Fitch Ratings has assigned Vietnam Oil and Gas Group's (PVN) first-time Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BB' with a Positive Outlook. The agency has also assigned PVN a senior unsecured rating of 'BB'.

Fitch Assigns Vietnam Oil and Gas Group First-Time 'BB' Rating; Outlook Positive
PVN's IDR is constrained by that of its parent, the Vietnam sovereign (BB/Positive), under Fitch's Government-Related Entities (GRE) Rating Criteria. The company is wholly owned by the state, which exerts significant influence over its operating and financial policies. Fitch assesses PVN's Standalone Credit Profile (SCP) at 'bb+', reflecting the company's high degree of integration, diversification and conservative financial profile. However, the SCP is constrained by PVN's relatively high oil production costs compared with other APAC national oil companies, and our expectations of negative free cash flow due to its large capex and investment programme.
Robust State Linkages: Fitch assesses the status, ownership and control factor under our GRE criteria as 'Very Strong'. PVN's annual targets are set and approved by Vietnam's government and its management is state-appointed, with the prime minister directly appointing its chairperson. PVN is also Vietnam's national oil company and benefits from exclusive rights to Vietnam's oil and gas reserves by regulation. Fitch regards the support record as 'Strong'. PVN has not required tangible financial support in at least five years due to its strong financial profile, although we expect support to be forthcoming if required.
'Very Strong' State Incentive to Support: Fitch assesses the socio-political implications of a PVN default as 'Very Strong'. Any disruptions in PVN's operations would have material implications for the entire energy value chain in Vietnam. PVN holds interests in all of Vietnam's upstream oil and gas assets, accounts for about a third of the country's refined product output, and supplies gas for power plants which make up about 15% of Vietnam's power generation. PVN also accounts for about 80% of Vietnam's fertiliser production. Fitch assesses the financial implications of a default as 'Very Strong'. PVN is a one of Vietnam's largest and most important GREs. A default by PVN could affect significantly the availability and cost of domestic and foreign financing options for the state and other GREs.
Integrated Operations: PVN benefits from its vertically integrated operations, in our view. PVN's operations span upstream oil and gas production, refining, fertiliser, oil marketing, gas distribution and power generation. PVN's net upstream oil and gas production volumes of around 6.5 million tonnes, compares well with its refinery output of around 7 million tonnes. PVN also supplies the majority of the gas feedstock required for its fertiliser manufacturing and gas power plants.
Stable Power, Gas Businesses: PVN's power generation revenues are based on long-term power purchase agreements with the state power utility, Vietnam Electricity (EVN, BB/Positive), and include cost pass-through mechanisms. Earnings from gas distribution are generally based on fixed selling prices that are increased annually and are sold mostly to EVN and PVN's power plants. Earnings from these two segments account for about 40% of PVN's gross profit and help reduce volatility from its upstream and downstream businesses.
High Cost Upstream Operations: PVN's upstream cash flow is relatively more sensitive to oil price fluctuations compared with other APAC national oil companies due to costs. The upstream segment contributed to 17% of consolidated gross profits in 2018 (2017: 14%). Fitch expects PVN's upstream operations to account for about 25% of its consolidated gross profit in the next three to four years, based on our oil price assumptions. PVN had significant proven reserves as of end-2017, resulting in a healthy reserve life. However, Fitch believes that the majority of these are offshore reserves that require considerable investment to be developed.
Investment to Rise Significantly: Fitch expects PVN's investment to rise significantly to VND321 trillion over the next five years (2018: VND38 trillion). PVN estimates over half of its expected consolidated capex and investment will be used to develop its upstream resources, mainly gas fields. We expect the investment to result in a meaningful increase in PVN's gas production after four to five years, and could improve its upstream business risk profile over the long term, taking into account the generally fixed-price gas sale contracts, while also driving up its gas transmission and distribution volumes.
Financial Profile to Weaken: Fitch expects PVN's free cash flow to turn negative from 2019 and adjusted net debt/EBITDA leverage to increase gradually to over 2x by 2021, due to its investment, capex and dividend policy which is set by the government. PVN has estimated VND380 trillion (around USD16 billion) in capex and investment from 2019 to 2023, mostly on developing its upstream operations. However, Fitch expects PVN to spend about VND321 trillion in this period, taking into consideration the company's record of falling short of its capex estimates.
PVN also expects meaningful cash inflows from a planned sale of partial equity stakes in some of its subsidiaries, but the timing and amount of such sales remain uncertain. Therefore, Fitch does not incorporate these sales in our forecasts.
Restructuring of PVCombank: PVN plans to dispose of its 52% stake in the Vietnam Public Joint Stock Commercial Bank (PVCombank) after the bank's restructuring, which is under the purview of the State Bank of Vietnam. PVCombank accounted for 50% of PVN's debt in 2018, but Fitch excludes PVCombank when calculating PVN's adjusted credit metrics considering PVN's disposal plans. There has not been any cash outflow from PVN to PVCombank since 2013, and Fitch does not anticipate any financial support from PVN to PVCombank during the restructuring. Still, Fitch believes any support is unlikely to have any material impact on PVN's financial profile. The earnings contribution from PVCombank to PVN is also immaterial.
Standalone Credit Profile of 'bb+': Fitch assesses PVN's SCP at 'bb+'. The assessment is supported by PVN's position as Vietnam's largest upstream oil and gas producer, vertical integration across midstream and downstream, and stable gas distribution and power earnings, but weighed down by high-cost upstream operations and our expectations of negative free cash flow over the medium-term due to high capex and investment.