NEW YORK–(BUSINESS WIRE)–Fitch Ratings has assigned foreign and local currency Issuer Default Ratings (IDRs) of ‘CCC’ and ‘B-‘, respectively, to Medanito S.A. (Medanito). The Rating Outlook for the company’s local currency IDR is Negative.
Fitch has simultaneously assigned an expected rating of ‘CCC+/RR3’ to Medanito’s proposed international senior unsecured bond issuance of up to USD150 million in Reg S notes with a five-year bullet maturity (2020 maturity). Proceeds from the transaction would be used to refinance existing debt and for general corporate purposes.
The ‘RR3’ Recovery Rating assigned to the notes reflects the expectation of a recovery in the range of 50%-70% in the event of default due to Fitch’s belief that a default by Medanito would most likely be driven by transfer and convertibility restrictions imposed upon the payment of foreign debt, not a material deterioration of the company’s business or financial profile.
KEY RATING DRIVERS
Medanito’s ratings are constrained by the ‘CCC’ country ceiling of the Republic of Argentina (Fitch local and foreign currency IDRs of ‘RD’). The company’s ratings are also restricted by the high regulatory risks associated with operating in the energy sector in Argentina, and the long-term need to pursue a robust capital expenditure plan to develop the company’s hydrocarbon reserves and increase production. The company faces a volatile domestic business environment and inflationary pressures on its cost structures.
Country ceilings are designed to reflect the risks associated with sovereigns placing restrictions upon private sector corporates, which may prevent them from converting local currency (LC) to any foreign currency (FC) under a stress scenario, and/or may not allow the transfer of FC abroad to service FC debt obligations. Key concerns of corporates domiciled in Argentina include high inflation, government meddling, economic uncertainty, and limited access to debt markets especially after the country’s recent default.
Regulatory Risk Remains High: Medanito’s ratings reflect high regulatory risk given strong government influence in the Energy sector, though the Nov. 22, 2015 election of a conceivably more market friendly administration could allay this risk. Medanito operates in a highly strategic sector where the government both has a role as the price regulator and also controls subsidies for industry players. In response to the economic crisis of 2001 and 2002, the Argentine government, pursuant to the Public Emergency Law (Law No. 25,561), established export taxes on certain hydrocarbon products. In subsequent years, in order to satisfy growing domestic demand and ease inflationary pressures, this policy was supplemented by constraints on domestic prices, temporary export restrictions, and subsidies on imports of natural gas and diesel fuel. As a result, until 2008, local prices for oil and natural gas products had remained significantly below those prevailing in neighboring countries and international commodity exchanges.
Hydrocarbon price increases have been seen in recent years in the Argentine domestic market, as the government has attempted to incentivize exploration and production (E&P) producers to increase production. Following the sell-off in global oil prices, this has led to a positive dynamic in the Argentine domestic market as it has allowed oil prices to remain at levels above global oil prices. Long-term prices are more difficult to project given the Argentine government’s volatile history. The only market segment where Medanito has been negatively impacted by the decline in global hydrocarbon prices is in its midstream services segment, as the company sells petroleum products in the export markets.
Higher Argentine Oil Prices: Positively, despite the global decline in oil prices seen during the last year, the price of light oil in the domestic Argentine market has declined by only 11% in 2015 (to USD77/bbl from USD84/bbl). Fitch is projecting that for 2015, the company’s implied price per barrel of crude oil sold will be USD75/bbl, which is approximately 50% higher than the average price of West Texas Intermediate (WTI) in the United States. In terms of gas prices, Medanito’s average realized price for gas sold increased to USD3.69/MMBTU in 2014 from USD3.18/MMBTU in 2012 (a 16% increase), mainly driven by its contract with the Chevron Corporation that has an annual price escalator component.
Diversified Business Model: Founded in 1993, Medanito benefits from its diversified business portfolio. The company was originally founded as a midstream oil and gas company, which then expanded into the upstream hydrocarbon E&P business. Medanito is currently the 13th largest oil producer in the country in terms of production. Besides E&P, the company’s business portfolio includes the following complementary business lines: 1) midstream; 2) power generation; and 3) oil & gas engineering services. In 2014, 53% of the company’s revenue base was composed of Upstream sales, with Midstream making up 29%, Generation 7%, and Engineering Services and Other Revenues 11%.
Chanares Improves Reserve Life: Via the acquisition of Chanares S.A. (CHASA), Medanito gained a presence in a new basin (the Cuyana basin in the province of Mendoza) and increased its reserve life from five years to 11 years (1P reserves). In July 2014, Medanito closed the transaction whereby it acquired 52% of CHASA for approximately USD59 million, with the remaining 48% purchased by Medanito’s shareholder, Exmed S.A. Subsequently, Medanito acquired an incremental 3% in Chanares, giving it a 55% ownership stake.
As of year-end 2014, Medanito’s consolidated net 1P reserves totalled 26.1 million BOE (83% oil). If the company manages to extend concessions that are expiring in the near- to medium-term, the company’s 1P reserves will total 34.3 million BOE. This corresponds to a reserve life of 11 years. Excluding CHASA, Medanito’s 1P reserves total 9.4 million BOE corresponding to a reserve life of five years.
