OREANDA-NEWS. Fitch Ratings has affirmed JSC National Company KazMunayGas's (NC KMG) Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB-' with a Stable Outlook. Fitch has also affirmed KazMunaiGaz Finance Sub B. V.'s foreign-currency senior unsecured rating at 'BBB-'. A full list of rating actions is at the end of this release.

We rate NC KMG on a top-down basis one notch below Kazakhstan (BBB/Stable), reflecting its strong links to the Kazakh state. The support factored into this rating includes an expectation that, in addition to the funds provided for the company's debt reduction programme in 2015, the state will over the medium term run NC KMG with a financial profile that gives it some standalone resilience to shocks.

We forecast that in 2016-2017 NC KMG's funds from operations (FFO)-adjusted gross leverage will be above 10x, and if this is sustained we would expect to widen the notching down from the sovereign. We expect management to take clear steps to reduce this leverage over the next year. If by mid-2017 there is no clear path to deleveraging towards 5x then negative rating action - an Outlook revision or downgrade - would be likely.

KEY RATING DRIVERS

Ratings Notched Down from Sovereign

The absence of an explicit state guarantee for a significant portion of NC KMG's debt prevents full rating alignment between Kazakhstan and NC KMG, despite their strong strategic and operational links. Our rating approach is based on the expectation that the state will provide sufficient and timely tangible support to the group when needed.

Support Mitigates Weak Performance

NC KMG's 2015 performance in upstream, downstream and pipeline transportation was weak, mainly due to sharply lower Brent, high costs and lower dividends from joint ventures (JVs). The company's Fitch-calculated EBITDA dropped by 65% and dividends from JVs by about 40%, resulting in negative free cash flow (FCF) of KZT261bn (USD1.2bn) in 2015.

To ensure that NC KMG complies with Eurobond covenants, in 2015 JSC Sovereign Wealth Fund Samruk-Kazyna (BBB/Stable) acquired from NC KMG a 50% interest in KMG Kashagan BV for USD4.7bn. We view this transaction as evidence of the tangible state support already incorporated into NC KMG's ratings.

Brent, Costs Hurt Upstream

JSC KazMunaiGas Exploration Production (KMG EP), NC KMG's key upstream subsidiary, which in 2014 accounted for two-thirds of the group's upstream EBITDA, fared extremely poorly in 2015 due to lower Brent and high production costs. Its Fitch-calculated EBITDA collapsed by 99% to a meagre USD3m on average lifting costs of USD13.3 per barrel (bbl) and average netback of USD21.3/bbl.

The average netback dropped to USD11.8/bbl in 1Q16, leading to further deterioration of the group's upstream performance, despite the decline in lifting costs to USD8.4/bbl. We forecast that NC KMG's upstream EBITDA will start improving only from 2017 due to gradually higher Brent of USD45/bbl in 2017 and USD55/bbl in 2018.

Pipelines, Downstream Suffer on Depreciation

The dollar-based financial performance of NC KMG's oil and gas pipelines and downstream suffered in 2015 as well, mainly due to the weaker tenge, but not as badly as that of upstream. In our rating case, we continue to consolidate the group's downstream assets, ie KMG International NV (KMGI, B+/Rating Watch Negative) and domestic Kazakh refineries, despite the announced disposal plans for these and other assets, as we believe it might be difficult to close the asset sales.

JVs' Dividends Decline Materially

We expect dividends from NC KMG's upstream JVs and affiliates to decline materially in 2016-2018 after previously being among the group's key sources of cash. In 2015, NC KMG received KZT173bn in gross dividends from JVs and associates, down 43% from KZT302bn in 2014, mainly from TengizChevroil LLP (TCO).

In 2016-2017, we expect lower payouts from TCO and other JVs due to lower Brent, weaker cash generation and TCO's multi-billion dollar expansion plans (capex estimates are USD35bn-plus). We forecast no dividends from Kashagan over the rating period as NC KMG will start repaying its debt related to the Kashagan acquisition after the project starts commercial oil production, which we assume will occur in 2017.

