OREANDA-NEWS. August 10, 2015. Fitch Ratings has affirmed South Korea-based SK Innovation Co., Ltd.'s (SKI) and its subsidiary SK Global Chemical Co., Ltd.'s (SKGC) Long-Term Issuer Default Ratings (IDR) and senior unsecured debt ratings at 'BBB'. The Outlooks are Negative. The agency has also affirmed SKI's Short-Term IDR at 'F3'.

The affirmation reflects SKI's stronger-than-expected turnaround in operations and debt reduction in 1H15, which has significantly reduced the possibility of a downgrade, compared with when the Outlook was changed to Negative from Stable in August 2014. Fitch has maintained the Negative Outlook on the ratings: we expect SKI's credit metrics to be much improved from 2014, but with a limited buffer against the negative rating guidelines for its 'BBB' rating level - coupled with the volatile oil market conditions likely in the near term. The affirmation of SKGC's ratings reflects the affirmation on SKI's ratings, given the strong linkages.

SKI is a vertically integrated petroleum company with operations including refining & marketing (R&M), petrochemical, exploration & production (E&P), and lubricants. SKGC is a 100%-owned subsidiary, and the petrochemical arm of SKI.

KEY RATING DRIVERS
Operations Turnaround but Uncertainties Remain: Fitch sees the near-term industry outlook for the petroleum and petrochemical sector as continuing to be volatile, due to upcoming capacity expansion in the market, which might put further pressure on refining margins and petrochemical spreads. Volatile oil prices may also mean swings in inventory requirements and inventory-related gains/losses, affecting its overall cash generation and FCF. SKI's operations improved significantly in 1H15 after a tough 2014, with higher-than-expected refining margins, high ethylene spreads and higher PX volume. As a result, the company posted operating profit of KRW1.3trn compared with an operating loss for full-year 2014.

Deleveraging Efforts: SKI has made various efforts to reduce debt since 2014. Year-to-date, it has raised KRW700bn cash through the sale of its Nexlene facility to a JV with Saudi Arabia Basic Industries Corporation (SABIC), and disposal of non-core pipeline assets in Peru. Capex should also come down to KRW800bn in 2015 - compared with above KRW2trn in 2013-2014 - with the completion of major expansion projects. The planned listing of its subsidiary SK Lubricants was part of its deleveraging plan. However, the company has recently halted the process due to unfavourable market conditions. We still believe the option to restart the process in the future adds to flexibility in managing its financial profile.

Improvement in Credit Profile: We expect debt to come down further with continued FCF generation. Debt has declined from its recent peak in mid-2014 with deleveraging efforts and improved operating cash flow. Reported net debt fell to KRW6.3trn as of June 2015, down from a recent peak of KRW8.5trn in 2Q14 - and is now close to 2013-end levels. Overall, we expect SKI's FFO net leverage to improve significantly in 2015, and to come down to below 3x (2014: 23.6x)

SKGC Ratings Linked to Parent: We assess the relationship between SKGC and its parent SKI as close enough to align the ratings, under Fitch's Parent and Subsidiary Rating methodology. There are strong legal, operational and strategic ties. SKGC is important to SKI as it has accounted for about 40%-90% of SKI's consolidated EBITDA in the last few years, and SKGC is integral within the SKI group in generating synergies among other affiliates. SKI's management exerts significant control over SKGC's operations, and the company currently holds 100% of SKGC. Fitch acknowledges the possibility of SKI ultimately reducing its stake in SKGC; however, the agency believes SKI will continue to hold a large chunk, and retain significant control and influence on SKGC's operating and financial policies.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for SKI and SKGC include:
- Oil price assumptions as per the Fitch Price Deck ("Revising Our Oil and Gas Price Assumptions", dated 8 June 2015)
- Industry refining margins to correct in 2H compared with 1H levels
- PX spreads to remain in the USD340-350 range
- No dividend payment in 2015
- Capex of KRW800bn (SKI consolidated) to increase gradually in 2016-2017, but still well below 2013-2014 levels of above KRW2trn.

RATING SENSITIVITIES

SKI
Negative: Developments that may, individually or collectively, lead to negative rating action include:
- Margin deterioration as well as sustained high capex leading to SKI unable to reduce FFO-adjusted net leverage comfortably below 3.0x

Positive: Developments that may, individually or collectively, lead to a revision to a Stable Outlook at current ratings include:
- FFO net leverage sustained below 3.0x
- Positive FCF generation to support debt reduction

SKGC
Negative: Developments that may, individually or collectively, lead to negative rating action include:
- Negative rating action on SKI
- Any evidence of weakening links with the parent

Positive: Developments that may, individually or collectively, lead to positive rating action include:
- Positive rating action on SKI, provided the rating linkages remain intact