The CHASA acquisition not only strengthened Medanito’s reserve profile, but it provides some upside potential from its exploration opportunities. CHASA’s concessions are not set to expire until 2027, and Medanito sees significant potential to increase production levels via aggressive well work and a new drilling campaign (four exploratory prospects with low-to-medium geological risk). Positive results can already be seen as average consolidated crude oil production for Medanito as of September 2015 was 3,470 bbld versus 2,664 bbld for 2014 (a 30% increase). Total Oil and Gas production of 6,171 barrels of oil equivalent per day (boed) increased by 15% versus 2014 average production of 5,387 boed.
Slightly Decreased But Stabilizing Financial Results: At YE December 2014, the company’s overall revenues of USD188 million were 4% higher than full-year 2013 revenues of USD181 million. Reported EBITDA of USD40 million declined by 30% versus 2013 results, as margins declined to 21% from 31%. Financial results in 2014 were negatively impacted by two large non-cash effects. Adjusting for both these non-cash charges, adjusted EBITDA in 2014 would have been approximately USD54 million yielding a 29% margin, which is slightly down versus 2013 EBITDA of USD56 million. Fitch uses average USD/Peso exchange rates to convert Medanito’s financial results into US dollar equivalent figures.
Revenue generation has improved on a reported basis since mid-2014, given the closing of the CHASA acquisition in July 2014. Revenues for the last 12 months (LTM) September 2015 period of USD199 million have increased by 6% versus full year 2014, while EBITDA was slightly improved at USD56 million versus normalized 2014 EBITDA of USD56 million. This can be explained by the upstream segment, in which the netback per BOE at CHASA is significantly lower versus Medanito’s legacy netbacks. For example, on a stand-alone basis Medanito’s netback per barrel was USD30.5 in the nine-month period ending September 2015. In the same period, CHASA registered a netback of USD8/BOE, which has helped to drag down EBITDA generation even though revenues have increased post-acquisition. Now that Medanito is integrating CHASA into its operations, the company expects to increase the netback in CHASA’s operations to more fully benefit from the transaction.
Long-term Leverage Targeted at 2x: On a normalized EBITDA basis, the company’s leverage ratio (defined as total debt:EBITDA) is approximately 2.9x as of September 2015, which is significantly higher than historical leverage levels though an improvement versus 2014. Historically, Medanito has had a very conservative capital structure with total debt:EBITDA of 1.5x-2.0x before 2014. Management is still targeting long-term leverage of 2.0x total debt:EBITDA, with incremental leverage above 2.5x requiring unanimous board approval. The CHASA acquisition, which increased leverage to 3.1x on an adjusted basis (4.2x on a reported basis), was seen by Medanito’s management as a significant opportunity to increase the company’s reserve life and ramp up production despite the fact leverage has risen to levels the company is not comfortable with for the long term. Fitch is projecting leverage will decline to under 2x starting with 2017.
RATING SENSITIVITIES
Negative: Future developments that could, individually or collectively, lead to negative rating actions in the short term:
–Further economic deterioration and the Republic of Argentina’s inability to convert and transfer foreign exchange for Medanito;
–Short-term liquidity concerns if the company is unable to refinance its 2015-2016 maturities;
–A significant deterioration of credit metrics;
–Sustained declines in hydrocarbon reserves / production or failure to further develop new fields, would be another potential negative factor.
Positive: A positive rating action in the short term is considered unlikely given Argentina’s current sovereign restricted default rating and the fact the company’s ratings are constrained by the sovereign’s credit quality. An upgrade of the sovereign rating could be a positive rating trigger.
LIQUIDITY AND DEBT STRUCTURE
Negative FCF and Stretched Liquidity: Given the company’s sizeable investment requirements, the company has not generated positive free cash flow in the last five years. Capex in 2014 totalled a record USD209 million, mainly accounting for the acquisition of CHASA. For this reason FCF in 2014 was -USD130 million versus (USD62 million) in 2013. Fitch projects the company will continue registering negative FCF during 2015-2016 as it works to integrate CHASA and ramp-up production and increase the acquired E&P assets’ netback per barrel. Assuming it is able to do both, Fitch projects positive FCF generation starting in 2017.
In the short- to-medium term, given expectations for continued negative FCF and expectations for ramped-up capex to increase production, the company’s liquidity position is stretched. Medanito currently has USD12 million of cash on hand, while it has USD71 million in short-term debt. To alleviate this situation, the company is looking to issue the international Reg S bond in the amount of USD150 million with a five-year bullet maturity. The purpose of this issuance would be to refinance approximately USD130 million in debt with the balance used for other corporate purposes. Post-issuance, the company’s liquidity position would be strengthened as a more manageable USD21 million in debt amortizations would come due in 2015-2016.
KEY ASSUMPTIONS
–Double-digit currency depreciation per year;
–Oil & gas production ramping up from 5,400 BOED to nearly 7,000 BOED in next five years;
–Oil prices straight-lining over next five years to Fitch Price Deck assumption of long-term price of USD70/BBL;
–Overall, EBITDA growing to the USD100 million in next five years;
–Contingent on international issuance, leverage levels peaking in 2015 and declining to 1.5-2.0x in the long term.
FULL LIST OF RATING ACTIONS
Fitch has assigned the following ratings to Medanito S.A.:
–Foreign currency IDR ‘CCC’;
–Local currency IDR ‘B-‘, Outlook Negative;
–International senior unsecured debt rating ‘CCC+/RR3’.
Additional information is available on www.fitchratings.com.
Applicable Criteria
Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=995845
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=995845
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY’S PUBLIC WEBSITE ‘WWW.FITCHRATINGS.COM’. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH’S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE ‘CODE OF CONDUCT’ SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.