Rating Action: Moody's affirms Ecopetrol's ratings and assigns Baa2 rating to its proposed notes
Global Credit Research - 23 Jun 2015
New York, June 23, 2015 -- Moody's Investors Service today affirmed Ecopetrol S.A. (Ecopetrol)'s Baa2 ratings and assigned a Baa2 rating to the company's up to USD1.5 billion in proposed notes due 2026. The proposed securities are senior unsecured and pari passu with Ecopetrol's other senior foreign currency debt, which is also rated Baa2. Proceeds from the notes issuance will be used primarily to fund capital expenditures. The rating outlook is stable.
RATINGS RATIONALE
"The rating affirmation was based on Ecopetrol's solid business strategy, now focused on expanding exploration activities to increase reserves as well as on improving production recovery and operating efficiencies across the board, which will help the company protect its credit quality through the current cycle of lower oil prices", said Nymia Almeida, a Vice president - Sr. Credit Officer at Moody's. The ratings affirmation also considered Ecopetrol's status as Colombia's leading oil and gas producer, accounting for about two-thirds of the country's production, and the size of its operations, which benefits from having valuable assets that can be relatively easily monetized. A baseline credit assessment (BCA) of baa3 underlies the company's Baa2 issuer rating, which derives one notch of uplift under Moody's joint-default analysis, based on a high level of government support and moderate default correlation.
Leverage will increase in 2015 but is manageable based on the company's declining production costs, operating efficiency programs and previously moderate financial leverage for its rating category. Moody's expects that Ecopetrol's leverage will peak during 2015 but will decline starting in 2016 as oil prices and production gradually increase and costs and expenses decline further. Moody's also expects that, during the current period of lower operating cash flows, the government take as a percentage of net income will remain below the usual 80%; the rating agency notes that the dividend payout ratio in 2014 (paid in 2015) was 70%.
Ecopetrol's capex program of USD7.9 billion in 2015, relatively stable from 2014, is focused on exploration and production in over 59% of total. Exploration capex alone should increase from USD600 million in 2015 to an average of over USD1 billion in the next three years, with the goal of sustaining replacement ratio at 100%, at least. Lower annual capex starting in 2016 will be driven by lower capex in downstream, which will decline materially from USD1.5 billion annually in the last several years to an immaterial amount after the upgrade of refinery Reficar is completed, at the end of 2015. Moody's expects Ecopetrol's daily oil and gas production, which was 755 mboed in 2014, to increase at mid-single rates annually in the next couple of years.
Ecopetrol's rating stable outlook incorporates higher financial leverage in 2015 given weaker internally generated cash flow, caused by lower oil prices, and lower production than originally planned. In addition, the company has traditionally paid a high statutory dividend, which competes with funds needed for reinvestment. However, Moody's expects that ongoing cost controls and operating efficiencies as well as lower dividend payout ratio, at least related to fiscal year 2015 and 2016, will support free cash flow. In addition, although the government's stake in Ecopetrol cannot fall below 80%, the company can still issue an additional 8.5% of equity for financing, if necessary, although not envisioned at this point by the company.
An upgrade is unlikely in the near term given Ecopetrol's weakened credit metrics. Longer term, its BCA and ratings could be upgraded if it strengthens its balance sheet and reduces financial leverage to around 1 time gross debt to EBITDA. Conversely, ratings could be pressured downwards if production growth is significantly underperforms or if the company's debt increases materially beyond expectations or if the company fails to maintain Retained Cash Flow/Net Debt above 20% on a sustainable basis beyond 2015. The ratings could also be pressured if we viewed government support as likely to weaken. Actual rating outcomes in the future would take into account sovereign rating considerations, such as country rating and ceilings or support and dependence assumptions between the company and the government of Colombia, among other factors.
The principal methodology used in these ratings was Global Integrated Oil & Gas Industry published in April 2014. Other methodologies used include the Government-Related Issuers methodology published in October 2014. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.
Ecopetrol S.A. is headquartered in Bogota, Colombia. For the twelve months ended January 31, 2015, the company generated revenues of USD38.4 billion and in March 31, 2015 it had total assets of USD52.3 billion.
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