Uzbekneftegaz (UNG), the state-owned oil and gas company of Uzbekistan, is expected to face continued challenges in terms of its leverage and liquidity in the coming years. S&P Global Ratings recently downgraded UNG's long-term issuer credit rating to 'B+' from 'BB-' and lowered its issue rating on the company's bond. These actions reflect S&P's assessment of the company's financial prospects and the significant influence of government support.
High Leverage Expected to Continue
UNG's leverage is expected to remain high throughout 2023 and 2024. This situation primarily results from the ongoing ramp-up of gas-to-liquids (GTL) operations and a doubling of interest expenses in 2023, which are projected to remain high into 2024 and 2025. As a consequence, UNG's funds from operations (FFO) to debt ratio is anticipated to be in the range of 7% to 12% in 2023 and 10% to 14% in 2024. The company's efforts to maintain gas production are also expected to put pressure on cash flow generation.
Liquidity Challenges Ahead
UNG's liquidity is set to remain constrained over the next two years. The company faces significant annual debt maturities, averaging around $550mn, and increasing maintenance capital expenditure. With the need to maintain gas production levels and meet these financial obligations, UNG will have limited flexibility in managing its liquidity, posing a challenge in the short term.
Key Factors Impacting UNG's Prospects
The availability of natural gas is crucial to UNG's operational and financial targets. However, Uzbekistan's domestic gas production has been on the decline, while consumption is on the rise. The balance between production and consumption has been weakening in recent years. UNG, which supplies a significant portion of gas and refined products to the domestic economy, is exposed to potential gas shortages, which could significantly impact its financial performance.
Moreover, the company's financial policies and strategic decisions are evolving. UNG has initiated projects involving significant financial commitments and complicated structures, which could affect its credit profile. The lack of predictability in the company's relationships with related parties and the sale of assets also raise some concerns.
Government Support Remains Vital
S&P Global Ratings considers UNG as a government-related entity (GRE) with an extremely high likelihood of government support. The Uzbek government's support for UNG is attributed to the company's critical role in supplying gas to the domestic economy at affordable prices and ensuring gas availability for industrial sectors. UNG's strong links with the government further reinforce the likelihood of support.
Stable Outlook with Government Support
The stable outlook on UNG's credit rating reflects S&P's expectation that there will be limited prospects for material deleveraging over the next 12 to 24 months, balanced by the extremely high likelihood of government support. This assessment is contingent on UNG's EBITDA gradually increasing and reaching UZS16 trillion (over $1.3bn) to UZS17 trillion (around $1.4bn) over the next two years, primarily driven by the GTL plant's ramp-up. Nevertheless, the company's high capital expenditures and limited free cash flow generation are expected to keep the FFO to debt ratio below or close to 12%, on average.
The Path Forward
For UNG to achieve a higher credit rating, several conditions need to be met. This includes improving FFO to debt and generating positive free operating cash flow, enhancing liquidity through proactive management, and maintaining a disciplined and predictable financial policy. However, any unexpected increase in dividend payments could further constrain UNG's credit metrics.
Environmental, Social, and Governance Factors
Environmental factors are a negative consideration in the credit rating analysis of UNG, with the energy transition and the risk of pollution being key environmental risks. Social factors also negatively affect the company's credit profile, given its social mandate to supply gas at regulated prices, limiting its financial performance. Governance factors pose another negative influence due to governance risks and lower transparency compared to peers in emerging markets.
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