OREANDA-NEWS. December 23, 2015. Fitch Ratings has placed KMG International's (KMGI) Long-term foreign currency Issuer Default Rating (IDR) of 'B+' on Rating Watch Negative (RWN). The RWN follows KMGI's announcement that JSC National Company KazMunayGas (NC KMG, BBB/Stable) has concluded a memorandum of understating with China Energy Company Limited (CEFC), which may lead to an ownership change in KMGI.

KMGI's ownership change may result in weaker ties with its current parent, NCKMG, (BBB/Stable), leading to a rating downgrade. Post-deal the credit profile of KMGI will also depend on the plans of the new shareholder regarding the funding and strategy of KMGI.

KEY RATING DRIVERS
Ratings Driven by Parental Support
KMGI's rating is based on a bottom-up approach in line with Fitch's parent and subsidiary rating linkage methodology. The rating reflects a three-notch uplift from the company's standalone credit profile, assessed at 'CCC' due to a weak financial profile (end-2014: funds from operations (FFO) adjusted net leverage of 36x), for parental support from NC KMG.

Fitch assessed the strategic and legal ties between KMGI and NC KMG as moderate to strong - even though operational ties are moderate - which supports the three-notch uplift to KMGI's standalone rating. The legal ties include a direct guarantee of KMGI's debt (USD200m) and a cross-default provision in the documentation for NC KMG's USD7.5bn global medium-term note programme, which also relates to KMGI's debt. Historical financial support has taken the form of a USD1.1bn cash injection as capital increase, and shareholder loans (USD0.9bn) converted into a 51-year hybrid loan. We will reassess the ties after the completion of the contemplated transaction.

Share Buyback Plans
KMGI's repurchase of 27% of Rompetrol Rafinare S.A.'s (RRC) shares from the government for USD200m did not take place in 2014, as the company had expected. Fitch understands from management that the government initiated the privatisation of its stake in RRC in 2015. KMGI's management expects that, within the framework of a potential transaction, NC KMG and CEFC will find an appropriate financing solution to support KMGI in the buyback of RRC shares.

Strong Macro Environment in 2015
Refining margins in north-west Europe increased to USD7.9/bbl in 9M15 from USD4/bbl in 9M14 and to USD5.3/bbl from USD1.4/bbl in the Mediterranean region in the same periods. Fitch expects refining margins to moderate in 2016 from the highs of 2015, but unlikely to revisit the lows seen in 2H13 and 1H14, due to depressed oil prices supporting demand for fuel and the lower cost of oil for refineries' own consumption.

Oversupply in Europe to Return
The longer-term outlook for the refining sector is more uncertain. Excess refining capacity, structural decline in fuel consumption because of growing engine efficiency and environmental policies, and stronger competition from new refineries in emerging markets are likely to put pressure on the European refining sector in the medium- to long-term.

Hybrid Loan Treated as Debt
Fitch treats the 51-year hybrid loan from KazMunayGas PKOP Investment B.V. (outstanding balance at end-2014 of USD0.9bn) as debt because interest payments are not deferrable if the company returns to profitability and starts paying dividends. FFO adjusted net leverage excluding shareholder financing totalled 13.9x at FYE14 (15.6x in FYE13). KMGI's post-deal funding structure is yet to be determined.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Annual EBITDA of approximately USD150m.
- Improved leverage metrics on the back of higher cash flow generation.
- Support from NC KMG for repurchase of RRC shares.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action including an affirmation are:
- Unchanged strategic, legal and operational ties between KMGI and NC KMG
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Weaker ties with NC KMG leading to reassessment of the three-notch uplift to the standalone IDR for parental support

LIQUIDITY
At 30 June 2015, KMGI's short-term debt was USD243m against an unrestricted cash balance of USD121m. The company's liquidity was supported by USD186m of undrawn credit facilities at end-June 2015, of which USD146m was committed. In April 2015, KMGI signed a USD360m credit facility, which will be used to refinance its existing loans. The facility includes a USD240m three-year committed revolving credit line and a one-year USD120m uncommitted overdraft.