By Mark Sadeghian, CFA
& Dino Kritikos
CHICAGO -- Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) of CITGO Petroleum Corporation (Opco) at 'B' and CITGO Holding Inc. (Holdco) at 'CCC'. In addition, Fitch has removed the ratings from Rating Watch Negative (RWN) and assigned a Stable Outlook. Fitch has also upgraded all senior secured debt ratings at Holdco to 'B'/'RR1' from 'B-'/'RR2' based on lower debt balances and stronger expected recoveries. The main driver for today's actions is the company's expected successful refinancing of its 2018 Holdco Term Loan, which was the key near-term refinancing risk.
CITGO's ratings are supported by quality refining assets, modest capex requirements, CITGO's actions to address near-term refinancing risk, and a robust macro environment for refiners. Rating concerns are material and revolve around linkage to financially stressed ultimate parent PDVSA (LT IDR: RD) as it relates to potential change of control issues, and future refinancing risk, insofar as contagion from PDVSA could impact the willingness of investors to refinance existing debt at CITGO. The 'CCC' rating at Holdco reflects the fact that Holdco will continue to face significant refinancing risk, and in less than two years could face another challenging refinancing when the 2020 Holdco notes come due in an upsized amount ($1.875 billion). This could be exacerbated by any changes in distribution policies, for example if more cash were retained at the Opco level or otherwise stopped being trapped at Holdco. Transaction Summary:
CITGO repaid the remaining $590 million balance of its Holdco Term Loan due May 2018 using a combination of $215 million in non-restricted cash, which had had built up at the Holdco level, and $375 million in new notes. The notes were $375 million due in 2020 10.75% notes, which were sold in a direct placement offering to Holdco's existing 10.75% noteholders. The sale was allowed under an 'additional notes' provision under the existing indenture for the notes. Proceeds of $375 million plus the existing $215 million in cash were used to retire the full amount of the Term Loan. Following the transaction, the next maturity due at the Holdco level is 2020. KEY RATING DRIVERS
Refinancing Lowers Near Term Risk: The refinancing of CITGO Holding's 2018 Term Loan has stabilized the near-term outlook for the credit, as uncertainty surrounding the Term Loan's refinancing was the main driver behind Fitch's previous placement on RWN. CITGO completed the transaction using an 'additional notes' provision under the existing indenture for its 10.75% notes. The new notes, which were made under a 144a offering to existing noteholders, have the same 10.75% coupon, the same CUSIP, the same maturity date, and the same shared security as the existing notes. The refinancing reduced net leverage at the Holdco level by approximately $215 million.
Sanctions Impact Manageable: The ongoing impact of U.S. sanctions against Venezuela has had a material but manageable impact on CITGO. On an operations level, CITGO continues to run its refining system with a majority of non-Venezuelan crudes, including U.S., Canadian heavy, West African, and other South American crudes. Fitch would note that the company already sources most of its crude on the open market from third parties (78% from third parties at Sept. 30, 2017). The current crude supply agreement allows for up to 310kbpd of crude sales from Venezuela, subject to availability, although actual quantities lifted from PDVSA fell well below that level. The Trump administration is reportedly considering new sanctions against Venezuela, which could potentially cut off oil imports. It is unclear if these measures would come to pass given they could raise gasoline prices; however, Fitch believes the direct impact on CITGO should be modest, as Fitch believes CITGO could find adequate third party supply with limited economic impact.
Change of Control Risks: In the case of a default on the PDVSA senior notes due 2020, foreclosure on the equity collateral (Citgo Holding stock) would likely trigger change of control provisions in CITGO's existing debt. If unable to obtain sufficient consents from lenders, Citgo would be obligated to make an offer to repurchase outstanding senior notes at 101. The company would have a 90-day repurchase window (complete offer within 30 days, complete transaction 60 days subsequent), providing some time to refinance the notes or otherwise raise sufficient liquidity. Citgo Holding's Term Loan had a significantly stricter three day requirement for repayment following a change in control, but has now been repaid. A change in control would constitute an event of default under Citgo Petroleum's revolving credit agreement and term loan. Lenders would have the option to accelerate the loans or provide change of control consent.
