BMI View : I n the face of a rapidly rising debt burden , Chilean state oil and gas firm Empresa Nacional de Petroleo has taken a number of steps to improve its downstream sector's weak financial position . However, despite its efforts, in the short term we expect margins will continue to be weighed down by elevated feedstock prices and a high debt servicing burden .
We hold a cautious short-term outlook on Chile's Empresa Nacional de Petroleo (ENAP) . While engaged in some upstream activity, the downstream sector has historically accounted for the majority of the state-owned firm's revenues and net profits (at 95% and 60% respectively). With limited hydrocarbon production and risin g demand though, the company is force d to import nearly all of its feedstock. As such, even with its efforts to reduce its substantial debt load and implement cost saving measures , given our expectations for high WTI prices, we believe margins are likely to remain tight.
|Chile - ENAP's Refineries' Capacity, % Total|
Increasing Efforts To Improve Financial Picture
In the face of a rapidly rising debt burden, which jumped from US$2.3bn in FY2008 to US$4.1bn in Q213, ENAP is in the process of implementing a number of measures to put itself on a stronger financial footing. First, we have seen both the company and government freeing up liquidity to allow ENAP to pay down its obligations. Indeed, as of August 2013 ENAP has announced its intention to sell its minority stakes Manu Peru and Primax Comercial del Ecuador. The divestment of these non-strategic assets will bring in US$312mn, and will be combined with the US$300mn capital injection that the Chilean government has committed to the company.
|Chile - ENAP Net Debt, US$mn|
Second, alongside directly paying down its obligations, the company is taking a number of steps to boost its downstream segment's margins. These include:
Refinery Upgrades: For several years we have seen the company focusing efforts on increasing heavy crude oil refining capacity as this feedstock is less expensive. In May ENAP inaugurated an alkylation plant in their Anconcangua Refinery, allowing it to boost profitability by transforming lower-value products like butane into a higher value product - namely, gasoline with only 15 parts per million of sulphur.
Renegotiated Contracts: At the end of last year, ENAP signed a new, more favourable LNG contract with Britain's BG Group, whereby it will gain access to "bigger volumes at a competitive price" from 2013 to 2030 according to the Chilean company. The firm also noted in its Q113 report that it is looking to find new crude feedstock sources in order to gain greater negotiating power with current suppliers.
Government Support: Under the 2013 Chilean Budget law, ENAP will be compensated for up to US$63.3mn per annum to continue selling heavily subsidised natural gas in the Magallanes area. In comparison to much of the rest of the country, the prices in Magallanes are far lower, but when ENAP proposed to hike prices substantially in 2011 in order to close its fiscal gaps, the move prompted widespread protests. The changes to the budget law allow the company to address its fiscal deficiencies without creating widespread unrest.
But Risks Remain
However, while the company and government's efforts may help to ease some of ENAP's financial burden, a number of factors suggest the firm's margins will remain under pressure, encouraging us to remain cautious. According to the company's 2012 report, its upstream operations supply only 2% of the total crude feedstock used by its refiners, which means that ENAP's margins are vulnerable to elevated WTI prices.
|Chile - ENAP Net Debt/Equity|
Moreover, the company is still highly leveraged, with net debt-to-equity of 25.5x in Q113, and debt-to-EBITDA, at 13.7x. While this represents a considerable improvement from FY2012 on the back of improved earnings, the debt-to-EBITA ratio it is still well above ENAP's long-term target of 2.5x.The company's high debt not only weighs on its growth potential, but also presents risks of further investment downgrades by the major ratings agencies as the Chilean government's own fiscal position becomes more tenuous.
Despite its weak finances, the company is still rated as investment grade which we believe is in part due to both the implicit and overt support of the Chilean government. Indeed, the company has been bolstered in recent years by a number of government actions, not leastcapital injections and the government waiving its right to collect dividends. However, as weaker copper prices and slowing demand for the commodity begins to weigh on Chile's growth and budgetary position, we could see the country forced to take a more hardline stance with the state-owned entity. We note that a further downgrade would only make it even harder to borrow, and, while not our core view, could see the company struggle to turn over its debt.
|Well Above Target|
|Chile - ENAP Net Debt/EBITA|
Ultimately, over the long term there is some light at the end of the tunnel for ENAP if Chile is able to bring its shale resources online. However, for now, with unconventional resource development in a nascent stage in the country, the company struggling to contain a considerable debt load and elevated WTI prices, we retain a cautious stance.