Source

Fitch Ratings has affirmed Vietnam Oil and Gas Group’s (PVN) Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘BB’ with a Stable Outlook. The agency has also affirmed PVN’s senior unsecured rating of ‘BB’.

PVN’s IDR is capped by that of its parent, the Vietnam sovereign (BB/Stable), under Fitch’s Government-Related Entities (GRE) Rating Criteria. The company is wholly owned by the state, which exerts significant influence over its operating and financial policies. Fitch assesses PVN’s Standalone Credit Profile (SCP) at ‘bb+’, reflecting the company’s conservative financial profile, diversification and integration.

Fitch expects PVN’s EBITDA to fall by about 55% and 30% in 2020 and 2021, respectively, from 2019, amid the weak oil price environment. Fitch, however, expects PVN to continue maintaining a net cash position over the next two years, as we anticipate a delay in its expansion plans. Fitch believes the earnings of PVN’s upstream, refining and oil distribution segments will be dampened severely in 2020. However, we expect earnings from its gas distribution, fertilizer and power businesses to remain relatively stable.

KEY RATING DRIVERS

Strong State Linkages: Fitch assesses the status, ownership and control factor as ‘Very Strong’. PVN’s targets are set and approved by the government and its management is state-appointed, with the prime minister appointing its chairperson. PVN is the national oil company with exclusive rights to Vietnam’s oil and gas reserves by regulation. Fitch regards the support record as ‘Strong’. PVN has not required tangible financial support in at least five years due to its strong financial profile, although we expect support to be forthcoming if required.

‘Very Strong’ State Support Incentive: Fitch assesses the socio-political implications of a PVN default as ‘Very Strong’. Any disruptions in PVN’s operations would have material implications for Vietnam’s energy value chain. PVN holds interests in all of Vietnam’s upstream oil and gas assets, accounts for about a third of the country’s refined product output, and supplies gas for power plants that make up about 15% of Vietnam’s power generation. PVN also accounts for about 80% of Vietnam’s fertilizer production. Fitch assesses the financial implications of a default as ‘Very Strong’. A default by PVN, one of Vietnam’s largest and most important GREs, could affect significantly the availability and cost of domestic and foreign financing options for the state and other GREs.

High-Cost Upstream Operations: Fitch expects PVN’s upstream segment EBITDA to drop to near breakeven in 2020 and 2021 from VND7.2 trillion in 2019 on weaker oil prices and its high cash costs. We think PVN may curtail some of its highest cost oil production, offsetting the weak crude prices. PVN’s upstream operations incurred losses in 2016 when Brent oil prices were around USD44/bbl. PVN said its upstream segment made marginal profits in 1H20 when oil prices averaged USD41/bbl, likely driven by curtailment of high cost production. PVN expects its oil production volume in 2020 to fall by 20% to 3.5 million tones.

Downstream Inventory Losses: Fitch assumes inventory losses and weak refining margins will result in marginal losses in PVN’s refining and oil-marketing segments in 2020, from VND12.6 trillion in EBITDA in 2019. We forecast profit will improve from 2021 with better margins and oil distribution spreads. Vietnam’s prices of refined petroleum products are usually market driven and PVN’s refining operations face import competition from other more efficient south-east Asian refineries. PVN is upgrading refinery operations to improve their capacity and complexity.

Stable Gas and Power Operations: PVN’s power-generation revenue is based on long-term power purchase agreements with state power utility Vietnam Electricity (EVN, BB/stable) and include cost pass-through mechanisms. Gas distribution earnings are generally based on fixed selling prices that are increased annually and sold mostly to EVN’s and PVN’s power plants. Fitch assumes these segments will remain more insulated from the commodity downcycle and economic slowdown.

Fitch assumes PVN’s 2020 gas segment EBITDA will fall by around 20% from 2019 to VND12.6 trillion due to lower volume uptake, while power segment EBITDA will remain relatively stable at VND6.7 trillion.

Financial Profile Remains Strong: Fitch expects PVN to maintain a net cash position in 2020 and keep net leverage (adjusted net debt to EBITDA excluding its banking subsidiary) below 2.5x until 2024, as its planned capex and investments are likely to be delayed amid the weaker oil prices.

We expect free cash flow (FCF) to turn negative in 2020 as PVN’s operating cash flow will fall in line with weaker oil prices. PVN plans considerable capex to develop upstream and downstream resources. PVN also expects meaningful cash inflows from a planned sale of partial equity stakes in some subsidiaries, but the timing and amount remain uncertain. Therefore, Fitch does not incorporate these sales in our forecasts, driving our negative FCF expectation over the medium term.

