Fitch Ratings has assigned Korea Gas Corporation's (KOGAS, AA-/Stable) proposed US dollar senior unsecured notes a rating of 'AA-'.

The proposed notes will be issued under the company's USD11 billion global medium-term note programme, which is also rated 'AA-'.

KOGAS will use the net proceeds from the proposed notes to refinance debt and for general corporate purposes. The proposed notes are rated at the same level as KOGAS's senior unsecured rating as they represent its direct, unconditional, unsecured and unsubordinated obligations.

KOGAS's ratings are equalised with those of South Korea (AA-/Stable), based on Fitch's Government-Related Entities (GRE) Rating Criteria. This reflects the company's strong likelihood of sovereign support.

Key Rating Drivers

'Strong' State Linkage: We assess KOGAS's status, control and ownership by the state as 'Strong'. The state directly and indirectly owns 55% of KOGAS and supervises the company's operations. We also assess the state's support record as 'Strong'. The state has provided subsidies and equity participation, although not on a consistent basis. We assume the government's willingness to support KOGAS, should it face financial difficulties, remains strong in light of its strategic importance to the state and the support record of other major GREs.

'Very Strong' Support Incentive: We assess the socio-political and financial implications for the Korean government, should KOGAS default, as 'Very Strong'. KOGAS imports most of Korea's natural gas and owns the entire transmission network. A default would jeopardise its ability to import and supply gas and there is no state-controlled gas producer that can step in to provide support. KOGAS is also a major borrower in domestic and international bond markets, a key source of GRE funding. A default would hurt other GREs' funding access and borrowing costs.

Higher Receivables: Insufficient tariff adjustments for residential and general use city gas under the cost pass-through system caused receivables to rise sharply in 2022 and 1Q23. KOGAS raised tariffs four times in 2022 and once in 2023, which allowed the recovery of receivables accumulated in 2020-2021. However, the increases have not able to cover receivables accrued since 2022 due to sharp increases in oil and gas prices after the invasion of Ukraine in early 2022. As a result, receivables related to the delay in the tariff adjustments rose to KRW11.6 trillion by end-March 2023 from KRW1.8 trillion at end-2021.

Robust Earnings: We expect earnings to remain robust in 2023 although the amount is likely to decline from a high base in 2022. Reported EBIT nearly doubled to KRW2.5 trillion in 2022 with higher regulated returns and contribution from exploration and production (E&P) assets. The company also posted a one-off EBIT increase due to changes in allocating costs among its customers.

Fitch expects regulated earnings, excluding one-off profit, to increase in 2023 from a higher asset base and rate of return. We expect a decline in the earnings contribution from E&P assets, but the decline should be partially offset by normalised production at its Prelude project and the impact of a full year of production at the new Coral liquefied natural gas project.

Stable Regulated Earnings: KOGAS generates the majority of its annual operating profit from regulated assets, as the gas-pricing formula enables the company to pass through fluctuations in raw-material prices and other variable costs and to recoup investments in regulated assets. We expect demand for city-gas to rise slightly in the medium term. However, we forecast demand from power generation will decline gradually over the next few years as more base-load capacity will come on board.

Pressure on Financial Profile: KOGAS's standalone profile deteriorated in 2022 as debt rose by more than 60% to KRW43 trillion. This was due largely to the receivables increase of KRW6.8 trillion and cash outflow from trade receivables, inventory and trade payable changes of close to KRW9 trillion. As a result, EBITDA net leverage rose to 10.6x in 2022 from 9.5x in 2021. We expect KOGAS to start recouping the receivables with the tariff increase in 2023, but recovery may take years, which means net leverage will remain above 10x over the next two-to-three years.

The impact of higher interest rates in 2022 was mitigated by the fixed rates on nearly all of the company's debt. Still, we expect the EBITDA interest coverage ratio to fall to around 2.7x (2022: 4.4x) by 2024 on the recent debt increase and higher market interest rates, before improving with the gradual reduction in receivables. The company's Standalone Credit Profile of 'bbb-' continues to reflect its robust business profile based on a large regulated asset base that generates stable earnings, its strong funding access and robust financial flexibility as a major Korean GRE.

Derivation Summary

KOGAS's ratings are equalised with those of its major shareholder, Korea, due to its status as a strategically important state-owned enterprise. We believe the likelihood of state support is high, similar to the assessment of other Fitch-rated state-owned enterprises whose ratings are equalised with the state, such as Korea Electric Power Corporation (KEPCO, AA-/Stable) and Korea National Oil Corporation (KNOC, AA-/Stable).

We assess KOGAS's status, ownership and control as 'Strong', similar to KEPCO. The government directs and supervises the companies' investments and financial plans and monitors their financial profiles. The rating factor for KNOC is assessed as 'Very Strong', reflecting its 100% state ownership, while KOGAS and KEPCO are listed companies. KOGAS's support record is assessed as 'Strong', as it has received state support. We also expect support to be forthcoming in times of financial distress, similar to KEPCO.

The 'Very Strong' assessment of KOGAS's socio-political and financial implications of default is the same as that of KEPCO and KNOC. A default by any of the three companies would disrupt Korea's supply of natural gas, power and energy security, respectively. The three companies are also major borrowers in international and domestic bond markets, a key source of funding for GREs, and a default would significantly affect funding access and borrowing costs for domestic GREs.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Brent oil price of USD85/barrel (bbl) in 2023 and USD65/bbl in 2024, in line with Fitch's price deck; see 'Fitch Ratings Cuts Near-Term Gas Price Assumptions, Oil Prices Unchanged', published on 5 December 2022;

Capex of around KRW1.5 trillion in 2023 and KRW1.3 trillion-1.8 trillion in 2024-2025;

Dividend payout ratio of 40% for 2023-2024 earnings

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Positive rating action on the sovereign, provided the likelihood of sovereign support remains intact.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Negative rating action on the sovereign;

Lower likelihood of sovereign support.

For the sovereign rating of Korea, the following sensitivities were outlined by Fitch in its rating action commentary of 13 March 2023:

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Public Finances: A sustained rise in government debt/GDP towards levels where Korea compares less favourably to peers, for example, as a result of increases in fiscal deficits or materialisation of contingent liabilities.

Macroeconomic: Economic or financial-sector distress resulting from impaired household debt-servicing ability, for instance, from stress in the housing market or a structural deterioration in the labour market.

Structural: A rise in geopolitical risks on the Korean peninsula sufficient to severely worsen Korea's economic metrics or security situation.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Structural: A structural easing of geopolitical risk to levels more in line with rating peers.

Structural: Improved governance standards, for example, through reforms to reduce ties between politics and business.

Public Finances: Fiscal consolidation sufficient to put the government debt/GDP ratio on a firm downward trajectory over the medium term.

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 Not a Major Issue: Short-term debt was KRW25.8 trillion as of end-March 2023, compared with readily available cash of KRW859 billion. We believe liquidity is not a major issue, despite the shortfall, as the risk is mitigated by the company's strong access to both domestic and overseas capital markets and its well-spread-out debt maturity profile.

Issuer Profile

KOGAS is Korea's only fully integrated gas-distribution company, with an effective monopoly over the import, transmission and wholesale of liquefied natural gas. It owns most of the country's gas infrastructure and imports the majority of the country's natural gas requirement.

Date of Relevant Committee

12 April 2023

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

KOGAS's ratings are equalised with those of its major shareholder, Korea, under Fitch's GRE Rating Criteria, reflecting the high likelihood of state support - given the company's strategic importance.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

(C) 2023 Electronic News Publishing, source ENP Newswire