India's largest oil refiners, Reliance Industries Ltd and Indian Oil Corporation ended the year badly as Standard & Poor's Ratings Services (S&P) downgrades both the companies.
The rating agency has revised its rating outlook on India's Reliance Industries Ltd to negative from stable. At the same time it affirmed its 'BBB' long-term corporate credit rating on Reliance Industries, while lowering its corporate credit rating on India's largest petroleum company Indian Oil Corp. Ltd. (IOC) to 'BB+' from 'BBB-' with a stable outlook.
The outlook revision on Reliance Industries, India's largest private sector company, reflects the company's increased debt and pressure on profitability.
The downturn in commodities and oil refining, stemming from the global economic slowdown, has affected profitability, which S&P expects would weaken the company's cash flow measures, including adjusted debt to EBITDA rising above 2.5x in the near term, but higher than its earlier expectations of about 2.0x.
"However, we do expect the ratio to improve somewhat in the medium term," it aded.
It also said that Reliance Industries' cash flow measures were expected to improve after its Jamnagar refinery becomes fully operational and "we expect its production to be ramped up to almost full capacity in fiscal 2010." The refinery came onstream in December 2008.
The company's liquidity is strong with cash of about $5.3 billion as at 30 November 2008, enough to cover about $3 billion debt due in one year. S&P said the company is likely to use about $1.5 billion for working capital requirements with the new Jamnagar refinery.
"Profitability, however, is expected to be adversely affected by lower fuel demand, especially in developed markets," said the rating agency analyst Mehul Sukkawala. This is evident from the company's gross refining margins softening to $13 per barrel in the quarter ended 30 September 2008, from $15 per barrel in the fiscal year ended March 2008. We project refining margins to decline further to $9-$10 per barrel in the near term.
The rating is likely to be lowered if the company is severely hit by the sharp downturn in the commodity cycle or if it continues to maintain high debt levels, resulting in weaker credit protection measures with debt to EBITDA of more than 2.2x on a sustained basis. The outlook could be revised back to stable on evidence of improved leverage and resilience in the face of the current commodity and refining cycle downturn.
Indian Oil Corporation
S&P's rating action on public sector Indian Oil reflects the deterioration in the company's financial profile and liquidity position and delays in adequate support from the government of India (BBB-/Stable/A-3).
"The lack of an institutionalised mechanism to provide timely compensation for the under-recoveries of cost of crude oil is not in line with our expectations for equating the rating to the government of India," it added.
Being the dominant refiner and distributor of automotive fuels and supplier of cooking fuel, IOC has an important socio-economic role, S&P noted. The strong influence of government policy on IOC's operating strategy and financial policy--through the government's control of retail prices of automotive and cooking fuels and a subsidy-sharing arrangement--results in the government's moral obligation to provide support.
"The Indian government directly owns more than 80 per cent in IOC and appoints all 16 of its board members. However, the lack of timeliness in subsidy and liquidity arrangement is a negative as it has resulted in high volatility in IOC's financial and liquidity profile," said Sukkawala.
The company's funds from operations (FFO) for the fiscal year ended March 2008 was small after adjusting for the oil bonds sold during the year, resulting in FFO to total debt of only 4 per cent. In addition, the company went through a liquidity crunch in the six months to September 2008, when it had limited cash and was rapidly approaching the single-borrower limits with primarily government-owned banks.
IOC's liquidity crunch was primarily "due to the time lag in the issuance of oil bonds by the Indian government," the agency said.
To provide IOC and other oil companies temporarily with much-needed liquidity, the government relaxed single-borrower limits for Indian banks. This has led to a significant reliance on short-term debt which, for IOC, amounted to Rs46,700 crore out of total debt of about Rs60,000 crore as of 30 September 2008.
"The stable outlook on the rating incorporates expected near-term improvement in IOC's financial metrics and the government's ultimate support," Mr. Sukkawala said.