OREANDA-NEWS. Fitch Ratings has affirmed Indian Oil Corporation Ltd's (IOC) Long-Term Foreign-Currency Issuer Default Rating (IDR), its senior unsecured rating and ratings on its outstanding senior unsecured debt at 'BBB-'. The Outlook is Stable.

KEY RATING DRIVERS

Strong Linkages with State: IOC has strong operational and strategic linkages with its 68.6% shareholder, the government of India (BBB-/Stable). The linkages remain strong despite the deregulation of diesel prices in October 2014. IOC continues to sell household liquefied petroleum gas (LPG) and kerosene at government prescribed prices, which are lower than market prices. The government makes up most of this difference between the selling and market prices, known as under-recovery (UR), through subsidies and discounts from upstream players. With the implementation of the direct benefit transfer scheme for LPG, IOC will be able to sell LPG at market prices, further reducing its total URs. Notwithstanding these developments, the state-owned downstream companies continue to be important policy tools of the state; as such Fitch equalises IOC's rating with that of India.

Benefits from Diesel Deregulation: The full deregulation of diesel pricing in October 2014 has completely eliminated under-recoveries on the sale of this product. Diesel accounted for around 45% of URs in the financial year ended 31 March 2014 for oil marketing companies. Although government subsidies cover the URs, there is typically a delay in the payment of the subsidies, which results in an increase in working capital requirements for the oil marketing companies. Fitch estimates that IOC's URs fell by more than 50% in FY15 to around INR350bn, and expects there will be less pressure on working capital because IOC will not need to wait for the government subsidies.

The diesel deregulation would also provide a level playing field for private refiners to retail diesel. However, this will not lead to substantial competitive pressure in the near term, as the state-owned oil marketing companies have significant infrastructure that the private players will have to build.

Dominant Market Position: IOC is the largest oil refining company in India with 65.7 million tonnes per annum (mtpa) of capacity, which accounts for 31% of India's refining capacity. It operates 10 of the 22 refineries in the country. With the commissioning of its 15mtpa Paradip refinery, IOC's market share in refining is likely to increase. IOC is also the largest marketer of petroleum products, with a market share of 42%.

Crude Oil Price Fall: IOC suffered inventory losses in FY15 as crude oil prices fell sharply. These losses had a one-time effect on profitability in FY15. On the flip side, the lower prices have led to lower inventory levels, which have eased working capital needs and correspondingly reduced short-term debt requirements.

Reducing Working Capital: In FY15, IOC's working capital needs would have decreased due to lower subsidies and inventory levels. Fitch expects the lower working capital requirements led to a reduction of around INR250bn in debt in FY15; at FYE14, IOC's consolidated total adjusted debt amounted to INR985bn.

Credit Profile and Liquidity: While the lower profitability in FY15 due to large inventory losses will lead to very high leverage levels, we believe that net leverage, as measured by net debt to EBITDA, will remain around 3.5x on a sustainable basis from FY16. IOC's liquidity continues to be comfortable with cash and equivalents of INR157bn (including oil bonds of INR120bn) at FYE14, and shares in other listed companies with a market value of about INR230bn. IOC also has very good access of domestic and international capital and banking markets.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Gross refining margins improve slightly over historical average due to commissioning of the Paradip refinery
- the capex is in line with past; no mergers and acquisition assumed
- the URs and the corresponding budgetary support requirements fall substantially in FY15 and decrease further in FY16

RATING SENSITIVITIES

IOC's ratings are equalised with those of India.

Positive: Future developments that may, individually or collectively, lead to positive rating action include
-An upgrade of the sovereign rating, provided the rating linkages with the state remain intact.

Negative: Future developments that may, individually or collectively, lead to negative rating action include
- A downgrade of the sovereign rating
- Weakening of linkages between IOC and the state

For the sovereign rating of India, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 9 April 2015.

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

- Fiscal consolidation or fiscal reforms that would cause the general government debt burden to fall more rapidly than expected
- An improved business environment resulting from implemented reforms and structurally lower inflation levels, which would support higher investment and real GDP growth

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

- Deviation from the fiscal consolidation path, leading to persistence of the high public debt burden, or greater-than-expected deterioration in the banking sector's asset quality that would prompt large-scale financial support from the sovereign
- Loose macroeconomic policy settings that cause a return of persistently high inflation levels and a widening current account deficit, which would increase the risk of external funding stress.