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TEXT-S&P: Polish oil & gas co PGNiG cut to ‘BBB’ and on watchneg

Published: September 5, 2012 | 8:12 am
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(The following statement was released by the rating agency)

Overview
– We believe Polish national gas supplier PGNiG SA’s 2012 results will be significantly below our previous expectations.
– This is because Poland’s regulatory framework appears to prevent PGNiG passing on the rising cost of imported natural gas to end-consumers on a full and timely basis, thereby threatening the company’s profitability, cash flow, and liquidity.
– We are lowering our rating on PGNiG to ‘BBB’ from ‘BBB+’ and placing it on CreditWatch with negative implications.

Rating Action

On Sept. 5, 2012, Standard & Poor’s Ratings Services lowered its long-term corporate credit rating on Polish integrated gas company PGNiG SA to ‘BBB’ from ‘BBB+’. We also placed the rating on CreditWatch with negative implications.

Rationale

The downgrade and CreditWatch negative placement reflect PGNiG’s widening losses on oil-indexed and U.S. dollar-based imported natural gas. PGNiG sells this gas on the domestic market under regulated prices below the imported cost. The mounting losses incurred for the regulated domestic gas supply business are therefore significantly weakening PGNiG’s overall profitability and cash generation. Should domestic gas tariffs not be allowed to increase materially, PGNiG will, in our view, likely post an operating loss for 2012. The Polish regulatory tariff framework’s apparent lack of timely and full pass-through of the cost of imported gas weakens our view of the relative supportiveness of the system. This negatively affects the group’s business risk profile, in our view.

We believe that PGNiG will continue to incur losses toward the end of the year, based on a forecast of EBITDA of below Polish zloty (PLN) 2 billion (EUR480 million) for 2012. Additionally, PGNiG’s recent investments in its upstream operations and the acquisition of Vattenfall Heat Poland have significantly increased the group’s financial indebtedness to PLN9 billion as of June 30, 2012. On a Standard & Poor’s adjusted basis, which increases the debt by adding PLN1.3 billion of pension and asset retirement obligations to the financial liabilities and does not net off the PLN1.4 billion of cash held on balance sheet, PGNiG’s funds from operations (FFO)-to-debt ratio on June 30, 2012, was about 19%, down from about 49% as of Dec. 31, 2011. Debt to EBITDA was 4.3x, down from 1.9x. We forecast that these credit metrics will further deteriorate. Permanently weaker credit metrics would likely lead us to lower our assessment of PGNiG’s financial risk profile.

Should trading losses continue at the current rate, or potentially further widen, PGNiG would be less able to refinance itself at reasonable cost in the long term, in our view. Eventually, this could weaken PGNiG’s liquidity. This is especially in relation to its main liquidity facility, its domestic-guaranteed note program, which to our knowledge restricts the use of the facility with financial covenants. At this stage, we still consider PGNiG’s liquidity as “adequate”.

The ratings further reflect our methodology for rating government-related entities and our opinion that there is a “moderately high” likelihood that the Republic of Poland (foreign currency A-/Stable/A-2, local currency A/Stable/A-1) would provide timely and sufficient extraordinary support in the event of financial distress. This is based on PGNiG’s “strong” link and an “important” role to the government. As a result, the ratings currently benefit from a one-notch uplift from the stand-alone credit profile (SACP), which we now assess as ‘bbb-’.

Liquidity

We consider PGNiG’s overall liquidity as “adequate,” as defined in our criteria. This incorporates our assumption that the reported current financial liabilities related to PGNiG’s domestic guaranteed bond program, whereby six domestic banks guarantee to underwrite the group’s short-term debt issuance, will be rolled over. We further assume that PGNiG will successfully reset the program’s leverage covenant in order to remain in covenant compliance at the end of fiscal 2012. We also factor in the potential for extraordinary liquidity support from the main shareholder, the Republic of Poland, should it become necessary.

PGNiG’s liquidity sources for the next 12 months consist of:

– Access to unrestricted short-term cash and marketable securities of about PLN1 billion as of June 30, 2012, according to the group;

– A guaranteed domestic bond program of PLN7 billion maturing in June 2015, PLN4.8 billion of which was not yet issued as of June 30, 2012, according to the group. Availability under this facility is subject to financial covenants, which we understand are tested biannually in April and October. We understand from the company that PGNiG is currently in compliance with the covenants and expects to remain in compliance in the forthcoming test based on June 30, 2012, financial reporting. We further understand that the group has started the process for resetting the covenants with the banks, and that a potential covenant breach would not entitle the lenders to accelerate the loans under the current agreement;

– A guaranteed bond program of PGNiG Termika SA, which currently has PLN1 billion of availability. We understand from the company that the availability under this program is limited to PGNiG Termika and has no link to financial indebtedness at the consolidated group level; and

– Our estimate of operating cash flow for the next 12 months ranging from PLN1.5 billion to PLN2.5 billion.

This compares with our assumptions for PGNiG’s liquidity uses for the next 12 months, which include:

– Investments of about PLN4.5 billion; and

– No dividend payment, as proposed by the group’s management board. Furthermore, all short-term maturities under the guaranteed domestic bond program are rolled over.

CreditWatch

We aim to resolve the CreditWatch negative placement on PGNiG within the next three months after meeting with management and gathering further information. We will discuss with management its expectations on the development of domestic gas tariffs and the state of negotiations on its long-term gas contracts. We will also discuss PGNiG’s capital expenditure and investment planning, its overall profitability and cash generation, and how the management intends to secure liquidity of the group. We will further review our opinion on the likelihood of extraordinary support in the case of financial distress by the Republic of Poland.

A further negative rating action could result due to the negative impact on the business risk profile of the group caused by the adverse effects of the domestic gas regulation. Further rating pressure could also materialize due to the negative impact on the group’s financial risk profile caused by weakened key credit metrics. However, we could affirm the ratings if we believed that the group’s business risk profile had not weakened more than to the extent expressed by the current business risk profile at the lower end of “satisfactory”, and if we saw a clear path toward stronger credit metrics from the present level.

We currently believe that any downgrade would be limited to one further notch. However, this is subject to our review of the group’s liquidity situation and the perceived likelihood of extraordinary support from the Republic Poland in the event of financial distress.

Related Criteria And Research

– Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011

– Principles Of Credit Ratings, Feb. 16, 2011

– Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010

– Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010

– Use Of CreditWatch And Outlooks, Sept. 14, 2009

– Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009

– Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008

– 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008

– 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List

Downgraded; CreditWatch/Outlook Action

To From

Polish Oil & Gas Company SA (PGNiG)

Corporate Credit Rating BBB/Watch Neg/– BBB+/Stable/–

PGNiG Finance AB

Senior Unsecured* BBB/Watch Neg BBB+

*Guaranteed by Polish Oil & Gas Company SA

Reuters

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