While Fitch believes Citgo would likely have the ability to either obtain lender consents or refinance the existing debt package, external events including capital market shocks or difficulty reaching consensus amongst a diverse bondholder group could impair the company's ability to do so within the applicable repurchase windows.
PDVSA Ownership Key Rating Constraint: There is a relatively strong operational linkage between CITGO and PDVSA (Long-Term Foreign and Local Currency IDRs RD). This relationship is evidenced by a history of use of CITGO as a source of dividends to its parent, frequent placement of PDVSA personnel into CITGO executive positions, control of CITGO's board by its parent, and existence of a crude oil supply agreement. However, there are important legal and structural separations between the two entities. CITGO is a Delaware corporation with U.S. domiciled assets and is separated from PDVSA by two Delaware C-Corps, CITGO Holding, Inc., and PDV Holding Inc. The most important factor justifying the rating notching between CITGO and PDVSA is the strong covenant protections in CITGO's secured debt, which limit the ability of the parent to dilute CITGO's credit quality. Key covenants include limitations on guarantees to affiliates, restrictions on dividends to CITGO Holding and PDVSA, asset sales, and incurrence of additional indebtedness. CITGO Petroleum debt has no guarantees or cross-default provisions related to either PDVSA debt or CITGO Holding debt.
Good Refining Assets and Positioning: CITGO owns and operates three large, high-quality refineries, providing sufficient economies of scale to compete with larger tier-one refiners. Positioning in the Midwest and Gulf Coast provides access to a variety of crudes, including U.S. sweet crudes, Canadian heavies, and heavy sour imports at the Gulf. CITGO's refineries have above-average complexity, including substantial coking capacity, allowing for conversion of discounted heavier and sour crudes into higher-value products. Coking capacity in particular is important for sustaining profitability now that the U.S. crude export ban has been lifted, and is expected to benefit from new IMO regulations in 2020, which limit the ability of marine vessels to burn residual fuel oil. CITGO's footprint on the Gulf coast allows favorable access to export markets, which is an important component in maintaining competitive gross margins relative to peers. The overall refining environment remains benign, and Fitch expects 2017 performance will be relatively robust driven by solid refining fundamentals including strong product demand, good crack spreads, and benefits associated with recent U.S. tax reform.CITGO HOLDING:
Debt Supported by CITGO Petroleum Cash Flow: Ratings for CITGO Holding reflect heightened refinance/probability of default risk, structural subordination and a reliance on CITGO Petroleum to provide dividends for debt service. Dividends from CITGO Petroleum provide the majority of debt service capacity at CITGO Holding, and are driven primarily by refining economics and the restricted payments basket. As part of the 2015 financing, CITGO Holding purchased $750 million in logistics assets from CITGO Petroleum, which have recently provided approximately $40 million in EBITDA at CITGO Holding available for interest payments. These logistics assets are pledged as collateral under the CITGO Holding debt package. Following the refinancing of the Holdco Term Loan, Holdco faces another potentially more significant refinancing exercise again in 2020 when its upsized 10.75% notes come due.DERIVATION SUMMARY
At 749,000 bbl/d day of refining capacity, CITGO is smaller than investment grade refiners MPC (1.8 million bbl/d), VLO (2.7 million bbl/d), PSX (2.1 million bbl/d), and Andeavor (1.2 million bbl/d). CITGO also lacks diversification from ancillary businesses that these peers do, primarily logistics MLPs. However, given CITGO's relatively strong asset footprint, cash flow potential, and size, Fitch informally estimates that, on a stand-alone basis with no parental rating constraints, CITGO could be rated significantly higher than its current rating.KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
--CITGO capex of $266 million in 2017 and $350 million per year across the remainder of the forecast;
--Regional crack spreads declining to mean inflation-adjusted levels over the forecast horizon;
--Long-run refining gross margin of $9-$10/bbl;
--No material increases in corporate SG&A and refining opex/bbl;
--CITGO Petroleum pays nearly all of its net income to CITGO Holdings.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
--Change in ownership to a higher-rated parent, or changes leading to a stand-alone credit analysis;
--Improved ratings at PDVSA given the explicit ratings linkage;
--Stronger structural separations between CITGO and PDVSA leading to a wider notching rationale between the two.
