Delek Group Ltd.

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September 21, 2016

Primary Credit Analyst: Matan Benjamin, 972-3-7539731 [email protected]

Secondary Credit Analyst: Tom Dar, 972-3-7539722 [email protected]

Table of Contents

...... Rationale

Rating Outlook

Standard & Poor’s Base-Case Scenario

Company Description

Rating Methodology

Business Risk

Financial Risk Please note that this translation was made for the company's Liquidity use only and under no circumstances obligates Standard & Poor's Maalot. In the case of any discrepancy with the official Hebrew version published on September 21, 2016, the Hebrew Covenant Analysis version shall apply.

Reconciliation

Related Criteria And Research

Rating Affirmation September 21, 2016 | 1

Delek Group Ltd. Delek Group Ltd.

Corporate Credit Rating Affirmed ilA/Stable

Rationale

Business Risk Financial Risk

 A medium/high quality investment portfolio  Good financial flexibility, stemming from a supported, in our opinion, by a high competitive tradable asset portfolio. position in the Israeli natural gas market.  “Adequate” liquidity at the holding company level,  Highly concentrated portfolio. dependency on asset divestment for debt repayment.  Limited geographical diversification, focused on the Israeli market.  A dividend distribution policy which we believe does not support capital structure strengthening.  Significant exposure to the relatively high-risk energy sector.

Outlook: Stable

The stable outlook reflects our assessment that Delek Group Ltd. will continue to focus on the upstream energy sector – natural gas and oil exploration, production and marketing – and our assessment that that the company will maintain an LTV (Loan to Value) ratio of up to 50%, while maintaining a balance between its new investments and dividend payments.

Downside Scenario We may consider a rating downgrade if we find that the company’s liquidity deteriorated or that its LTV ratio exceeds the 50% threshold which we consider to be commensurate with the current rating given the characteristics of the company’s investment portfolio. A higher leverage could stem, among other things, from a decline in the asset portfolio’s value or from an aggressive investment or dividend policy. We may also consider a rating downgrade if the operating performance of the company’s major holdings significantly deteriorates or their credit risk increases to a level that forces the group to inject significant funds to support these holdings.

Upside Scenario We may consider a rating upgrade if the company succeeds in completing several maturing asset divestments and thus sustainably decreases its debt burden to an LTV of less than 30%. A rating upgrade is also dependent on the company’s ability to maintain its current liquidity profile.

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Standard & Poor’s Base-Case Scenario

Principal Assumptions Key Metrics

 Still relatively low dividends, management fees and natural gas royalties at the holding 2015A* 2016E 2017E companies level. Total coverage ratio** 0.7x <1.0x <1.0x  Focusing on the energy sector while realizing assets outside the group’s core operations. Net debt/portfolio value 41% <50% <50% (LTV)

A – Actual, E – Estimate.

* As of last follow-up – October 2015. ** Total coverage ratio = (dividend receipts + management fees + interest income) / (interest expenses + general and administrative expenses + dividends paid)

Company Description Delek Group is a holding management company with various assets in Israel and abroad. Most of its operations are in the following sectors: gas and oil, gas stations and road convenience stores, financial services and insurance, water desalination, power plants, automotive and biochemistry. Following recent natural gas discoveries off the Israeli shore and in the Mediterranean Sea, in which the company was involved, it has been focusing its operations in the energy field – exploration, production and sale of oil and natural gas (upstream) and gas stations (downstream). The major shareholder in Delek Group is Mr. Yitzhak Tshuva, who holds about 62% of its shares. The remaining shares are held by the public, including institutional investors.

Rating Methodology We classify Delek Group as an “operating holding company”. Companies of this kind have core holdings, i.e. controlled operating companies (usually cash flow generating). An operating holding company has material influence over the management and business strategy of its subsidiaries, although its investments are managed as independent operating entities which it considers to be strategic, long-term investments. Operating holding companies focus on cash flow generation of its subsidiaries and draw dividends from them. Thus, they are exposed to the business operation of their portfolio assets, and not just to stock price fluctuations. However, the fact that operating holding companies hold shares as their main assets makes them more financially flexible than operating companies or conglomerates.

