Moody's changes outlook on Qatari Diar Finance's rating to negative; affirms Aa3 rating
Moody's Investors Service has changed to negative from stable the outlook on the Aa3 long-term issuer rating of Qatar's national oil and gas company Qatar Petroleum (QP), the A1 long-term issuer rating of QP subsidiary Industries Qatar Q.S.C. (IQ), and the A1 long-term issuer rating of Qatar Electricity and Water Company Q.S.C. (QEWC).
Concurrently, Moody's has affirmed the ratings on all three government-related issuers (GRIs).
At the same time, Moody's changed the outlook on the long-term issuer rating and senior unsecured bond ratings of government-owned special purpose vehicle Qatari Diar Finance Q.S.C. (QDF) to negative from stable and affirmed the Aa3 ratings.
This action follows the change of Qatar's sovereign rating outlook to negative from stable and the affirmation of its Aa3 rating on 4 July 2017, and is in line with the rating action on the sovereign rating of the Government of Qatar and primarily reflects the strong credit linkages between QP and the sovereign.
As Qatar's national oil and gas company, QP remains at the heart of Qatar's economy and social development and provides more than 75 per cent of the government's revenues both directly (through taxes and royalties, mainly on exports) and indirectly (through dividends from QP), as well as contributing to a large portion of the country's gross domestic product (GDP). This is reflected in Moody's high extra-ordinary support and very high dependence assumptions.
While the current dispute between Qatar and other Gulf Cooperation Council (GCC)-based countries, mainly the United Arab Emirates (UAE; Aa2 stable) and the Kingdom of Saudi Arabia (KSA; A1 stable), has resulted in some logistical challenges to the company, Moody's expects that the impact on QP's credit profile will remain limited. This is driven by the limited exposure QP has to other GCC countries as the company exports the majority of its products to Asia.
This action follows the rating action on the sovereign rating of Qatar and also reflects the strong credit linkages between IQ and the Aa3-rated QP as a result of IQ's strategically important position as a Qatar Petroleum subsidiary in developing its mature downstream activities. This translates into Moody's high extra-ordinary support and very high dependence assumptions. Moody's classifies IQ as a GRI and as a result of the change in rating outlook to negative for the sovereign rating of Qatar as well as that of QP, Moody's has also changed the outlook on IQ's rating to negative. IQ's GRI support uplift remains at three notches while the company's baa1 baseline credit assessment (BCA), a measure of standalone credit profile, remains unchanged.
The affirmation of IQ's A1 issuer rating reflects Moody's view that the standalone credit fundamentals of IQ remain strong and that Moody's does not currently anticipate any meaningful deterioration in the company's credit profile as a result of the ongoing dispute with the UAE, Saudi Arabia, Egypt and Bahrain. Approximately 14 per cent of IQ's 2016 sales were to the Middle East and about six per cent to Africa.
Within these regions, Moody's assumes that IQ has moderate sales exposure to UAE, Saudi Arabia and Egypt because these are large markets that have demand for commodities such as fertiliser and steel. The closure of borders and port access to these countries implies that IQ is unable to do business with customers based in these markets. However, in Moody's view the financial impact to IQ is immaterial because the company is able to redirect its sales of commodity products to other markets.
IQ's financial profile has strengthened over the past few years, following the gradual decrease in capex to QAR500 million in 2016 from more than QAR3.0 billion spent annually during the 2009 to 2012 period. This has resulted in a significant cash build-up of QAR11 billion in 2016 while outstanding debt has been steadily decreasing and currently stands at QAR2.6 billion. IQ's baa1 BCA is underpinned by the high degree of financial flexibility that the company has managed to build over the past five years. Moody's expects that IQ will remain free cash flow positive for the foreseeable future, benefitting from low capex requirements and given the maturity of its asset base. Moody's estimates that IQ's debt to EBITDA stood at 0.8x at end-2016.
