(Fitch Ratings, 8.Apr.2021) — Fitch Ratings affirmed the Long-Term Issuer Default Rating (IDR) of CITGO Petroleum (Opco) at ‘B’ and CITGO Holding (Holdco) at ‘CCC+’, Opco’s senior secured term loans, notes, and industrial revenue bonds at ‘BB’/’RR1’, and Holdco’s senior secured term loans and bonds at ‘B+’/’RR1’. Fitch withdrew the ratings on Opco’s $650 million July 2021 term loan, which was repaid earlier. The Rating Outlook was revised to Stable from Negative.
The Outlook revision reflects CITGO’s improved liquidity and maturity wall along with signs that the pandemic recovery will continue to accelerate.
CITGO’s ratings are supported by the quality of its refining assets, modest capex requirements, improved liquidity, favorable impact of recent refinancing activity, and a recovering macroeconomic environment for refiners.
Rating concerns include operational risks from U.S. sanctions; heightened contagion effects associated with CITGO’s ownership by PDVSA; and potential structural changes to working from home and business travel trends that could impact long-term transport demand.
The Ratings for Opco’s $650 million July 2021 term loan was withdrawn as it was repaid earlier.
KEY RATING DRIVERS
Improved Liquidity: In 4Q20, Opco’s liquidity increased to $1.264 billion from $971 million, largely due to its reinstated $250 million A/R Securitization facility. Cash also rose to $1,014 million, helped by reduced inventory levels needed in a lower demand environment. An additional $550 million in cash tax refunds from the CARES Act is anticipated around 2Q21. Fitch believes CITGO has adequate liquidity to get through a prolonged downturn in 2021.
Recovery Gains Steam: Fitch expects the downstream recovery will strengthen in 2H21 driven by increased U.S. vaccination rates, the passage of a $1.9 trillion U.S. stimulus package, and the release of pent-up leisure and holiday travel demand. Core refined product demand continues to recover, with both gasoline and distillate having made up most of the declines seen since the pandemic lows. Crack spreads are showing strength heading into the driving season, and TSA checkpoint numbers for travellers have also trended higher. Other factors could slow the return to complete pre-pandemic demand levels, including a lagging vaccine rollout in Europe, weakness in international travel, and potential changes to working from home and business travel trends.
Pandemic Hits Credit Metrics: Pandemic conditions and hurricane-related downtime at its largest refinery, Lake Charles, resulted in record low 2020 results. As calculated by Fitch, Opco’s EBITDA declined to -$587 million, versus positive $1.05 billion the year prior. CITGO saw extensive planned maintenance, with Lake Charles incurring an additional six weeks of downtime due to hurricane activity. As a higher complexity refiner, CITGO has also been unfavorably impacted by tighter light-heavy crude differentials, driven by OPEC curtailments, and increased competition from Asian refiners for heavy sour barrels in the gulf.
Change of Control Risks: The financial weakness of CITGO’s indirect parent PDVSA, which is owned by the government of Venezuela, means there are multiple paths that could trigger change of control clauses and a forced refinancing in CITGO’s debt. These include creditor lawsuits against PDVSA and affiliates seeking to obtain judgements for litigation/arbitration awards in U.S. courts, actions by PDVSA’s secured exchange note holders to collect on pledge of 50.1% of CITGO Holding’s capital stock; and any future actions by OFAC to allow such a share sale to proceed.
CITGO’s notes contain a two-part test (less than majority ownership by PDVSA and a failure by rating agencies to affirm ratings within 90 days). Fitch also believes its credit profile would likely improve under different ownership. These factors should limit bondholder incentives to tender if change of control was triggered. Nonetheless, this risk remains a key overhang on the credit. All of CITGO’s drawn debt contains this double trigger.
Access to Capital: The legacy effects of PDVSA ownership, including change of control risks, as well as the impact of various Office of Foreign Assets Control (OFAC) sanctions on entities doing business with Venezuela, are also an overhang for the company in terms of capital market access. In 2019, CITGO had to replace revolver liquidity with a drawn term loan, given bank concerns about OFAC sanctions against Venezuelan entities. Fitch believes CITGO has access to a capital pool that is narrow but deep.
