Nov 08 -
-- Russian independent natural gas producer NOVATEK has announced its intention to buy a 49% equity stake in ZAO Nortgas for $1.375 billion.
-- We forecast that NOVATEK’s operating cash flow should remain strong in 2012 and 2013, reflecting increasing gas prices and high oil and condensate prices.
-- We are affirming our ‘BBB-’ and ‘ruAA+’ ratings on NOVATEK.
-- The stable outlook reflects our assessment that NOVATEK’s credit metrics will remain commensurate with the current rating, despite the acquisition and very little headroom relative to our ratio benchmarks.
On Nov. 8, 2012, Standard & Poor’s Ratings Services affirmed its ‘BBB-’ long-term corporate credit rating and ‘ruAA+’ Russia national scale rating on OAO NOVATEK, Russia’s largest independent natural gas producer. The outlook is stable.
The rating action reflects our assessment that NOVATEK’s credit metrics will stay within our parameters for the current rating after its $1.375 billion acquisition of a 49% stake in ZAO Nortgas. This is although at present there is very little headroom compared with our rating benchmarks.
We believe the acquisition will improve NOVATEK’s business through higher reserves and production. However, we continue to assess the business risk profile as satisfactory. We also regard the company’s continued diversification into already producing assets as positive. The financial risk profile remains intermediate.
The acquisition is expected to close in the last quarter of 2012. By year-end 2012, we estimate NOVATEK’s ratio of funds from operations (FFO) to debt (after our adjustments) to fall to about 55%, and adjusted debt to EBITDA to be about 1.5x, after the acquisition. We view this as a peak in the company’s leverage under the current rating and anticipate that the company will subsequently reduce debt on the back of robust cash flow generation.
We still forecast NOVATEK’s EBITDA in 2012 at about Russian ruble (RUB) 100 billion-RUB105 billion ($3.1 billion-$3.3 billion, assuming an exchange rate of $1 to RUB32), up from RUB90 billion in 2011, and FFO at about $2.5 billion, even after the acquisition.
We understand NOVATEK will use equity accounting for its interest in Nortgas. From our estimates, NOVATEK’s debt will likely increase to RUB135 billion-RUB140 billion ($4.2 billion-$4.4 billion) by year-end 2012, including the acquisition, and credit ratios could be somewhat weaker than our previous expectations. However, assuming higher production and gas prices, we foresee adjusted FFO to debt and adjusted debt to EBITDA improving to about 60% and 1.3x, respectively, in 2013. The upward trend in domestic gas prices supports our assessment.
On the negative side, we still view NOVATEK’s financial policies as borderline aggressive. This reflects the group’s large acquisitions in recent years, which have led to significant debt increases, and a likely substantial increase in capital spending in the coming years. Although a final decision is pending, we anticipate that NOVATEK and its partners will construct a liquefied natural gas (LNG) plant in the Yamal peninsula, estimated to cost at least $18 billion. Our base-case scenario therefore includes continually high capital spending, although we understand current capital expenditure commitments are relatively low.
Another constraint in our view is the group’s inherent exposure to country risk from operating in Russia. Currently, NOVATEK does not export gas, and domestic gas prices are relatively low, albeit likely to gradually increase. In our view, profitability and cash flow are nevertheless exposed to volatile oil and condensate prices, which are linked to international benchmarks and are not regulated. Sales of oil and condensate attract very low taxation rates compared with crude oil sales. Consequently, they provide a relatively large share of NOVATEK’s EBITDA (we estimate about 40%), enabling the company to benefit significantly from currently high international hydrocarbon prices. Other important country risk factors include uncertainty about future taxes and regulations, exposure to the volatile U.S. dollar-Russian ruble exchange rate, a relatively weak domestic banking system, and developments in the domestic gas market in which state-controlled OAO Gazprom remains the largest player.
We assess NOVATEK’s liquidity as “adequate” under our criteria. We understand the company will use a bridge loan to help finance the acquisition of Nortgas. In addition, NOVATEK has recently issued a RUB20 billion bond, the proceeds of which we understand will partly finance the acquisition.
We think that the group’s debt maturities should be manageable. Nevertheless, we note relatively sizable debt totalling about RUB27 billion and due by December 2013.
Our assessment of NOVATEK’s liquidity profile incorporates our estimates of the following liquidity sources over the next 12 months:
-- About $4.0 billion-$4.5 billion in cash, including about $300 million that we assume is tied to the operations;
-- FFO of about $2.5 million;
-- A long-term committed credit facility from Russia-based Sberbank due in December 2014, of which RUB30 billion is currently undrawn, according to management; and
-- Acquisition financing of about RUB42 billion, toward which the company has already placed a bond of RUB20 billion and will shortly finalize a RUB30 billion bridge loan.
We estimate liquidity uses over the period at about $4.6 billion, including the $1.375 acquisition, capital spending, short-term debt, and dividends.
As of June 30, 2012, the group had an ample EBITDA cushion against a consolidated leverage ratio covenant, reflecting an EBITDA-to-debt ratio of 3x, and EBITDA interest coverage of more than 4x.
The stable outlook reflects our view that NOVATEK will continue to benefit from increasing production, as well as gradually rising domestic gas prices. We anticipate that this should enable the group to generate FFO of about $2.5 billion-$2.8 billion in 2012 and 2013, by our estimates, and to bring credit ratios in line with the rating in 2013. We expect the group will continue to manage its liquidity.
We could take negative rating actions if the debt-to-EBITDA stayed higher than 1.5x and FFO to debt exceeded 60% at year-end 2013. The rating could also come under pressure if management in the short term does not secure financing for the acquisition. Also, given no headroom after the acquisition, further acquisitions would put additional pressure on the rating. Negative rating actions could also follow adverse regulatory changes, operational risk related to Gazprom, an escalation of costs or capital expenditure, or increased mineral taxes.
If NOVATEK decides to develop the LNG project in the Yamal peninsula, we anticipate that it will pass on a large share of the development costs to two international partners, in line with its guidance. To date, only one partner, Total S.A. (AA-/Stable/A-1+) has been announced. Ratings upside is unlikely because of the group’s exposure to country risk.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
-- Key Credit Factors: Global Criteria For Rating The Oil And Gas Exploration And Production Industry, Jan. 20, 2012
-- Revised Methodology For Oil And Natural Gas Price Assumptions, Nov. 16, 2011
-- Assumptions: Revised Oil Price Assumptions For 2011, 2012, and 2013, July 22, 2011
Corporate Credit Rating BBB-/Stable/--
Russia National Scale ruAA+/--/--
Senior Unsecured BBB-
Senior Unsecured ruAA+
Novatek Finance Ltd.
Senior Unsecured* BBB-
*Guaranteed by OAO NOVATEK.