OREANDA-NEWS. Fitch Ratings has affirmed Saudi Basic Industries Corporation's (SABIC) Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'A+' and Short-term IDR at 'F1'. The Outlook on the Long-term IDR is Stable. The senior unsecured rating on SABIC Capital's guaranteed bonds has also been affirmed at 'A+'.

The ratings reflect SABIC's vertically integrated operations, state of the art world-scale production facilities and access to competitively priced natural gas feedstock (methane and ethane) in the Kingdom of Saudi Arabia (KSA, AA/Negative). Competitive access to feedstock results in strong free cash flow and best-in-class EBITDA margins, especially in KSA which compensates for other under-performing regions. This mitigates the inherent cyclicality in SABIC's markets (petrochemicals, agri-nutrients, metals) and has limited the cash flow impact of the group's large expansion projects and occasional associated cost overrun or delays in the past. In Fitch's view, SABIC's standalone business and financial profile already embed any benefits from its state ownership.

Robust Margins Despite Revenue Fall
Lower chemical prices have dampened earnings considerably for the nine months to 3Q15, with sales being 21% lower than the nine months to 3Q14. However, the overall EBITDA margin has increased to 30% at 3Q15 from around 28% at FY14 due to lower non-fixed costs and better European performance. Overall cash generation is forecast to be lower on absolute levels. However, headroom remains within SABIC's financial profile to allow for lower cash flows.

Improvement in European Operations
Earnings from SABIC's European operations are improving due to European naptha cracking becoming more profitable following the oil price fall, a pick-up in demand in end consumer markets and realised efficiencies from the April 2013 restructuring programme, which included employee cost savings and the conversion of SABIC's cracker in the Teesside plant in the UK from naphtha to methane to tap favourably priced US gas. However, the gap between European and KSA financial performance remains large.

Capex and Inorganic Expansion to Continue
SABIC plans to increase annual capex compared with 2011-2013, although to a level significantly below the pre-2008 level. This is partially driven by the multi-billion potential Oil to Chemicals project, on which a decision is expected in 2Q16. Other key development projects include a 400,000 tonne per annum elastomer production site, potential steel plant and a methyl- and polymethyl methacrylate site in KSA. There also remains the possibility for SABIC to acquire other businesses. Overall there is sufficient headroom within metrics for these projects, with funds from operations (FFO) net leverage remaining below 1.5x despite the resurgence of expansionary capex.

Group Structure
A large portion of consolidated earnings is generated by partly owned operating companies. In Fitch's view, the associated risks (structural subordination, restricted access to cash flow or reliance on dividend payments) are mitigated by SABIC's management control over these entities, the stable stream of dividends and fees historically received by the holding company, a high level of operational integration across the group, and large cash balances maintained at the holding company. Fitch's FFO based leverage and coverage ratios exclude dividends paid to minorities to account for cash leakage to minority shareholders.

Fitch's key assumptions within the rating case for SABIC include
- Revenues move in line with oil prices from 2015. A large decrease is forecast in 2015 and in line with results to date, with revenues moving with the Fitch oil price deck.
- EBITDA margins for the existing business remain at 28% and increase with new earnings from inorganic investments.
- Capex, tax, dividends received and dividends paid as per management forecasts.

Negative: Future developments that may individually or collectively lead to negative rating action include:
-FFO-adjusted net leverage sustained at above 1.5x through the cycle due to aggressive debt-funded expansion.
-Material adverse revisions in the group's feedstock supply arrangements, significant changes in SABIC's shareholding structure or any material impairment in the control of its affiliates/joint-ventures and resulting ability to access/upstream cash.

There is little scope within SABIC's current business profile for it to be rated above 'A+', which we generally consider the highest rating attainable for companies in the chemical sector due to the inherent cyclicality of the industry. We believe that the only realistic source of upward rating pressure in the short term could be a strengthening of ties with KSA, demonstrated by extensive, tangible financial support from the state.

Given its structure, Fitch would expect SABIC to maintain larger cash balances and lower net leverage ratios than peers with the same rating. Liquidity is forecast to remain strong. At end-September 2015, cash balances and short-term investments amounted to SAR36.4bn and SAR31.1bn, respectively. This compared with maturing long-term debt of SAR14.9bn.

Long-term IDR: affirmed at 'A+; Outlook Stable
Short-term IDR: affirmed at 'F1'
Senior unsecured rating: affirmed at 'A+'

SABIC Capital I B.V.:
Senior unsecured rating: affirmed at 'A+'

SABIC Capital II B.V.:
Senior unsecured rating: affirmed at 'A+'