Covenant Waiver: At the end of 2020, Opco received a waiver to increase its net debt-to-capitalization ratio from 60% to 70%, effective until Q1 of 2022. The waiver creates additional headroom if the downturn is prolonged. The company didn’t apply for a waiver for covenants governing distributions to CITGO Holdco (positive dividend basket, maximum net debt to cap of 55% and minimum $500 million in liquidity pro forma post distribution). Holdco has enough liquidity to service its debt without additional dividends from Opco until at least July 2022, but this could become an issue thereafter if market conditions are weak. The dividend basket at the end of Q420 was -$81 million, and CITGO would need to earn its way back to positive basket before re-starting distributions.
Parent-Subsidiary Linkage: Fitch rates the IDR of Holdco two notches below that of its stronger subsidiary, Opco. The notching stems from the significant legal and structural separations between the two, primarily the strong covenant protections for Opco’s debt, which limits the ability of the direct parent to dilute its credit quality. Key covenants include limitations on guarantees to affiliates, restrictions on dividends, asset sales and restrictions on the incurrence of additional indebtedness. Opco does not guarantee Holdco debt and a Holdco default does not cross default Opco.
Holdco: The ratings for Holdco reflect its structural subordination to Opco and its reliance on Opco to provide dividends to cover its significant debt service requirements. Dividends from Opco provide the majority of debt service capacity at Holdco and are driven by refining economics and the restricted payments basket. Holdco’s pledged security includes approximately $40 million-$50 million in run-rate EBITDA from midstream assets available for interest payments. These logistics assets are pledged as collateral under the Holdco debt package.
At 769,000 bpd day of crude refining capacity, CITGO is smaller than peer refiners such as Marathon Petroleum Corporation (BBB/Negative) at 2.9 million bpd, Valero Energy Corporation (BBB/Negative) at 2.6 million bpd, and PBF Holding (B+/Negative) at 1.04 million bpd. However, it is larger than HollyFrontier Corporation (BBB-/Negative) at 405,000 bpd and CVR Refining (BB-/Negative) at 206,500 bpd.
CITGO lacks the earnings diversification from ancillary businesses seen at a number of peers in areas such as logistics master limited partnerships, chemicals, renewables or retail. However, CITGO’s core refining asset profile is strong and relatively flexible, given the high complexity of its refineries, which allows it to process a large amount of discounted heavy and light shale crudes. Crude differentials have been compressed in the pandemic-led downturn, particularly light-heavy spreads, which have been a key support for CITGO.
Legacy PDVSA ownership and related capital markets access issues remain a key overhang on the issuer despite its relatively good asset profile.
– West Texas Intermediate (WTI) oil prices of $55/bbl in 2021, and $50/bbl thereafter;
– Refinery throughput recovers from a pandemic low of 638,000 bpd in 2020 to 684,000 bpd in 2021, 736,000 bpd in 2022 and 780,000 bpd in 2023;
– Cash operating expenses/bbl decline from $6.24/bbl in 2020 to $5.40/bbl in 2021, $5.18/bbl in 2022, and $5.13/bbl in 2023 in line with rising throughput volumes;
– CARES cash tax refund of received in 2021, improving liquidity;
– Capex of $280 million in 2021 stepped up across the forecast as conditions normalize and flexibility to make moderate strategic investments increases;
– Company resumes dividends up to Holdco beginning in 2022.
KEY RECOVERY RATING ASSUMPTIONS
The recovery analysis assumes that CITGO Corporation would be reorganized as a going-concern in bankruptcy rather than liquidated.
Fitch has assumed a 10% administrative claim.
Going-Concern (GC) Approach
The GC EBITDA estimate of $975 million reflects Fitch’s view of a sustainable, post-reorganization EBITDA level upon which Fitch bases the enterprise valuation (EV). This value is moderately lower than the previous GC estimate and reflects the industry’s move from current trough conditions to low midcycle conditions, with somewhat narrower crude spreads assumed due to structural changes in the market.
