KUALA LUMPUR (July 27): Following the Malaysian government's local bond downgrade, Fitch Ratings has decided to also downgrade Petroliam Nasional Bhd's (Petronas) long-term foreign- and local-currency issuer default ratings to "A-", from "A", although the international rating agency has maintained the short-term foreign-currency issuer default ratings at "F1".
At the same time, Fitch said it has downgraded Petronas' foreign-currency senior unsecured rating and the rating on debt issued by Petronas Capital Ltd and guaranteed by Petronas to "A-" from "A".
But Petronas continues to maintain a strong standalone credit profile, which Fitch put at "AA-". The outlook on Petronas' long-term issuer default ratings, said Fitch in a statement, is "stable".
"Petronas' issuer-default ratings are constrained by Malaysia's. The reasons in support of Malaysia's long-term local-currency issuer-default ratings downgrade also weaken the case for rating Petronas' foreign-currency obligations above the sovereign foreign-currency rating," the rating agency said.
Fitch downgraded Malaysia's long-term local bonds' credit rating to "A-" from "A" last week. The key factors now absent in Malaysia are strong public finance fundamentals against external finance fundamentals, and the erstwhile preferential treatment of local-currency creditors against the foreign-currency ones.
"Fitch concluded that Malaysia's credit profile no longer supports a notching up of the long-term local-currency issuer default rating above the long-term foreign-currency issuer default rating. This reflects Fitch's view that neither of the two key factors cited in the criteria that support upward notching of the long-term local-currency issuer default rating are present for Malaysia," it said.
As is the case that Petronas is a wholly-owned company of the government, Fitch said Malaysia's administration can "exert significant influence over its operating and financial policies".
While Petronas has managed to maintain a strong standalone credit profile amid the oil price plunge, Fitch said the rating headroom for its standalone profile has narrowed because of its operating cash generation continuing to be under pressure as oil prices stay low.
Even when the national oil corporation has lowered its dividend pay-out to the government, the forecast period for oil prices is seen to be recovering at a slow pace, it added.
According to the statement, Fitch's expects Brent crude to average at US$33 (RM134.76) a barrel in 2016. It will trend up to US$45 in 2017 and US$55 in 2018. Compared to this time three years ago, the benchmark oil price was above US$100 a barrel.
As at writing, Brent fell 1.07% to US$44.39 a barrel.
Nonetheless, the lower dividends to Petronas' parent — namely Ministry of Finance Inc — helps to support Petronas' credit profile.
"Fitch expects Petronas to pay a lower dividend of RM16 billion in 2016, down from RM26 billion in 2015 and RM29 billion in 2014. With this reduction in dividends, Fitch expects Petronas to meet a majority of its capital expenditure (capex) from internal cash generation, even though operating cash generation is likely to be weaker due to low commodity prices," Fitch said.
The ratings agency said Petronas' capex should be significant in the medium term, as the group is embarking on the Refinery and Petrochemical Integrated Development (RAPID) project in Pengerang, Johor, which Fitch said will cost Petronas US$16 billion in total.
And there is also the liquefaction and production facility with its Canadian joint venture — Pacific NorthWest liquefied natural gas project — which is still pending the receipt of final environmental approval.
"Fitch expects Petronas' free cash flows to remain weak, reflecting the expected slow recovery of oil prices, high committed capex and dividend payments," the ratings agency said.
"Petronas' financial flexibility, however, remains strong as it benefits from lower dividend payments in 2015 and 2016, as well as lower funding costs for its US$5 billion bond issuance in March 2015," it added.
According to Fitch, Petronas' cash pile stood at RM116 billion as at March 31, 2016, against debts of about RM54 billion, putting the group in a net cash position. Its leverage, as measured by funds from operations (FFO)-adjusted net leverage, was negative at 0.7 times (a net cash position), and its FFO interest coverage was at 27 times for 2015.
The ratings agency has also downgraded three local insurers by one notch, given the sovereign rating's downgrade. They are Etiqa Insurance Bhd, Etiqa Takaful Bhd, and Malaysian Reinsurance Bhd, according to another statement.
They are part of the seven Asian insurance companies that had their ratings downgraded. The remaining four — Etiqa Insurance Pte Ltd, Muang Thai Life Assurance Plc, Thai Life Insurance Plc and Thai Reinsurance Plc — were downgraded after Thailand government's long-term local-currency issuer default rating was downgraded to "BBB+" from "A-" recently.
The outlook however remains at "stable".
In Fitch's view, only very strong insurance groups can be rated above the sovereign if they are judged to be sufficiently strong to withstand a sovereign crisis. In certain cases, Fitch would allow insurers that hold high levels of government debt (that is, more than 20% of their invested assets) to be rated above the sovereign rating if they have very good credit quality and sizeable international business diversification.