Moody's Investors Service has downgraded the corporate family rating of HPCL-Mittal Energy Ltd to Ba2 from Ba1, and changed its outlook on the rating to stable from negative. The rating was downgraded due to weak refining margins arising from a slump in fuel demand, it said in a statement.
"The downgrade to Ba2 reflects the deterioration in HMEL's credit metrics, driven by the weak refining environment in Asia as well as the company's expansion into petrochemicals, which has kept HMEL's borrowings at elevated levels," said Sweta Patodia, a Moody's analyst.
The weak industry conditions are reflected in the Singapore benchmark refining margins, which declined to around USD 3.7 per barrel for 2019 compared to its historical average of USD 6-7 a barrel.
"This decline in the benchmark was due to the extremely weak fuel oil spreads, which in turn were driven by International Maritime Organization's new regulation restricting the use of heavy fuel oil in marine transportation," it said.
Also, the credit metrics of HPCL-Mittal Energy Ltd (HMEL) was impacted by its ongoing expansion into petrochemicals which has led to an increase in its borrowings.
The company, which operates an 11.3 million tonnes a year oil refinery at Bhatinda in Punjab, is in the process of setting up a dual-feed petrochemical capacity of 1.2 million metrics tons per annum (mtpa).
The project, which commenced in October 2017, was originally planned to be completed by March 2022. However, the company now intends to complete it by April 2021, accelerating its capital spending and keeping its borrowings at elevated levels.
Moody's said there have been no material cost overruns so far and the total project cost continues to largely remain within management's initial estimates.
Tightening regulations on the use of heavy fuel oil in the shipping industry, which kicked off in January 2020, could lead to higher demand for middle distillates and thus provide some support to refining margins, particularly for complex refiners like HMEL, it said.
"The industry environment continues to remain uncertain and sustained weakness in regional refining margins could delay improvement in HMEL's credit metrics," the rating agency said.
Moreover, the impact of the coronavirus outbreak on the regional demand growth for petroleum products remains uncertain.
Furthermore, HMEL's refinery will undergo 35 days of a planned shutdown during September-October 2020, which will constrain its earnings and cash flow during the fiscal year ending March 31, 2021 (fiscal 2021).
"The stable outlook reflects Moody's view that the company will maintain high utilisation of its refinery resulting in strong operating cash flow such that its credit metrics will continue to support its standalone credit profile," the statement said.
HMEL's Ba2 rating is supported by the company's high complexity refinery that generates strong refining margins and by its 15-year offtake agreement with Hindustan Petroleum Corporation Ltd (HPCL) that provides high visibility on sales volumes.
"The rating, however, is constrained by the moderate scale of the company's operations, with a single refinery and crude distillation unit, and by its exposure to the cyclical nature of the refining industry," it added.
HMEL is privately owned with HPCL and Mittal Energy Investments holding a 49 percent stake each.
HPCL is in turn 51.1 percent owned by Oil and Natural Gas Corporation (ONGC), which is 67.7 percent owned by the Government of India.
Mittal Energy Investments is a 100 percent subsidiary of Mittal Investments SARL.
As of December 3, 2019, HMEL had cash and cash equivalents of Rs 790 crore which along with expected cash flow from operations of around Rs 2,600-2,700 crore will be sufficient to cover routine capital expenditures of around Rs 1,060 crore and Rs 930 crore of debt maturities over the next 12 months.
"Moody's is unlikely to upgrade the ratings until HMEL completes its ongoing expansion and successfully ramps-up its petrochemical plant," it added.