PVCombank Restructuring: Fitch excludes Vietnam Public Joint Stock Commercial Bank (PVCombank) in calculating PVN’s adjusted credit metrics as PVN plans to dispose of its 52% stake after the bank’s restructuring. PVCombank accounted for about 70% of PVN’s consolidated debt in 2019. There has been no cash outflow from PVN to PVCombank since 2013. Fitch does not anticipate major financial support from PVN to PVCombank during the restructuring. PVCombank’s earnings contribution to PVN is also immaterial.

Standalone Credit Profile of ‘bb+’: The ‘bb+’ assessment is supported by PVN’s position as Vietnam’s largest upstream oil and gas producer, vertical integration across midstream and downstream segments, and stable gas distribution and power earnings. It is weighed down by high-cost upstream operations and our expectations of negative FCF over the medium term due to high capex and investments.

DERIVATION SUMMARY

PVN’s IDR will remain equalised with that of Vietnam should its Standalone Credit Profile deteriorate below the sovereign rating. The assessment is comparable with that of both EVN and PT Pertamina (Persero) (BBB/Stable), which are also linked to their sovereigns. PVN’s status, ownership and control by the state is assessed as ‘Very Strong’, similar to our assessment of EVN and Pertamina in light of their complete state ownership. The support record and expectations factor is assessed as ‘Strong’ for both PVN and EVN, compared with ‘Very Strong’ for Pertamina. This reflects Pertamina’s stronger state support mechanism, such as subsidy reimbursements, state debt guarantees for specific projects, and first right of refusal for a majority stake in all expiring upstream production-sharing contracts including producing fields.

Fitch assesses the financial implications of a default on the sovereigns and other GREs to be ‘Very Strong’ for PVN, EVN and Pertamina. Fitch regards the socio-political implications of a default as ‘Very Strong’ for PVN – somewhat higher than that of EVN – as any disruptions to PVN’s operations will affect the entire energy value chain in Vietnam. The ‘Strong’ assessment for EVN reflects the presence of other state-owned entities that can step in to produce power if EVN is in financial distress, and feedstock for power generation is procured mostly from other state-owned enterprises. Like PVN, Pertamina’s socio-political implications of a default are also assessed as ‘Very Strong’ for similar reasons.

KEY ASSUMPTIONS

Fitch’s Key Assumptions Within Our Rating Case for the Issuer

Crude prices in line with Fitch’s Brent price deck assumptions; USD41/bbl in 2020, USD45/bbl in 2021, USD50/bbl in 2022 and USD53/bbl thereafter

Oil production declines by 20% in 2020, stays constant thereafter

Gas production and prices unchanged until 2024

Upstream lifting cost per barrel improves temporarily in 2020 as higher cost production is curtailed.

Refining volumes remain constant

Refining EBITDA falls from USD5.2/bbl to USD1.5/bbl in 2020. Gradual increase to USD4.5/bbl 2022.

Gas distribution volume to fall to 9.25 billion cubic meters (bnm3) in 2020 from 9.96bnm3 in 2019 as per company expectations. Margins remain unchanged from 2019

1.2GW capacity additions per annum from 2021

EBITDA margins stay unchanged at around 20%

Capex of around VND300 trillion until 2024 – majority for upstream business

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

– Positive rating action on the sovereign

Factors that could, individually or collectively, lead to negative rating action/downgrade:

– Negative rating action on the sovereign

For the sovereign rating of Vietnam, the following sensitivities were outlined by Fitch in a rating action commentary on 8 April 2020:

Factors That Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:

– Sustained record of macroeconomic stability, demonstrated in part by greater policy flexibility, including that related to the external sector to ensure adequate currency flexibility and maintenance of foreign exchange buffers.

– Improvement in public finances, reflected in smaller budget deficits or a decline in the general government debt ratio or contingent liabilities.

– A material reduction in risks posed to the sovereign balance sheet from weaknesses in the banking sector.

Factors That Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:

– A shift in the macroeconomic policy mix that results in macroeconomic instability or an increase in macroeconomic imbalances.

– Crystallization of contingent liabilities on the sovereign’s balance sheet.

– Depletion of foreign-exchange reserves; for instance, through a decline in foreign investment on a scale sufficient to destabilize the economy.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Strong Liquidity: PVN had a readily available cash balance of VND170 trillion, excluding PVCombank, compared with total debt of VND59 trillion, supporting its net cash position. Fitch does not foresee much difficulty in PVN raising funds for its investment plans, if required, in light of its status as one of Vietnam’s most important state-owned enterprises. PVN could, however, require access to offshore capital markets over the long term if it is to execute some of its larger expansion plans.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS

PVN’s ratings are linked and capped by that of the sovereign.

ESG CONSIDERATIONS

PVN has an ESG Relevance Score of 4 for Financial Transparency due to the below-average timeliness and transparency of financial disclosure compared with other rated corporates, which has a negative effect on the credit profile, and is relevant to the ratings in conjunction with other factors.

Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch’s ESG