We assess the business risk of an operating holding company on the basis of the credit quality of its subsidiaries, the asset and sector diversification of the portfolio, the liquidity of held shares, and our assessment of the management’s willingness to sell its shares in order to adjust leverage. When assessing financial risk, the main parameter is the holding company’s financial leverage, as expressed in the ratio between net total debt

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(solo) to portfolio value (LTV), and coverage as expressed in the ratio between dividend and management fees received, and interest expenses plus G&A expenses and dividends paid to shareholders. The combination of business and financial risk determines the company’s level of financial flexibility, and its ability to refinance debt on the basis of asset value or to quickly sell assets in order to pay its debt maturities.

Business Risk High competitive position in the natural gas market, highly concentrated portfolio Delek Group’s business risk profile is underpinned, in our opinion, by the group’s high competitive position in the Israeli natural gas market (Tamar gas field, 31% held by the company, is currently Israel’s sole natural gas provider). The correlation between the group’s assets’ operating performance is relatively low, and most of the group’s holdings benefit from a high competitive position in their respective areas of activity. On the other hand, the group’s business risk is adversely affected by relatively high concentration of portfolio assets and by de-facto low liquidity of major holdings. The investment portfolio’s concentration is reflected by the fact that the company’s subsidiary Delek Energy Systems Ltd. currently constitutes around 49% of the portfolio value, and the largest three companies in the portfolio constitute around 60% of its value. Although around 70% of the company’s holdings are registered for trading on the stock exchange, we estimate that the actual liquidity of held shares is relatively low, since the group holds controlling interests and is therefore, in our opinion, less willing, and sometimes less able, to sell shares in order to adjust its leverage. This is especially true regarding the group’s energy holdings.

We expect significant changes in the company’s portfolio in the short- to medium- term, due to its strategy of focusing on the energy sector, and the realization of non-core assets. These steps include transactions for the realization of The Pheonix Holdings (the completion of which is subject to the approval of the Director of Capital Markets, Insurance and Savings) and the Republic insurance company (completed in April 2016), the Ashkelon power plant (to be completed in Q1 2017) and possibly IDE. In addition, according to the conditions of the natural gas regulatory framework approved by the Israeli government, the group must realize its holdings in the Tamar field by 2022 in order to preserve its holdings in the Leviathan field and to develop it. Also, since late 2014 the company has been increasing its holdings in foreign gas and oil companies. Among other things, in 2015 the company announced the acquisition of 19.9% in Ithaca Energy, an independent oil and gas operator in the North Sea, for about $66 million. We estimate that the focus on the energy sector will increase the company’s business risk by decreasing business diversification and due to the sector’s relatively high volatility. On the other hand, we estimate that proceeds from asset realization will be partly used to reduce debt, thus reducing financial risk.

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Financial Risk Intermediate leverage, financial flexibility The group’s financial risk profile is underpinned, in our opinion, by leverage in the holding company level commensurate with its rating category. On the other hand, the group’s dividend distribution policy is relatively aggressive, at the expense of strengthening its capital structure (about NIS 500 million were distributed in 2015), and the group’s liquidity profile is “adequate” according to our criteria, and mainly characterized by dependency on asset realization or debt refinancing to meet medium to long term maturities. At the holding company level, the company has limited independent cash flow sources, and it relies on dividends from subsidiaries and on asset realization to meet their obligations. We believe these weaknesses are mitigated by ownership of mostly unencumbered, tradable assets, which provide the group with financial flexibility to use refinancing or asset sale to pay its maturities.

