This news release
OREANDA-NEWS. Fitch Ratings has affirmed India-based Bharat Petroleum Corporation Limited's (BPCL) Long-Term Foreign-Currency Issuer Default Rating (IDR), its senior unsecured rating, and ratings on its outstanding senior unsecured debt at 'BBB-'. The Outlook is Stable.

KEY RATING DRIVERS

Strong Linkages with State: Fitch equalises BPCL's rating with that of its largest shareholder, the state of India (BBB-/Stable) (54.9% shareholding), due to their strong operational and strategic linkages. Fitch believes the linkages remain strong despite the deregulation of diesel prices in 2014 and introduction of the direct benefit transfer scheme - which transfers subsidies directly to the consumers - for household liquefied petroleum gas (LPG). BPCL continues to retail kerosene at government-prescribed prices that are lower than market prices. Government covers the under-recoveries (the difference between market prices and state-controlled selling prices) from the sale of kerosene through subsidies and discounts from upstream companies, whereas downstream companies had borne part of the under-recoveries in the past.

Fitch may reassess BPCL's linkages with the state if the state-owned oil marketing companies' policy role weakens due to further deregulation of prices for petroleum products. Fitch will also take into consideration government's commitment to maintaining market-based prices for already-deregulated products when oil prices rise. The lower oil prices and deregulation of diesel have improved BPCL's finances significantly. Fitch assesses the standalone credit profile at 'BB+'.

Falling Subsidies: The oil sector reforms by way of deregulation of diesel prices in 2014, along with low crude oil prices, has resulted in a zero subsidy for BPCL during the financial year ending 31 March 2016 (FY16) (FY15: INR4.9bn). We expect no subsidy burden for BPCL over the next two years, given Fitch's assumptions of oil prices at USD42 per barrel (bbl) in 2016 and USD45 per bbl in 2017. Furthermore, government hiked the subsidised LPG prices by INR1.98 in July 2016 and by INR1.93 in August 2016. Similarly, government increased kerosene prices by INR0.25 per litre in July 2016.

Fitch believes that under-recoveries could be reduced significantly if the price hikes continue on a regular basis. Nevertheless, it remains uncertain as to how government will approach subsidies at higher crude prices, especially prices above USD60 per bbl.

Significant Operator: BPCL is the third-largest refiner in the country, with a capacity of 30.5 million tonnes per annum (mtpa) - representing 13% share of India's refining capacity - and the second-largest marketer of petroleum products, with around a one-quarter market share. BPCL marketed 36.8 mtpa of petroleum products in FY16 (FY15: 35 mtpa) and refined 29.8 mtpa (FY15: 29.3mtpa). We expect BPCL to maintain its leading position over the medium to long term, given its capex plans for enhancing capacity.

Comfortable Financial Profile: We expect BPCL's net leverage (net adjusted debt/operating EBITDAR) to remain below 3x and EBITDA interest cover above 4.5x over the next three years. This is despite the large capex and investment. Credit metrics improved during FY16, with net leverage of 1.3x (FY15: 1.7x) supported by strong gross refining margins (GRM) of USD6.59 per barrel (bbl) (FY15:USD3.62 per bbl).

We expect the GRMs to moderate over the next two years in line with the industry. This, together with the large investment plans, is likely to result in a marginal weakening of credit metrics during FY17 and FY18. However, we expect the benefits from the expanded Kochi refinery and continuing strong performance of the Bina refinery (GRM FY16 USD11.7/ bbl; FY15 USD6.1/bbl) to support improvement in operational cash flows from FY18.

Large Capex: We expect BPCL's capex to remain high at over INR600bn over the next five years (FY16: INR113.6bn). In addition, the company (through its subsidiary) is acquiring a stake in Rosneft's Taas-Yuriah and Vankor fields in Russia for a consideration of around USD1.1bn (around INR75bn). The large investments are likely to result in BPCL's FCF remaining negative over the medium term. The largest portion of the capex is for the expansion of the Kochi refinery to 15.5mtpa from the current 9.5mtpa, at a cost of around INR165bn. The company expects to complete expansion of the Kochi refinery by end-2016, and to start operations in early 2017.

Upstream Discoveries: BPCL has 17 upstream blocks (seven in India and 10 abroad), from which some successful discoveries have been made, and is in the process of acquiring a stake in two blocks owned by Rosneft. Other than the current acquisitions which are producing fields, the most notable is BPCL's 10% participating interest in the Rovuma Basin in Mozambique (discovery of 75 trillion cubic feet of natural gas resources). The other noteworthy discoveries are in its Brazilian assets (20% participating interest), and West Australian onshore assets in Perth (27.8% stake). We expect BPCL to start benefiting from its upstream investments in the medium to long term.

KEY ASSUMPTIONS

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

- Industry refining margins to moderate during FY17 and FY18

- No net under-recoveries for FY17 and FY18

- Oil prices of USD42 per bbl for FY17, USD45 for FY18 and USD55 for FY19 in line with Fitch's base-case price deck, as outlined in "Corporate Oil Price Assumption Raised for 2016; Slow Recovery From Here", dated 27 July 2016

- Total consolidated capex of around INR600bn over the next five years

RATING SENSITIVITIES

Positive: Developments that may, individually or collectively, lead to positive rating action include:

-An upgrade of the sovereign rating, provided the rating linkages with the state remain intact.

Negative: Developments that may, individually or collectively, lead to negative rating action include:

- A downgrade of the sovereign rating

- Weakening of linkages between BPCL and the state.

For India's sovereign rating, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 18 July 2016.

The main factors that, individually or collectively, could lead to positive rating action are:

- Fiscal initiatives that would cause the general government debt burden to fall more rapidly than expected in the medium term

- An improved business environment resulting from implemented reforms and persistently contained inflation, which would support higher private investment and real GDP growth.

The main factors that, individually or collectively, could lead to negative rating action are:

- Further deviation of the already-high public-debt burden from the peer median, which may be caused by stalling fiscal consolidation or greater-than-expected deterioration in the banking sector's asset quality that would prompt large-scale sovereign financial support

- Loose macroeconomic policy settings that cause a return of persistently high inflation levels and a widening current-account deficit, which would increase the risk of external funding stress.