June 12, 2020 Chennai Petroleum Corporation Limited: Rating assigned to NCD programme; reaffirmed for CP programme Summary of rating action Previous Rated Amount Current Rated Amount Instrument* Rating Action (Rs. crore) (Rs. crore) Commercial Paper 6000.0 6000.0 [ICRA]A1+; reaffirmed Non-Convertible Debenture 0.0 1000.0 [ICRA]AAA(Stable); assigned Total 6000.0 7000.0 *Instrument details are provided in Annexure-1 Rationale ICRA has taken a consolidated view of Chennai Petroleum Corporation Limited (CPCL/ the company), along with its parent Indian Oil Corporation Limited (IOCL) (rated ICRA]AAA(Stable)/[ICRA]A1+), as both the entities have strong business links, particularly pertaining to imported crude oil sourcing and product off-take. IOCL has 51.9% stake in CPCL. ICRA is of the opinion that IOC would support CPCL to meet the latter’s financial obligations, should the need arise. CPCL remains strategically important to IOC as the latter meets its product requirements for the South Indian market from the former. The rating reflects CPCL’s strategic position within the IOC group, which result in low demand risk; its long-standing track record in the refining business; and the high financial flexibility with lenders by virtue of being a subsidiary of IOCL. The IOCL group has a diversified refinery base, at 11 locations, on a consolidated basis and its integration into marketing, pipelines and petrochemicals segments reduces the impact of cyclicality associated with the refining segment (which contributed ~22% of EBIDTA in FY2019). The rating reflects the consolidated entity’s dominant and strategically important position in the Indian energy sector, and its role in fulfilling the socio-economic objectives of the Government of India (GoI). The rating also reflects IOC’s high financial flexibility by virtue of its large sovereign ownership (51.5% stakes owned by the GoI), the significant portfolio of liquid investments (~ Rs. 20,940 crore as on March 31, 2020 including GoI bonds and investments in GAIL (India) limited, Oil & Natural Gas corporation and Oil India limited (OIL)), and its ability to raise funds from the domestic/foreign banking system and capital markets at competitive rates. The rating, however, also considers the vulnerability of the consolidated entity’s profitability to global refining margin cycle, import duty protection, and INR-USD parity levels. The consolidated entity is also exposed to project implementation risks as both IOCL and CPCL are executing large projects that span the entire downstream value chain; however, the risk is significantly mitigated by the Group’s proven track record of successfully implementing several large projects. The gross refining margins (GRMs) of CPCL (standalone) had weakened considerably in FY2020 as steep crude oil price decline in Q4FY2020 resulted in high inventory losses. The GRM of the consolidated entity is also expected to be adversely impacted in FY2020. The consolidated GRMs are expected to be adversely impacted in FY2021 as well because of low capacity utilisation of refineries and weak crack spreads, as the Covid-19 pandemic suppresses global economic activity. While, at present, the capacity utilisation of refineries remains subdued, with easing of the lockdown restrictions, the economic activity is expected to pick up and the refinery operations of the consolidated entity are expected to witness improvement. The Group also remains subject to regulatory risks related to intervention in product pricing as PDS Kerosene and domestic LPG are sensitive products. Although, this risk is high in a high oil price scenario, the track record of the GoI to ensure low under-recovery levels for PSU Oil Marketing Companies (OMCs) provides 1 comfort from the credit perspective. Any adverse change in the GoI’s policy in this regard that weakens key credit metrics of the consolidated entity will be a key rating sensitivity The stable outlook on the [ICRA]AAA rating reflects ICRA’s opinion that IOCL group (including CPCL) will continue to benefit from its dominant position in the domestic energy sector and its strategic importance to the GOI. Key rating drivers and their description Credit strengths Strong parentage - Indian Oil Corporation Limited has the controlling stake in the company, with shareholding of 51.9%. CPCL derives significant operational benefits from being a part of the IOC group, with respect to imported crude oil sourcing and product off-take. IOC also extended financial support to CPCL in FY2016 by subscribing to Rs. 1000.0 crore non -convertible preference shares on a private placement basis. However, during June 2018, with improvement in financial performance in the preceding two fiscals, CPCL repaid Rs. 500.0 crore of non-convertible preference share to IOCL. ICRA believes because of CPCL’s strategic position within the IOC group in South India, should the need arise, IOC would support CPCL to meet its financial obligations. IOC, being the largest oil refining and marketing company in India, commands considerable economic importance. The company holds significant strategic importance