In order to appropriately reflect IQ's exposure to the credit risk of its underlying joint-ventures (JVs), Moody's makes adjustments to the company's reported financial numbers and proportionately consolidates the financials of key JV entities that are represented on IQ's financial statements under the equity method of accounting since the adoption of IFRS 11 in 2013.
The rating action on QEWC follows the rating action on the Government of Qatar because of the strong credit linkages between QEWC and the sovereign, given that–together with its JV partners–the company owns, operates and manages the entirety of the country's power and water generating assets. This translates into Moody's high extraordinary support and very high dependence assumptions.
In addition to having a central position in the Qatari power sector, the baa1 BCA, a measure of standalone credit profile, is underpinned by the long-term power and water purchase agreements with Kahramaa (unrated, 100 per cent owned by the Qatari government), the sole off-taker of QEWC's power and water; and matching fuel supply agreements with QP.
These strengths largely offset the weakening, albeit strong, financial profile of the company due to an increase in debt to fund capex and overseas investments. Reserve margins in both electricity (around 13 per cent as of December 2016) and water (around seven per cent as of December 2016, which increased from six per cent a year earlier following the commissioning of the RAF A3 desalination plant with a capacity of 36 million imperial gallons a day) have decreased in the last few years because of economic growth. This has led QEWC to invest in capex and hence increase its gross debt and leverage.
Moody's expects that the current dispute between Qatar and other GCC countries, in particular the UAE and Saudi Arabia, will have limited impact on QEWC's credit profile, given that QEWC has no exposure to these countries through feedstock, off-take or investments. While there is a risk that demand might slow down in Qatar in case of an economic slowdown, this is largely offset by the contractual agreements the company has with Kahramaa, which mitigate to a large extent demand risk.
The change of outlook to negative from stable on QDF's Aa3 ratings is in line with the action on the sovereign rating of Qatar as the government, acting through the Ministry of Finance, unconditionally and irrevocably guarantees the payments in respect of the bonds that QDF issued.
Moody's does not assume any changes to QP's status, including the level of government control and ownership. Therefore, given high support and dependence assumptions, QP's ratings and outlook will move in sync with any changes to Qatar's sovereign rating.
QP's ratings could be downgraded if support assumptions are lowered or if the supporter's ratings are downgraded.
Given the negative outlook, an upgrade of the rating at this stage is unlikely. Ratings could be stabilised if the outlook on the ratings of the Qatari government were to change to stable.
Moody's could downgrade IQ's rating as a result of (1) a downgrade of the sovereign rating of the government of Qatar; (2) a downward revision in the rating agency's assumption of high extra-ordinary support; (3) a decrease in QP's shareholding to less than 50 per cent; or (4) a weakening of the BCA.
Moody's could lower IQ's baa1 BCA if (1) the company were to experience material operational problems - including adverse changes to the existing and future contractual framework within which the group operates, such as a change towards a less favourable feedstock supply arrangement with QP; or (2) IQ's financial metrics were to deteriorate significantly such that adjusted debt to EBITDA remains materially elevated above 1.5x.
Given the negative outlook, an upgrade of the issuer rating is unlikely at this stage. The BCA could be under positive pressure if the company sustains a strong operating performance, with fund from operations interest coverage consistently above 4.0x, FFO to debt in the high teens and debt to book capitalisation sustained below 70 per cent could put positive pressure on the ratings, though this would also have to be assessed in the context of the already high exceptional support assumption as well as taking into account future capital spending requirements. A sovereign upgrade could also trigger an upgrade of QEWC's ratings.
An adverse shift in the contractual agreements, currently not anticipated over the life of the projects in place, could materially affect the ratings. The ratings could also be downgraded if QEWC's credit strength deteriorates substantially, such that its adjusted FFO interest coverage falls below 3.5x. This could be a result of more aggressive than expected international acquisitions or investments funded predominantly by debt. Any change in our current high support assumption or a downgrade of the sovereign rating could also negatively impact ratings.
QDF's ratings are expected to move in line with any movements in the ratings of the Qatari government and assume that the government ownership, the mandate and oversight of the company remain unchanged.