On the back of the final approval of the natural gas regulatory framework and the expected launch of the Leviathan field development, most of the group’s tradable holdings have gained value in the past 12 months, especially holdings in the gas and oil exploration sector. We estimate, as of September 6, 2016, Delek Group’s LTV ratio at around 43%. Given our current estimate of business parameters (portfolio risk), we believe that the current rating is commensurate with an LTV ratio of up to 50%,

Liquidity: Adequate Dependence on refinancing/asset realization in the medium term According to our criteria, Delek Group’s liquidity at the holding company level is “adequate”. We estimate that the company’s sources to uses ratio in the next 12 months will exceed 1.2x. This assessment is based on the level of cash on hand and other liquid assets, on estimated cash inflow, such as dividends from subsidiaries, and on loan repayment. Our scenario does not include receipts from future realizations that have not yet been completed. The company also has committed credit facilities of about NIS 1 billion maturing in H1/2017.

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According to our criteria, committed credit facilities maturing in less than a year are not included in our liquidity assessment. Nevertheless, we estimate that the existence of these facilities contributes to the group’s financial flexibility, as does its holding of high-quality tradable assets.

In our base-case scenario, we assume the company’s sources as of June 30, 2016, to be as follows:  About NIS 850 million in cash and tradable financial assets;  About NIS 630-670 million in expected income from dividends until the end of 2017;  About NIS 20 million in gas royalties until the end of 2017;  Bond issuance of NIS 1.1 billion completed in August 2016;  Repayment of NIS 320 million of seller financing until the end of 2017.

We assume the company’s uses as of June 30, 2016, to be as follows:  Interest expenses of about NIS 540 until the end of 2017;  Long-term debt and other maturities of about NIS 1.7 billion until the end of 2017;  General and administrative expenses of around NIS 45 million until the end of 2017;  Dividend distribution of about NIS 80 million, already announced (we estimate that any additional asset liquidation would be accompanied by parallel dividend distribution).

Delek Group Ltd. – Debt Maturities

(NIS million) Q3-Q4/2016 2017 2018 2019 2020 2021 and thereafter

Maturities 738 697 963 1,115 819 3,913

Covenant Analysis As of June 30, 2016, the group meets all its financial covenants with sufficient headroom, and we expect them to be complied with in the medium term. The company’s covenants vis-à-vis banks and bond holders include, among other things, a requirement to maintain equity above NIS 2.4 billion.

Reconciliation In order to create a basis for comparison with other rated companies, we adjust the data reported in the company’s financial statements which we use to calculate coverage ratios. The main adjustments we made to Delek Group’s consolidated data are deducting surplus cash, as we define it, from reported financial debt and including financial guarantees given to third parties in respect of engagements by subsidiaries.

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Related Criteria And Research

 National And Regional Scale Credit Ratings, September 22, 2014  Standard & Poor's National And Regional Scale Mapping Tables, January 19, 2016  Standard & Poor's Ratings Definitions, February 1, 2016  Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of ‘D’ And ‘SD’ Ratings, October 24, 2013  Corporate Methodology, November 19, 2013  Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, December 16, 2014  Standard & Poor’s National And Regional Scale Mapping Tables, September 30, 2014  Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, November 13, 2012  Group Rating Methodology, November 19, 2013  Methodology: Investment Holding Companies, December 1, 2015

Rating Details (As of 21-Sept- 2016)

Delek Group Ltd. Issuer rating(s) Local Currency LT ilA/Stable

Issue rating(s) Senior Unsecured Debt Series 11,12,13,22,31,32,33 ilA

Issuer Rating history Local Currency LT 26-Dec-2011 I ilA/Stable 5-Jan-2011 ilA/Negative 26-May-2009 ilA/Stable 30-Nov-2008 ilAA/Watch Neg 26-Mar-2007 ilAA/Stable 29-June-2005 ilAA 1-Sep-2001 ilAA-

Other Details Time of the event 19/09/2016 17:04 Time when the analyst first learned of 19/09/2016 17:04 the event Rating requested by Issuer

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