Training on sovereign risk credit analysis, October 24

ACRA affirms AAA(RU) to Gazprom Neft PJSC, outlook Stable, and AAA(RU) to bond issues

The credit rating of Gazprom Neft PJSC (hereinafter, the Company, Group, or Gazprom Neft) is based on the Company’s very strong connections with the supporting institution (SI), strong business profile, high level of corporate governance, very large scope of business, high profitability, low leverage, high coverage, and very high liquidity. The standalone creditworthiness assessment of the Company is affected by a weak cash flow amid substantial capital expenditures and dividends.

Gazprom Neft is the third Russian largest vertically integrated oil company (VIOC) in terms of production output, with a diversified structure of refinery and distribution operations. In 2018, the Company produced 92.9 mln tons of crude oil equivalent (up 3.5% compared to 2017) and refined 42.9 mln tons of crude oil (up 7% compared to 2017).

Key rating assessment factors

Very strong connections with the supporting institution. Gazprom Neft is marked by very strong connections with its major shareholder Gazprom PJSC (ACRA rating: AAA(RU), outlook Stable): Gazprom Neft is both directly affiliated with the SI (shareholding control and cross-default provisions under Gazprom’s obligations) and strategically important for Gazprom as it develops Gazprom’s deposits with high liquid hydrocarbons content. In addition, Gazprom has previously transferred ownership of deposits to Gazprom Neft on comfortable terms.

The strong business profile is based on low production costs and costs to replenish hydrocarbon resources, the high level of hydrocarbon reserves and large scope and depth of refining operations, as well as very strong market accessibility and diversification of upstream operations. The Company controls refining assets in the most attractive locations in the country; its chain of fuel filling stations is the third largest in Russia. The Company has an active presence in international markets.

The high assessment of corporate governance takes into account the high assessment of the Company’s governance strategy and risk management system, adequate assessment of governance structure and structure of the group, and very high financial transparency level. The Company’s strategy implementation produces solid growth of both physical production indicators and financial results. Going forward, the Company has no plans for aggressive growth and focuses on increasing output from existing assets and the quality of its refining capacity. The Company’s financial transparency level is in line with international best practices in terms of financial and operating indicator disclosure. The Company’s structure is complicated due to historical specifics in its development: some assets were acquired in the form of joint ventures, and some were transferred from the parent company (common practice in the industry).

Low leverage and high coverage. Despite substantial funding needs in the next three years, growing CFFO boosted by higher market prices and production volumes will result in a decrease in the adjusted debt to FFO before net interest payments from 1.6х in 2018 to 1.2х by 2021. ACRA notes the high quality of the Company’s liabilities as, in the next three years, the Company is to repay as low as 22% of its current debt portfolio. The debt coverage is high compared to other VIOCs and it is expected to grow up to 12.7x. The Agency assesses the liquidity level as very high because of the substantial amount of undrawn credit lines. The Agency also notes the Company’s ample capabilities to attract debt financing and shareholder capital both in the Russian and international markets, irrespective of the possible prolongation of the sanctions imposed against the Company.

High returns amid very large scope of business. The FFO margin before interest and tax is estimated at 26.6%, which is high for the industry. This is explained by tax reliefs established for new deposits, conveniently located high-quality oil refineries, and an effective retail sales model focused on cross-selling. In terms of its scope, the Company is a very large VIOC in the Russian Federation.

Weak cash flow is caused by substantial capital expenses and a conservative dividend policy, as dividend payments are expected to reach 30-35% of net profits in 2019-2021.

Key assumptions

  • Crude oil prices remaining within 58-63 USD/bbl by 2021 with the annual average USD/RUB exchange rate of 61.3-62.3;
  • Growth in hydrocarbon production output up to 100 million tons of crude oil equivalent by 2020 with the structure of downstream operations remaining stable in the core markets;
  • Increase in Company costs at a rate no higher than 5% in 2019-2021;
  • Dividend payments at 34-35% of net profits.

