Fitch Ratings-Singapore/Mumbai: Fitch Ratings has affirmed India-based Bharat Petroleum Corporation Limited's (BPCL) Long-Term Foreign-Currency Issuer Default Rating (IDR), its senior unsecured rating, and the rating on its outstanding senior unsecured debt at 'BBB-'. The Outlook is Stable. Fitch has also affirmed the rating on subsidiary BPRL International Singapore Pte. Ltd.'s US dollar guaranteed notes at 'BBB-'.

Fitch equalises BPCL's rating with that of its largest shareholder, the state of India (BBB-/Stable), based on the assessment of the likelihood of government support in line with Fitch's Government-Related Entities (GRE) Rating Criteria. We continue to assess BPCL's standalone credit profile at 'BB+' to reflect its dominant market position as the second-largest oil marketing company (OMC) in India, the average-but-improving complexity of its refining assets, limited vertical integration and a moderate financial profile.

KEY RATING DRIVERS

Strength of State Linkages: Fitch believes BPCL's status, ownership and control by the sovereign is 'Strong'. The state directly owns around 54% and appoints BPCL's board. We assess the support track record and expectations for the likelihood of state support for BPCL as 'Strong'. BPCL has received tangible support from the government in the form of subsidies in addition to indirect support in the acquisition of upstream assets abroad.

State's Incentive to Support: Fitch assesses the socio-political implications of a default by BPCL as 'Very Strong'. A default would significantly affect the country's energy security due to BPCL's position as the second-largest OMC. BPCL and two other state-owned OMCs import a large share of crude oil and a default would jeopardise their ability to do so, resulting in disruptions to the economy. Fitch sees the financial implications of a BPCL default as 'Strong' as it is one of the key state-owned borrowers in India and a default may have a significant impact on the availability and cost of domestic or foreign financing options for the state and its other GREs.

Price Regulation to Hurt Margins: The Indian government directed the country's three state-owned OMCs including BPCL to reduce petrol and diesel prices by INR1 per litre on 4 October 2018. This will have a negative impact on BPCL's marketing margins and push up leverage in the near term. We expect the directive to remain in force during the rest of the financial year ending March 2019 (FY19), before being reversed in FY20. The risk of further price controls exists if crude prices continue to increase. However, a material decline in crude prices could lead to a reversal in price controls that is sooner than our expectations.

Significant Downstream Player: BPCL reported domestic sales volume of over 41.2 million tonnes (MMT) in FY18, and a 23% domestic market share by the number of retail outlets, making it the second-largest OMC. It is also the third-largest refiner in the country with a refining capacity of 36.5 MMT per annum (MMTPA) as of March 2018, including 6 MMTPA at joint venture Bharat Oman Refineries Limited (BORL), following the completion of the 6 MMTPA expansion project at its Kochi refinery. We expect BPCL to maintain its strong market position over the medium-to-long term due to its capex plans to further enhance its capabilities and its various efforts to retain retail market share.

Moderate Capex: We expect BPCL's capex to remain moderate with the completion of its Kochi refinery expansion. Fitch expects capex of around INR75 billion per year through FY22 with the majority of the spending in FY19 and FY20 for its ongoing petrochemical project at Kochi and the upgrade of its Kochi and Mumbai refineries to meet Euro VI emission standards. Fitch has also factored in investment for BPCL's stake in its Mozambique block with the final investment decision likely to be made during mid-2019 and initial investments in its proposed Mumbai expansion. However, a delay in the Mozambique final investment decision may cause capex to be lower than our expectations from FY20.

Stable Financial Profile: Fitch expects BPCL's financial profile to remain stable over the medium term, except for a temporary leverage spike in FY19, as the retail price controls exacerbate the impact of higher crude prices and rupee depreciation. We expect BPCL's net leverage (net adjusted debt/operating EBITDAR including BORL on a proportionately consolidated basis) to rise to 2.4x in FY19 (FY18: 2.2x), before falling below 2.0x thereafter. Despite the better profile and greater complexity of the Kochi refinery after the recent expansion, we expect overall gross refining margins (GRMs) to decline during FY19 and FY20 (FY18: USD6.85 per barrel), in line with our expectations for an industry-wide moderation.

Diversification Efforts: BPCL plans to increase its presence in gas distribution to diversify from regular petroleum products. The company expects gas distribution and an increased focus on petrochemicals to mitigate long-term risks related to auto fuels and liquefied petroleum gas. The company, through its wholly owned subsidiary Bharat Gas Resources Limited, secured 11 licenses in the city-gas distribution bidding in September 2018, reversing from its record of adopting joint ventures for the gas-distribution business.

