Medco Ratch Power Riau in Tenayan, Pekanbaru Riau - Photo by MPI

JAKARTA (TheInsiderStories) – Moody’s Investors Service has assigned a B1 rating to the proposed USD-denominated backed senior unsecured notes to be issued by Medco Bell Pte. Ltd., a wholly-owned subsidiary of PT Medco Energi Internasional Tbk (Medco, B1 stable). The proposed notes will be irrevocably and unconditionally guaranteed by Medco and some of its subsidiaries.

The bond proceeds will be initially kept in an escrow account and will ultimately be used to repay Medco‘s upcoming Rupiah bond maturing in 2021 and exercise a call or early tender of Medco’s 2022 USD Bond. The outlook is stable.

“Medco’s B1 rating reflects its improved scale and the geographic diversification of its reserves and production, following the acquisition of Ophir,” says Vikas Halan, a Moody’s Senior Vice President on Monday (01/13).

Pro forma for Ophir acquisition, Medco expects to produce 110 thousand barrels of oil equivalent (boe) per day in 2019, up from 87 thousand boe per day in 2017. Also, Medco’s proved reserves has increased to 249.3 million boe at 30 September 2019 from 233.5 million boe at 31 December 2017.

Further, there has been an improvement in Medco’s cash flow visibility with revenue from fixed price gas contracts accounting for 29 percent of total revenue for 2019 compared with 24 percent in 2017.

“Medco’s credit metrics and liquidity are also supportive of its B1 rating. We expect the company’s debt/EBITDA to improve to below 4.0x in 2019 from 4.4x in 2018. This is despite the increase in its debt to fund the acquisition of Ophir Energy in 2019,” says Halan, who is also Moody’s Lead Analyst for Medco.

Moody’s expects Medco‘s adjusted net debt/EBITDA (net of cash in escrow earmarked for debt repayment) will improve to around 3.2x-3.5x over the next two years, from around 3.9x for LTM September 2019 and 4.4x in 2018. Over the same period, its EBITDA/interest cover will be around 3.5x-3.7x and RCF/adjusted net debt will be about 11-12 percent.

At the same time, the B1 rating remains constrained by Medco’s exposure to the cyclicality of commodity prices, its acquisitive growth appetite, and the execution risk associated with its annual investment plan of around $300 million.

In addition, Medco’s rating benefits from its proactive liquidity management with the company refinancing its upcoming debt maturities well in advance, increasing the average weighted debt maturity profile of its debt. Pro forma for the proposed bonds issuance, 72 percent of Medco’s debt will come due beyond 2024.

In terms of environmental, social and governance (ESG) factors, the ratings also consider the following:

For environmental factors, Medco’s rating incorporates the environmental risk that the company is exposed to through its oil & gas, power, and mining businesses. However, the risk is somewhat mitigated by its high proportion of natural gas business that accounts for about 50 percent of its revenue, and by its long-term fixed-price gas contracts that generate sufficient EBITDA to cover its interest expenses.

Further, the environmental risk for its power business is largely mitigated by the company’s fuel mix which is heavily weighted towards renewable sources like geothermal and hydro. Medco has only a minority interest in its copper mining business, which is an open-pit mine and is well-positioned to benefit from higher EV penetration.

With regard to social factors, Medco’s business mix includes sectors that are exposed to moderate to high social risks, especially responsible production and health & safety issues. However, the risk is mitigated by the company’s long track record of operating its businesses without any major incidents.

As for governance factors, the rating incorporates Medco’s strong appetite for growth as shown by its history of debt-funded acquisitions, and its concentrated ownership structure which could lead to the increased potential for conflicts of interest. Nonetheless, these risks are partially mitigated by (1) Medco’s public commitment to deleveraging and target net debt/EBITDA of 3.0x; and (2) it’s listing on the Indonesian stock exchange, which requires the company to comply with listing rules.

Medco’s liquidity profile is strong with cash and cash equivalents of $262 million, short term investments of $26 million and cash earmarked for debt repayment in an escrow account of $170 million as of 30 September 2019. Against this, $329 million of debt is maturing over the next 12 months. However, despite Medco’s strong EBITDA growth, its free cash flow generation remains constrained by its high taxes, interest expense, and capital spending.

The stable outlook on Medco’s rating incorporates Moody’s expectation that Medco’s credit metrics will continue to remain supportive of its rating, supported by stable cash flow generation from its existing portfolio and planned sale of non-core assets.

An upgrade of Medco’s CFR will require an increase in the company’s scale and a further improvement in its credit metrics. Credit metrics supportive of a higher rating include adjusted net debt/EBITDA falling below 3.0x, RCF/adjusted net debt rising above 20 percent and EBITDA/interest expense increasing above 4.5x.

In addition, an upgrade would also require the company to maintain strong liquidity with cash and cash equivalents covering at least the amount of debt maturing over the next 12 months.

Downward pressure on the rating could build if Medco fails to renew a significant portion of its fixed-price gas sales contracts that expire over the next two years, makes large debt-funded acquisition, provides funding support to its mining or power businesses and fails to maintain sufficient liquidity to cover its debt maturing over the next 12 months.

Specific credit metrics indicative of downward pressure include adjusted net debt/EBITDA rising above 4.0x, RCF/adjusted net debt falling below 10 percent and EBITDA/Interest expense falling below 3.5x.

Written by Lexy Nantu, Email: lexy@theinsiderstories.com