Fitch Assigns KNOC's USD Bond Final 'AA-' Rating
KNOC will use the net proceeds from the bond to refinance existing debt and for general corporate purposes.
The notes are rated at the same level as KNOC's senior unsecured rating as they represent direct, unconditional, unsecured and unsubordinated obligations of the company.
The assignment of the final rating follows the completion of the bond issuance and receipt of documents conforming to the information previously received. The final rating is the same as the expected rating assigned on 22 September 2015.
KEY RATING DRIVERS
Ratings Equalised with Sovereign: The ratings of KNOC are equalised with Korea's (AA-/Stable) due to the company's strong strategic and operational ties with the state. KNOC is a key vehicle in the execution of Korea's energy policy. Its role entails the acquisition of oil and gas reserves, exploration and production activities to improve the country's self-sufficiency, and managing the country's strategic oil reserves. Its operations are closely aligned with the government's energy plan and monitored by the government.
Strong Continuous Government Support: KNOC undertakes substantial investments that require considerable financial assistance from the government. The government provides capital injections to support KNOC's policy objectives and operational targets. The government's capital injections into the company totalled KRW10.1trn as of December 2014, equivalent to nearly 40% of its total assets. The KNOC Act also states that the government may provide financial guarantees to KNOC, although there are no explicit guarantees to date.
Lower Oil Prices Take Toll: KNOC's revenue fell 32% yoy and the company posted an operating loss of KRW119bn in 1H15 due lower oil prices. Fitch expects the trend to continue because oil prices in the quarter to date are averaging around USD50/barrel (bbl), compared with nearly USD100/bbl in 2014 and USD60/bbl in 1H15, and our assumption is that prices will stay at these levels through the end of the year. Some of KNOC's upstream assets such as the Dana Petroleum operations are more vulnerable to oil price declines because of high production costs.
Measures to Improve Financial Profile: With the government's push to reduce debt at Korean state-owned entities (SOEs), KNOC has been shifting its strategy towards a more conservative investment and operational target, and towards improving its financial position. As such, we believe it will be unlikely that the company will make major acquisitions in the near term. The company has also been restructuring its asset portfolio to improve its financial profile by selling overseas upstream and downstream assets and domestic real estate properties.
Standalone Credit Profile to Weaken: The company's standalone credit profile remains weak for its rating levels due to major debt-funded acquisitions in recent years. At current oil price levels, we expect the company to continue to post negative free cash flow, which would put further pressure on the company's credit profile. As such we expect the company's FFO adjusted net leverage to increase to above 10x in 2015 (2014: 5.5x) but to improve gradually from 2016 onwards, reflecting slightly higher oil price assumptions.
Fitch's key assumptions within our rating case for the issuer include:
- Oil prices in line with Fitch's base case price deck as outlined in the "Fitch Oil and Gas Assumptions Summary", dated 11 February 2015
- Production volume to remain nearly flat in 2015
- Capex of KRW3.5trn in 2015 and KRW3trn in 2016
The issuer's rating is currently equalised with that of Korea.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
- A negative rating action on the sovereign.
- The government's inability to curtail the rate of increase in public-sector entities' debt, resulting in deterioration in the state's ability to provide timely and adequate support to key public-sector entities.
- Weakening of linkages with the state.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
- A positive rating action on the sovereign, provided that the rating linkages between KNOC and the state remain intact and that the state's ability to support key state-owned entities remains strong.
For the sovereign rating of Korea, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 13 July 2015:
The main factors that, individually or collectively, could trigger positive rating action are:
- A convincing strategy to reduce the broader public debt burden, which would be reflected in lower debt to GDP ratios for the general government or state-linked enterprises
- Evidence that the economy can continue to grow over time, thereby narrowing the per-capita income gap with rating peers, without deterioration in the combined household balance sheet
The main factors that, individually or collectively, could trigger negative rating action are:
- An unexpected large rise in the public-sector debt burden caused by a deviation from the current prudent fiscal policy framework or crystallisation of financial sector or other contingent liabilities
- Evidence that GDP growth will be structurally lower than expected, potentially reflecting medium- to long-term challenges for Korea's economic model.