of the Outlook to Stable include:
- FFO-adjusted net leverage (adjusted for factoring of trade accounts receivable) comfortably below 2.5x (2016E: 3.2x) and FFO fixed charge cover above 5x (2016E: 5x).
- Consistently positive FCF.
- Positive rating action on the sovereign would be a prerequisite for any positive rating action.
Negative: Future developments that could lead to negative rating action include:
- FFO-adjusted net leverage (adjusted for factoring of trade accounts receivable) consistently above 2.5x and FFO fixed charge cover well below 5x.
- Consistently negative FCF.
- Substantially higher capex and/or dividends leading to higher than expected leverage.
- Negative rating action on the sovereign.
For the sovereign rating of Turkey, the following sensitivities were outlined by Fitch in its rating action commentary of 19 August 2016:
The following factors, individually or collectively, could trigger a a downgrade:
- Prolonged or deepened political instability, insecurity or geopolitical stresses that undermine economic performance or economic policy credibility.
- A materialisation of stresses stemming from external financing vulnerabilities.
- A reversal in the declining trend in debt/GDP or a worsening of external imbalances.
As the Outlook is Negative, Fitch does not anticipate developments with a high likelihood of triggering an upgrade. However, the following factors, individually or collectively, could lead to a revision of the Outlook to Stable:
- A more stable and predictable domestic political and security environment.
- Implementation of reforms that address structural deficiencies in the economy.
At 30 June 2016 Tupras's cash balance of around TRY3.5bn (excluding blocked deposits and amounts Fitch assumes being not freely available for debt service) was exactly in line with its short-term debt of TRY3.5bn. In addition, the company's liquidity is supported by a significant amount of uncommitted credit lines and our expectation of a positive after-dividend FCF in 2016-19.
Factoring Adds To Leverage
Tupras's factoring amounts are included into the company's indebtedness according to Fitch's methodology. At end-2015 the company's balance of factored trade receivables amounted to TRY0.8bn (TRY2.3bn at end-2014), compared to its net balance sheet debt of TRY7.9bn.