Potential outlook or rating change factors

The Stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18-month horizon.

A negative rating action may be prompted by:

  • Termination of Gazprom’s contingent commitments with respect to the obligations of Gazprom Neft PJSC;
  • Decrease in legal affiliation with the SI;
  • Decline in strategic importance of Gazprom Neft PJSC for Gazprom;
  • Lower credit rating of Gazprom.

Rating components

Standalone creditworthiness assessment (SCA): aa-.

Support: on par with PJSC Gazprom.

Issue ratings

Gazprom Neft PJSC (ISIN RU000A0JXYL4), maturity date: July 30, 2024, issue volume: RUB 15 bln — ААA(RU).

Gazprom Neft PJSC (ISIN RU000A0ZYDS7), maturity date: October 17, 2022, issue volume: RUB 25 bln — ААA(RU).

Gazprom Neft PJSC (ISIN RU000A0ZYLC4), maturity date: December 12, 2024, issue volume: RUB 10 bln — ААA(RU).

Gazprom Neft PJSC (ISIN RU000A0ZYLQ4), maturity date: December 16, 2024, issue volume: RUB 5 bln — ААA(RU).

Gazprom Neft PJSC (ISIN RU000A0ZYXV9), maturity date: March 7, 2024, issue volume: RUB 25 bln — ААA(RU).

Credit rating rationale. The bond issues represent senior unsecured debt of Gazprom Neft PJSC. Due to the absence of either structural or contractual subordination of the issue, ACRA ranks the bonds pari passu with other existing and future unsecured and unsubordinated debt obligations of the Company. In accordance with ACRA’s methodology, taking into account the high creditworthiness and low leverage of the Company as well as the absence of a substantial secured debt, the issues are rated AAA(RU), i.e. on par with Gazprom Neft PJSC — AАА(RU).

Regulatory disclosure

The credit ratings were assigned to Gazprom Neft PJSC and bonds (RU000A0JXYL4, RU000A0ZYDS7, RU000A0ZYLC4, RU000A0ZYLQ4, RU000A0ZYXV9) issued by Gazprom Neft PJSC under the national scale for the Russian Federation based on the Methodology for Credit Ratings Assignment to Non-Financial Corporations under the National Scale for the Russian Federation, Methodology for Analyzing Member Company Relationships within Corporate Groups, Methodology for Analyzing Relationships Between Rated Entities and the State, and the Key Concepts Used by the Analytical Credit Rating Agency Within the Scope of Its Rating Activities. In the course of assigning a credit rating to the above bond issues, the Methodology for Assigning Credit Ratings to Individual Issues of Financial Instruments under the National Scale of the Russian Federation was also applied.

The credit ratings assigned to Gazprom Neft PJSC and bonds (RU000A0JXYL4, RU000A0ZYDS7, RU000A0ZYLC4, RU000A0ZYLQ4, RU000A0ZYXV9) issued by Gazprom Neft PJSC were first published by ACRA on July 13, 2017, August 8, 2017, October 23, 2017, December 21, 2017, December 25, 2017, and March 15, 2018, respectively. The credit rating of Gazprom Neft PJSC and its outlook and the credit ratings assigned to bonds (ISIN RU000A0JXYL4, RU000A0ZYDS7, RU000A0ZYLC4, RU000A0ZYLQ4, RU000A0ZYXV9) issued by Gazprom Neft PJSC are expected to be revised within one year following the publication date of this press release.

The credit ratings were assigned based on the data provided by Gazprom Neft PJSC, information from publicly available sources, as well as ACRA’s own databases. The credit ratings are solicited, and Gazprom Neft PJSC participated in their assignment.

No material discrepancies between the provided data and the data officially disclosed by Gazprom Neft PJSC in its financial statements have been discovered.

ACRA provided additional services to Gazprom Neft PJSC. No conflicts of interest were discovered in the course of credit rating assignment.

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