An EV multiple of 5.0x was applied to the GC EBITDA to calculate a post-reorganization EV of $4.875 billion. This is below the median 5.7x exit multiple for energy in Fitch’s Energy, Power and Commodities Bankruptcy Enterprise Value and Creditor Recoveries (Fitch Case Studies – August 2020), but above the multiple for the only refining-related bankruptcy contained in that study, Philadelphia Energy Solutions. It is also higher than the multiple used for HY refining peer PBF Holdings (3.75x), given PBF’s weaker asset profile, as evidenced by its need to idle portions of its East Coast refining system during the pandemic.
The liquidation estimate reflects Fitch’s view of the value of balance sheet assets that can be realized in sale or liquidation processes conducted during a bankruptcy or insolvency proceeding and distributed to creditors.
For liquidation value, Fitch used an 80% advance rate for the company’s inventories since crude and refined products are standardized and easily re-sellable in a liquid market to peer refiners, traders or wholesalers. Fitch also assigned relatively light discounts to CITGO’s net PP&E, based on historical refining transactions. In conjunction with A/R, these items summed to a total liquidation value of $3.85 billion.
The maximum of these two approaches was the going concern approach of $4.875 billion.
A standard waterfall approach was then applied. Subtracting 10% for administrative claims resulted in an adjusted EV of $4.39 billion, which resulted in a three-notch recovery (RR1) for all of CITGO Petroleum’s secured instruments (including the new notes), which are pari passu.
A residual value of approximately $1.43 billion remained after this exercise. This was applied in a second waterfall at CITGO Holdco, whose debt is subordinated to that of Opco. The $1.43 billion was added to approximately $360 million in going concern value associated with the Midstream assets ($45 million in assumed run-rate midstream using an 8x multiple), as well as $196 million in restricted cash, most of which was escrowed in a debt service reserve account for the benefit of secured Holdco debt. This resulted in total initial value at Holdco of approximately $1.99 billion. No administrative claims were deducted in the second waterfall. Holdco secured debt also recovered at the ‘RR1’ level.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
– Improved market access
– Reduced overhang associated with legacy PDVSA ownership issues;
– Mid-cycle debt/EBITDA below 3.0x
– Mid-cycle FFO leverage below approximately 4.0x.
– Improved market access;
– Reduced overhang associated with legacy PDVSA ownership issues;
– Alleviation of restrictions on R/P basket or otherwise increased ability to make dividends to Holdco;
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– Deterioration in liquidity/market access;
– Mid-cycle debt/EBITDA above 4.0x
– Mid-cycle FFO leverage above approximately 5.5x;
– Weakening or elimination of key covenant protections in the CITGO senior secured debt documents.
– Deterioration in market access
– Sustained inability of Holdco to receive dividends due to R/P basket restrictions;
– Weakening or elimination of key covenant protections in CITGO Holding senior secured debt documents.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
LIQUIDITY AND DEBT STRUCTURE
Liquidity Improving: At YE 2020, Opco’s liquidity increased to $1.264 billion vs. $971 million at Q3. The largest source of the increase was the company’s newly reinstated $250 million A/R Securitization facility (undrawn at Q4), however cash also rose modestly to $1,014 million, helped by improved working capital. The majority of OpCo’s cash is from proceeds of a $1.2 billion term loan, which was issued in 2019 as replacement liquidity for a terminated senior secured revolver. Opco’s liquidity is set to further improve around Q2, as the company is expected to receive an additional $550 million in tax refunds on a consolidated basis from the CARES Act.
Holdco Liquidity Adequate: Liquidity at the Holdco level was also adequate, and included cash available to Holdco of $118 million, as well as approximately $200 million in restricted cash mostly associated with the debt service reserve account to meet Holdco debt payments, and FCF from midstream assets dedicated to Holdco. While Opco is unable to distribute money to Holdco until it earns its way back from losses in its dividend basket (-$81 million as of YE 2020), the company estimates it has adequate liquidity to service Holdco debt until July 2022.