to the GoI as it helps to meet the socio-economic objectives of price control of sensitive products such as subsidised liquefied petroleum gas (LPG) and superior kerosene oil (SKO). The company is also the largest contributor to the government exchequer. Thus, the sovereign support is expected to continue. The company dominates the domestic refining sector, with 32.4% share. The company is also the leading public oil marketing company, with a ~40% market share (including private players) in FY20191. The company has the largest marketing network spanning across the country and actively undertakes multiple branding and customer loyalty initiatives. On a consolidated basis, IOC has 11 refineries (including two under CPCL) across India. Low demand risk due to locational advantage; integrated operations of Group mitigates cyclicality risk in refining segment of consolidated entity – CPCL benefits from being the only refinery company in the IOC group in South India, resulting in low demand risk. Over the last decade, IOC has implemented several pipeline projects in order to evacuate products from CPCL in a cost-effective manner and to strengthen its presence in the southern Market. IOC’s large marketing operations generate stable profits, although it is subject to risks from regulatory developments and inventory gains/losses to some extent. Further, a large pipeline infrastructure owned by the company also results in stable cash generation. The forward integration of IOC into the petrochemical segment provides operational synergies such as conversion of surplus products in the country such as naphtha, into higher value petrochemicals (like HDPE, PP etc), which also lead to higher margins. Overall, significant integration across segments reduces the risks related to refining operations. Financial flexibility with lenders - Due to its long track record and group support, CPCL enjoys high financial flexibility with lenders, allowing it to avail debt at a short notice at low interest rates. IOC continues to enjoy high financial flexibility, which has enabled it to borrow from the domestic and overseas banking system and capital markets at competitive rates, to fund its large working capital requirements and for project finance. The same is supported by IOC’s strong parentage, arising from the GoI’s 51.5% stake. The company’s investments in ONGC, GAIL, and Oil India with aggregate market value of ~Rs. 9,919.0 crore as on March 31, 2020 besides the unsold stock of GoI Special Oil bonds and GoI securities of ~Rs. 11,021 crore as on March 31, 2020 provides considerable financial flexibility 1 As per consumption data from Petroleum Planning and Analysis Cell, PPAC 2 Credit challenges Leveraged capital structure and project implementation risks - CPCL’s financial risk profile is characterised by leveraged capital structure, as the company is amid a debt-funded capex cycle, which also constrained the profit margins in FY2019 and FY2020. CPCL’s gearing increased to 1.9x as on March 31, 2019 and 7.3x as on March 31, 2020, with the severe moderation because of high inventory losses in Q4FY2020. Further, ICRA takes note of expansion plans of the refinery capacity of the CBR unit, which will entail significant capex. In June 2020, CPCL’s board has approved incorporation of a JV with IOCL, in which CPCL and IOCL will have 25% stake each and the remaining will be held by financial institutions/investors and CPCL can invest upto Rs. 25 billion in the JV. While, the overall project is estimated to be ~Rs. 289 billion, the overall funding strategy is yet to be finalised and will need to be approved by IOCL board and the developments on this front will be monitored. The gearing of the consolidated entity stood at 0.38x as on March 31, 2019 and while some deterioration in capital structure is expected in FY2020 for the consolidated entity, it is expected to remain healthy. The consolidated entity has significant capex plans, spanning the entire downstream value chain with an outlay of ~Rs. 2,000 billion over the next 6-7 years. The capex plans include the ongoing up-gradation of refineries for production of BS-VI compliant fuel, brownfield expansion of refineries, setting up of nearly 6,500 km of pipeline infrastructure, investments in setting up of retail infrastructure, petrochemical plants etc. Besides the company is also planning to set-up a mega refinery under a JV with other two PSU OMCs along with ADNOC and Saudi-Aramco on the west coast of India for nearly $60billion (IOC’s share of $15 billion). Any material time or cost overruns in the group projects could lead to an increase in the company’s borrowing levels and moderation of credit metrics. However, the risk is largely mitigated by the company’s proven track record of successfully implementing several large projects. Vulnerability of profitability to global refining margin cycle, import duty protection, and INR-USD parity levels- CPCL has limited pricing flexibility and its margins are vulnerable to movement in international crude prices and crack spreads, import duty differentials and foreign exchange rates.