OREANDA-NEWS. Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) on South Korea-based SK Innovation Co., Ltd. (SKI) and its subsidiary SK Global Chemical Co., Ltd. (SKGC) at 'BBB'; the Outlook on the ratings has been revised to Stable from Negative. At the same time, their senior unsecured debt ratings are affirmed at 'BBB' and SKI's Short-Term IDR affirmed at 'F3'.

Fitch's revision of SKI's Outlook to Stable reflects the strong operating and financial performance of SKI and SKGC in 2015, which was the result of robust refining margins and petrochemical spreads offsetting the sharp decline in oil prices, and the debt reduction by the companies.

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

Improved Industry Outlook; Uncertainties Remain: Regional refining margins improved in 4Q15, following a decline in 3Q. Lower oil prices and improved supply-demand balance spurred strong gasoline demand, which helped margins to rebound. This helped to offset still-sluggish diesel demand due to lower industrial demand from China. Fitch expects a modest correction in regional refining margins in 2016, but expects the near-term outlook for the petroleum industry to remain relatively favourable. However oil prices remain volatile, which might result in swings in inventory-related gains and losses, which may affect overall cash generation.

Robust 2H15 Performance: The company posted strong 2H15 results despite inventory losses from lower oil prices and one-off losses. Robust refining margins and ethylene spreads and stable paraxylene (PX) spreads were the main contributing factors. SKI posted a revenue decline of 27% for the full year, but posted an operating profit of KRW2.0trn, reversing from an operating loss of KRW231bn in 2014. We expect 2016 profit to remain similar to 2015's with a slight moderation in refining margins but stable petrochemical spreads and reduced one-off inventory losses.

Stronger Credit Profile: SKI's credit profile continued to improve in 2H15 with robust operating cash flow, low capex, and reduced working capital due to lower oil prices. As a result, the company's net debt fell by a further KRW2.8trn during 2H15 and by KRW4.3trn for the whole of 2015. We estimate that the company's FFO-adjusted net leverage ratio fell to 1.7x in 2015 from 23.6x in 2014. We expect the company's net leverage to remain below 2.0x over the next two to three years, barring a sharper-than-expected fall in margins, a significant increase in investments or shareholder returns.

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 operational and strategic ties. SKGC is important to SKI as it accounted for 20%-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. SKI could ultimately reduce its stake in SKGC, but Fitch believes SKI will continue to maintain a controlling stake, 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 ("Oil Price Assumption for Fitch Corporate Analysis Lowered to USD35 for 2016", dated 24 February 2016)
- Industry refining margins to correct modestly in 2016 compared to 2015 but to remain robust
- PX spreads to remain in the USD340-350 range
- Capex of KRW1.2trn (SKI consolidated) in 2016

RATING SENSITIVITIES
SKI

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

Positive: Developments that may, individually or collectively, lead to positive rating action include:
- Positive rating action is not expected in the medium-term, unless SKI can increase business diversification to an extent that earnings volatility through the cycle is reduced, while maintaining low financial leverage

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.