Improving Integration: We expect BPCL's vertical integration to improve in the medium term, supported by its upstream and petrochemical investments. However, integration will remain limited in the medium term due to the small size of these businesses, which would have a modest impact on overall cash flow stability. Integration may improve in the longer term with more upstream assets becoming operational though we do not anticipate any major increase in the medium term. BPCL received dividends in FY18 from its upstream investment in Russia-based Rosneft of around USD72 million.

Standalone Credit Profile: BPCL's standalone credit profile of 'BB+' reflects its leading position in India's fuel-retailing market, limited integration in its refining and marketing operations and a stable financial profile. We believe the high complexity of BPCL's upgraded Kochi refinery and its petrochemical project will support the improvement in operating cash flows over the medium term despite Fitch's expectations of a moderation in industry-wide GRMs.

DERIVATION SUMMARY

We equate BPCL's rating with the state of India under our GRE criteria with the likelihood of support from the sovereign assessed as 'Strong'. The rating for its key Indian peer, Indian Oil Corporation Ltd (IOC; BBB-/Stable), the largest OMC in India, is also equated with the sovereign for the same reason. BPCL's other key peer is Hindustan Petroleum Corporation Limited (HPCL; BBB-/Stable), which is rated under Fitch's Parent and Subsidiary Rating Linkage criteria. HPCL's rating is aligned to the credit profile of its parent, Oil and Natural Gas Corporation Limited (ONGC), based on our assessment of strong linkages between them.

BPCL's credit profile of 'BB+' on a standalone basis is the same level as that of IOC and one notch above that of HPCL. BPCL and IOC have a stronger market position as India's top two oil refining and marketing companies with relatively better vertical integration compared with HPCL. BPCL currently has higher leverage than HPCL but we expect it to peak in FY19 and drop from FY20 due to BPCL's modest capex plans.

BPCL is rated one notch below the 'BBB-' standalone credit profile of Indonesian oil refiner PT Pertamina (Persero) (BBB/Stable). Pertamina benefits from being Indonesia's sole refiner and largest fuel retailer along with better vertical integration and financial profile compared with BPCL, resulting in the one-notch differential in terms of their standalone credit profiles.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer

- Oil price (Brent) of USD65 for 2019 in line with Fitch's assumptions

- INR1 per litre loss on marketing margins for petrol and diesel from October 2018 to March 2019.

- Marketing volume growth of around 5% over the medium term

- Moderation in gross refining margins over the medium term

- Capex of around INR75 billion per year over the next four years, including USD800 million for the Mozambique block over FY20 and FY21

- Dividends received from its upstream assets of USD75 million per year from FY19

- Dividend payout ratio of 45%

RATING SENSITIVITIES

Developments That May, Individually or Collectively, Lead to Positive Rating Action

- An upgrade of the sovereign rating provided the likelihood of support from the state remains strong Developments That May, Individually or Collectively, Lead to Negative Rating Action.

- A downgrade of the sovereign rating

- The likelihood of support from the state is reduced significantly

For Standalone Credit Profile

Developments That May, Individually or Collectively, Lead to Positive Rating Action.

- We do not expect an upgrade in BPCL's standalone credit profile during the next two years unless there is a significant improvement in its business profile through an enhancement in its refining asset quality and/or rising downstream integration while maintaining an adequately robust financial profile in line with its business profile.

Developments That May, Individually or Collectively, Lead to Negative Rating Action

- Sustained retail price controls and/or any weak operations and/or capex resulting in a worsening of BPCL's net leverage (net adjusted debt/operating EBITDAR including BORL on a proportionately consolidated basis) to over 3x on a sustained basis may result in a downgrade.

For India's sovereign rating, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 15 November 2018.

The main factors that, individually or collectively, could trigger positive rating action are:

- A reduction in general government debt over the medium term to a level closer to that of rated peers.

- Higher sustained investment and growth rates without the creation of macro imbalances, such as from successful structural reform implementation.

The main factors that could trigger negative rating action are:

- A rise in the government debt burden, for instance due to the absence of fiscal consolidation or larger government support to public-sector banks, shadow banks or state-owned enterprises.

- Loose macroeconomic policy settings that cause a return of persistently high inflation and widening current-account deficits, which would increase the risk of external funding stress.

LIQUIDITY

Comfortable Liquidity: BPCL's liquidity remains comfortable with cash and cash equivalents of INR60 billion as of FY18 (FY17: INR 62 billion). The company also has good access to domestic and international capital markets and has very strong banking relationships, which has been demonstrated in its transactions during FY18. The company's debt maturity profile is also well-distributed with only limited debt maturities in the near term (FY20: INR36 billion).

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