Debt Reduction, Vitol Prepayments

By end-2015, NC KMG had completed an early partial repayment of Eurobonds (face value of USD3.7bn) and early repayments of nearly USD0.7bn in other external debt following the transaction with Samruk-Kazyna. The group was in compliance with the 3.5x net debt (including guarantees) to EBITDA covenant at year-end.

We view the prepayments of up to USD3bn from Vitol SA for NC KMG's 20% share in TCO oil as neutral for NC KMG's gross leverage as long as the group uses cash to pay down its borrowings. We treat prepayments as debt-like and include them in NC KMG's gross leverage. The company says that NC KMG's liability under the prepayments will not depend on oil prices.

Large Refinery Upgrades Capex

The group is upgrading its domestic Atyrau, Shymkent (a JV) and Pavlodar refineries to ensure compliance with Euro-4 and Euro-5 emission standards by end-2017. NC KMG estimates its total domestic downstream capex at over USD1.8bn in 2016-2017. The 2016-2017 downstream capex may end up lower than projected due to under-funding and delays, as has happened in recent years.

High Gross Leverage Expected

We continue to rate NC KMG on a gross leverage basis because we do not consider the group's significant cash balance at 31 March 2016 of KZT1.5trn, including short-term deposits, to fully offset its high leverage. Historically, the group relied on external debt financing for capex funding. NC KMG's standalone gross leverage and coverage in 2016-2019 are commensurate with those of weak 'B' rating category EMEA oil and gas companies

KMG EP Buyout

In June 2016, NC KMG proposed to buy out the minority stake in KMG EP. We do not incorporate the buyout in our base rating case, but the possible deal would be unlikely to affect NC KMG's rating.

RATING SENSITIVITIES

Positive: Developments that may, individually or collectively, result in positive rating action include:

- A sovereign upgrade resulting from such factors as sustained recovery in external and fiscal buffers, reduction of the non-oil deficit or substantial improvements in the business climate and governance supporting diversification and a sustained recovery in Kazakhstan's economy.

Negative: Developments that may, individually or collectively, result in negative rating action include:

- A sovereign downgrade resulting from such factors as policy mismanagement, prolonged low oil prices leading to a further weakening in the sovereign external balance sheet or renewed weakness in the banking sector, which leads to contingent liabilities for the sovereign.

- Evidence of weakening state support, ie the state's failure to provide timely tangible financial support to the company.

- Failure to improve the standalone credit metrics to those commensurate with a mid 'B' rating category oil and gas company, eg FFO-adjusted gross leverage of around 5x over the medium term.

LIQUIDITY AND DEBT STRUCTURE

Manageable Maturities, High Leverage

At end-March 2016 the group's short-term debt of KZT316bn (USD0.9bn) was covered by its cash of KZT546bn and short-term investments of KZT951bn (figures exclude discontinued operations). According to NC KMG, it had around USD1.9bn in unused credit lines at 31 December 2015, which supports its short-term liquidity. We expect NC KMG to generate nearly KZT440bn in negative free cash flow in 2016-2017.

At end-March 2016, over 93% of the group's borrowings were denominated in foreign currencies, primarily US dollars, while only 73% of the group's revenues and 51% of its costs in 2015 were US dollar denominated.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuers include:

- Brent oil price equal to USD35/bbl in 2016, USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl thereafter.

- Average USD/KZT exchange rate of 360 in 2016, 340 in 2017, 320 in 2018 and 300 thereafter.

- Stagnant oil and gas production and no dividends from Kashagan in 2017-2019.

- Dividends from JVs averaging slightly over KZT80bn a year in 2016-2019.

- KZT1.6trn of total capex over 2016-2019.

- No significant asset disposals in 2016-2019.

FULL LIST OF RATING ACTIONS

NC KMG

Long-Term Foreign-Currency IDR: affirmed at 'BBB-'; Outlook Stable

Long-Term Local-Currency IDR: affirmed at 'BBB-'; Outlook Stable

Short-term Foreign-Currency IDR: affirmed at 'F3'

Foreign-currency senior unsecured rating: affirmed at 'BBB-'

Local-currency senior unsecured rating: affirmed at 'BBB-'

KazMunaiGaz Finance Sub B. V.

Foreign currency senior unsecured rating: affirmed at 'BBB-'