--Change in ownership to a higher-rated parent, or structural changes leading to a stand-alone credit analysis.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
--Weakening or elimination of key covenant protections in the CITGO senior secured debt documents;
--Inability to refinance debt;
--A sustained operational problem at one or more refineries leading to impaired cash flow forecasts and credit metrics.
--Weakening or elimination of key covenant protections in CITGO Holding senior secured debt documents;
--Inability to refinance debt;
--Operational problems or weakening long-run fundamentals at CITGO that negatively affect the dividend stream to CITGO Holdings.LIQUIDITY
CITGO Petroleum At Sept. 30, 2017, CITGO Petroleum had approximately $1.2 billion in available liquidity, consisting of $895 million in revolver availability, $229 million in cash and $70 million in availability on the accounts receivable facility. Fitch believes this will be adequate for near-term liquidity requirements in the ordinary course of business, which would consist primarily of working capital needs following another large move in crude or product prices. Fitch expects that capex, dividends and other calls on liquidity will be funded with operating cash flow. CITGO Petroleum's next maturity due is its revolver (2019), followed by its term loan B (2021).
CITGO Holding Following the proposed refinancing of the Holdco TL, total cash at CITGO Holdco is expected to be approximately $230 million (of which, $30 million is unrestricted). If a change of control occurs, CITGO Holding would be required to make an offer to purchase its 10.75% and 6.25% senior secured notes.
STRONG RECOVERY: The recovery analysis was based on the maximum of going concern and liquidation value. For liquidation value, we used standard haircuts for the company's A/R, after adjusting for receivables that were associated with the company's securitization program. We used a relatively light discount of 25% for inventories, based on the fact that crude and refined products are easily re-sellable to peer refiners, traders or wholesalers. We also used a relatively light discount for CITGO's net PP&E, based on a review of historical refining transactions.
These items summed to a total liquidation value of $4.54 billion.
Our going concern valuation for CITGO was $5.0 billion, comprised of our run-rate EBITDA of $1.0 billion times a 5.0x multiple. The 5.0x multiple reflects the fact that while CITGO's parent has run the assets to maximize free cash flow and dividends over the last several years, historical transactions for higher quality, high complexity refineries on the Gulf coast have occurred at robust levels. We would expect there would be strong interest in these assets, regardless of whether they required incremental capex. The maximum of these two approaches was the going concern approach of $5.0 billion.
A standard waterfall approach was then applied. Subtracting 10% for administrative claims, resulted in an adjusted EV of $4.5 billion, which resulted in 100% recovery (RR1) for CITGO Petroleum's secured revolver, TL, and notes. A residual value of approximately $2.2 billion remained after this exercise. This was applied in a second waterfall at CITGO Holdco, whose debt is subordinated to that of CITGO Petroleum insofar as dividends after debt service at Petroleum are used to service debt at Holdco. The $2.2 billion was added to approximately $380 million in going concern value associated with the Midstream assets at Holdco for total initial value of $2.59 billion. After deductions for administrative claims, Holdco secured debt recovered at the 100% (RR1) level as well. FULL LIST OF RATING ACTIONS
Fitch has taken the following rating actions:
CITGO Petroleum Corp.
--Long-Term IDR affirmed at 'B';
--Senior secured revolver affirmed at 'BB'/'RR1';
--Senior secured term loan affirmed at 'BB'/'RR1';
--Senior secured notes affirmed at 'BB'/'RR1';
--Fixed rate industrial revenue bonds affirmed at 'BB'/'RR1'.
CITGO Holding Inc.
--Long-term IDR affirmed at 'CCC';
--Senior secured term loan upgraded to 'B'/'RR1' from 'B-'/'RR2';
--Senior secured notes upgraded to 'B'/'RR1' from 'B-'/'RR2'.
The ratings have been removed from Rating Watch Negative and assigned a Stable Outlook for both entities.