Reuters: Financial Services and Real Estate: TEXT-S&P revises Russian LUKoil otlk to pos;afrmd at 'BBB-/ruAA+'

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TEXT-S&P revises Russian LUKoil otlk to pos;afrmd at 'BBB-/ruAA+' May 4th 2012, 09:32 Fri May 4, 2012 5:32am EDT LUKoil's business profile is underpinned by its position as the second-largest vertically integrated oil company in the Russian Federation (foreign currency BBB/Stable/A-3; local currency BBB+/Stable/A-2; Russia national scale 'ruAAA'), its large and profitable upstream operations, comfortable reserve life, and vertical integration into refining, which increases profitability because product exports in Russia are taxed lower than crude exports. The natural hedge that stems from taxation linked to the Urals price in Russia and the historical U.S. dollar-to-ruble exchange rate make LUKoil's profits more resilient than those of local peers. On the negative side, LUKoil's production declined by 5.3% in 2011 owing to the maturity of its core Russian fields. The Russian government depends significantly on tax revenues from the oil and gas sector. Therefore, like other Russian companies, LUKoil is subject to a very heavy tax burden and uncertainties about potential changes in the tax regime. Moreover, the group is exposed to the risks of operating in Russia, where institutions are weak, in our view. However, LUKoil's good record of managing country risk and its moderate international diversity partly mitigate these risks. LUKoil's financial risk profile is supported by the company's very favorable debt metrics, both currently and in our credit scenario. LUKoil has announced a major increase in capital expenditures to stabilize and increase production, as well as to modernize its refineries, with the 2012 capital expenditure budget set at $15 billion, compared with $8.3 billion in 2011. The company plans to stabilize core production in Russia, commission smaller new fields, and develop its international upstream, notably gas production in Uzbekistan and the large West Qurna II field in Iraq. Still, we expect LUKoil's credit metrics to remain solid, and free operating cash flow (FOCF) to be broadly neutral. Liquidity We consider LUKoil's liquidity to be "adequate" under our criteria, and estimate its ratio of liquidity sources to liquidity uses to be greater than 1.2x over the next 12 months. We also view LUKoil's bank support and access to markets as comfortable, although these factors could fluctuate as for any emerging-market issuer. On Dec. 31, 2011, LUKoil had $2.8 billion of cash, of which we considered about $1 billion as tied to operations, and $1.3 billion of committed bank lines. Under our price scenario, we estimate cash from operations to be about $15 billion. LUKoil's debt maturities over the next 12 months are about $1.8 billion. We expect the company to increase dividends in line with its new dividend policy adopted in 2012 to above $2 billion. Capital expenditures are on the rise, but we believe LUKoil has some flexibility with them. Outlook The positive outlook reflects our expectation that we could upgrade LUKoil if the company manages to stabilize and potentially grow its production, invest capital efficiently--especially as we understand it plans to increase capital expenditures--and if it retains healthy credit metrics while avoiding excessively negative FOCF. Despite the expected increase in capital expenditures and shareholder distributions, we think that, under our standard oil price scenario of Brent at $100 in 2012, LUKoil should be able to demonstrate an adjusted ratio of funds from operations to debt much greater than 1x, and higher than 50% under our long-term price assumption of Brent at $80. We expect the company to maintain some headroom under its financial policy, which sets the maximum ratio of reported debt to debt plus equity at 20%, and to be closer to historical levels of about 15%. An upgrade would also likely require more certainty on energy tax policy in Russia, given the heavy interdependence between the government's budget and the oil companies' fundamental economics. We could revise the outlook to stable if LUKoil fails to stabilize production, if we anticipate or see significantly negative FOCF, or if the oil pricing and tax environment for the Russian oil industry substantially deteriorates. Related Criteria And Research All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated. -- Key Credit Factors: Global Criteria For Rating The Oil And Gas Exploration And Production Industry, Jan. 20, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Assumptions: Revised Oil Price Assumptions For 2011, 2012, and 2013, July 22, 2011 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List CreditWatch/Outlook Action; Ratings Affirmed To From LUKoil OAO Corporate Credit Rating BBB-/Positive/-- BBB-/Stable/-- Ratings Affirmed LUKoil OAO Russia National Scale Rating ruAA+ Senior Unsecured ruAA+ Senior Unsecured BBB- LUKoil International Finance B.V. Senior Unsecured* BBB- *Guaranteed by LUKoil OAO. 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