OREANDA-NEWS. S&P Global Ratings today raised its long-term corporate credit rating on MOL Hungarian Oil and Gas PLC to 'BB+' from 'BB'. The outlook is stable.

We also raised our issue rating on MOL's senior unsecured bonds to 'BB+' from 'BB'. In addition, we withdrew all our ratings on subsidiary Magnolia Finance Ltd. as per the issuer's request.

The upgrade primarily reflects our expectations that MOL's credit metrics will be stronger than we anticipated due to the downstream division's better performance. We now forecast MOL's funds from operations (FFO) to debt, as adjusted by S&P Global Ratings, at 45% on average over 2016-2018, which we see as commensurate with an intermediate financial risk profile. We also think that with reduced capital spending, the company will likely generate positive discretionary cash flows even under our assumption of an industry-wide 30% contraction in refining margins in 2016.

Record high refining and petrochemical margins mainly drove the doubling of downstream EBITDA in 2015. That said, we recognize that a substantial part of the growth followed structural improvements in the refining business, which should support cash flow resilience even in a weaker market environment. We note that the company is progressing well with its efficiency improvement program, and its growth projects in petrochemicals (butadiene and polyethylene) along with investments in retail should bring in about $150 million in EBITDA per year.

In our base-case scenario for MOL, we assume:A Brent oil price of $40 per barrel (/bbl) for the rest of 2016, $45/bbl in 2017, and $50/bbl in 2018 and thereafter. 30% weaker refining margins in 2016 compared with 2015. Cash capital expenditures (capex) of Hungarian forint (HUF) 350 billion-HUF400 billion ($1.2 billion-$1.4 billion).Dividends of HUF50 billion-HUF80 billion. Based on these assumptions, we arrive at the following credit metrics for the company:FFO to debt of about 40% in 2016, improving to 45%-50% in 2017-2018.Positive discretionary cash flow in 2016-2018. Our assessment of MOL's business risk profile as fair reflects the group's diversification across upstream activities, refining, petrochemicals and retail operations in Central and Eastern Europe. MOL's two main refineries are strategically located, highly complex, integrated plants. However, MOL is particularly exposed to Hungary and is smaller in terms of production than peers that have a stronger business risk assessment. Our assessment is also constrained by the ongoing dispute with the Croatian authorities over MOL's 49% owned subsidiary INA, which we view as strategically important for the company.

Under our criteria, we regard MOL as a government-related entity (GRE), but this is neutral for the rating. We assess MOL's role for and link with the Hungarian government as important and limited, respectively. This leads to our view of a moderate likelihood of timely and sufficient extraordinary support from the Hungarian government (BB+/Stable/B) to MOL in the event of financial distress. The Hungarian government owns about 25% of MOL.

The stable outlook on MOL balances our view on:The near-term challenging industry outlook under our oil price assumption of $40-$50/bbl over 2016-2018 and a 30% narrowing in refining margins in 2016; andOur expectation that the company's credit metrics will gradually improve on the back of cost optimization and material capex reduction, which should allow for positive free cash flow generation. We expect that MOL's FFO to debt will stay at about 45% on average over 2016-2018, and likely somewhat short of this level in 2016. We think the company's previously made investments in refineries should support resilient cash flow generation, even under our assumption of reduced refining margins.

We could lower our rating on MOL if its performance weakened markedly, owing to an even sharper decline in downstream margins, or if the company's debt increase substantially from the current level due to acquisitions or financial policy decisions. Downside rating risk could materialize if FFO to debt decreased to sustainably below 40%.

We could raise the rating if we saw a pronounced improvement in MOL's business, particular on the upstream side. MOL could achieve such improvement if it positively resolved the conflict with Croatian authorities related to its subsidiary INA or it otherwise increased the scale of its upstream business. We could also raise the rating if MOL's credit metrics improved further, with FFO to debt at higher than 60%, although we see this scenario as unlikely in the next 12-18 months.

Upside rating potential also depends on MOL's ability to sustain a hypothetical default of Hungary, which we currently rate at the same level as MOL.