MOL’s “significant” financial risk profile reflects the sensitivity of credit ratios to volatile and cyclical operating cash flows, as well as to the above-mentioned country-related risks. It also factors in material capital-expenditure needs to develop oil and gas resources, although we understand that management seeks to balance investments with operating cash flows. Relative strengths are “adequate” liquidity and significant positive free operating cash flow (FOCF) when taking into account maintenance capital spending. Moreover, improving financial ratios in the past quarters have increased financial headroom.
Although we view MOL as a Hungarian government-related entity, we accord no uplift for this factor, given the sovereign rating level, according to our criteria. We assess MOL’s role to the Hungarian government as “important” and its link as “limited”. We factor in, among other things, the significant amount of cash—nearly EUR1.9 billion—that the government spent in 2011 to buy out Russian Surgutneftegas’ 21.2% stake in MOL. We believe the government is unlikely to dispose of the stake; it recently even raised it to 24.6%.
S&P base-case operating scenario
We assume MOL’s EBITDA will reach Hungarian forint (HUF) 500 billion-HUF530 billion ($2.2 billion-$2.4 billion) in 2012. This reflects our assumption of favorable oil prices, with Brent at $100/barrel (bbl) for the remainder of 2012 ($90/bbl for 2013), compared with an actual price average of $113.6/bbl in the first half of 2012. We assume lower hydrocarbon production than in 2011 from the loss of Syrian production of about 20,000 barrels of oil equivalent per day, or 14% of output in 2011. We note the favorable performance from the refining segment in the second quarter of 2012, driven by high gasoline crack spreads (the profit margin that an oil refinery can expect to make by “cracking” crude oil) and an improving Brent-Ural spread. But we assume more difficult industry conditions for the last part of 2012, given excess capacity, the challenging economic conditions, and falling regional demand.
In the first half of 2012, MOL’s reported EBITDA on a clean-cost-of-supply basis stood at HUF279 billion ($1.2 billion).
Strategically, after continued negative FOCF in the refining segment in 2011, we expect MOL to pursue its focus on improving efficiency and upgrading the refineries of its 49%-owned, fully consolidated Croatian subsidiary INA (not rated), notably the Rijeka refinery. The restructuring will likely require significant cash outlays and time, however.
S&P base-case cash flow and capital-structure scenario
We foresee MOL’S funds from operation at about HUF425 billion-HUF450 billion in 2012, which we think will be about 30% of adjusted debt. In line with the company’s financial policy, we expect capital spending to be covered with internally generated funds. As we assume about HUF300 billion-HUF350 billion of capital expenditures, we expect moderately positive FOCF. We do not assume any significant acquisitions or shareholder distributions.
MOL’s mainly U.S. dollar- and euro-denominated debt exposes the company to a translation affect toward the forint, its reporting currency. The bulk of revenues is linked to the dollar and we think the exchange rate and working-capital movements will likely continue to influence the company’s reported debt at the end of any given quarter.
We classify the company’s liquidity as “adequate” according to our criteria.
Under our base-case scenario, we anticipate that liquidity sources will surpass needs by more than 1.2x over the 12 months started July 1, 2012.
Our base-case scenario incorporates the following as of June 30, 2012:
— About HUF233 billion of cash at the beginning of the period, of which we view HUF40 billion as tied to operations and not immediately available for debt reduction. We note positively that a large part of cash is held in euro. Most of the debt is denominated in euro or U.S. dollars.
— A significant amount of around EUR1.8 billion available under long-term committed bank lines. MOL has three major facilities: a EUR0.6 billion line maturing in June 2017 (with the possibility of extension for one year); an EUR825 million line due in June 2013; and a EUR500 million line maturing in September 2014 (of which EUR30 million matures one year before). We understand that the EUR0.6 billion facility is contracted to increase to EUR1 billion when the EUR825 million facility falls due in July 2013. All lines are subject to financial covenants.
— Adequate covenant leeway. Key tests are the 3x company-reported net financial debt-to-EBITDA limit and minimum tangible net worth of HUF600 billion. Covenant leeway was high on June 30, 2012.
— Our assumption of slightly positive FOCF in 2012.
— About EUR1.7 billion (HUF500 billion) of short-term financial debt.
We assume that MOL will be able to obtain funding from international or local banks, if need be, and that the company will continue to proactively refinance its committed bank lines well ahead of maturity.
The stable outlook balances positive company-specific elements against country-related pressures.
We could keep our rating on MOL at ‘BB+’, even if we downgraded Hungary to ‘BB’. As positive credit factors, we anticipate that credit metrics will continue to be supported by upstream price realizations and continuing adequate liquidity, shown by significant covenant leeway, material cash balances, and sizable availability under long-term committed bank lines. We assume MOL will exhibit prudent financial policies, including cash flow-funded capital expenditures and spending cuts in case of adverse events.
As credit weaknesses, we chiefly see country-related factors, including a potentially heightened corporate tax burden in its core countries of operation. We anticipate low refining profits owing to the macroeconomic environment and some excess capacity in the industry. We see funds from operations to debt of 25% as commensurate with the rating.
Rating pressures would primarily arise from any significant changes to the creditworthiness of the main countries where the company operates. Rating pressures would increase if we were to lower the sovereign rating on Hungary by more than one notch, if we were to lower the sovereign rating on Croatia, or if we revised our Transfer & Convertibility assessment on Hungary to below ‘BB+’.
Rating pressures would also surface if MOL’s access to banks or capital markets were to decline. Major acquisitions or significant dividends beyond those contemplated over the plan would also pressure the rating. We view these as unlikely, however, given MOL’s financial policies and the uncertain macroeconomic environment.
We do not see any upside for the ratings, given the sovereign rating pressures in the core countries where MOL operates.