Delek Group Ltd. Monitoring Report October 2017

Transcription

1 Delek Group Ltd. Monitoring Report October 2017 This credit rating report is a translation of a report that was written in Hebrew for a debt issued in Israel. The binding version is the one in the original language. Contacts: Kobi Rachmani, Analyst Lead Rating Analyst kobir@midroog.co.il Liat Kadish, CPA, Senior Team Leader Secondary Rating Analyst Liatk@midroog.co.il Sigal Issachar, VP, Head of Corporate Finance i.sigal@midroog.co.il

2 Delek Group Ltd. Series Rating A2.il Outlook: Stable Midroog affirms the A2.il rating of bonds issued by the Delek Group Ltd. (hereinafter "the Delek Group" or "the Company"). Rating outlook is stable. Outstanding bonds rated by Midroog: Debenture Series ISIN Rating Outlook Maturity K Nonmarketable A2.il Stable 18/07/2018 L Nonmarketable A2.il Stable 25/11/2017 O A2.il Stable 18/10/2017 M A2.il Stable 29/09/2021 N A2.il Stable 18/07/2018 R A2.il Stable 31/10/2022 S A2.il Stable 10/11/2022 V A2.il Stable 31/12/2021 EE A2.il Stable 20/02/2025 FF A2.il Stable 10/07/2019 GG A2.il Stable 10/01/2022 Summary of Rating Rationale The Company's rating is supported by a large portfolio of holdings and a high business positioning in the Israeli natural gas market, through its direct and indirect holding in Delek Drilling LP (A1.il/stable, "Delek Drilling"), which holds, directly, 22% of the rights in the Tamar reservoir and also has a stake in Tamar Petroleum (40%) which holds an additional 9.25% of the rights in the Tamar reservoir. Delek Drilling holds, as well, 45.34% of the Leviathan reservoir. At the same time, the rating is negatively impacted by the high exposure of the holdings portfolio to the energy sector, mainly in Israel, which accounts for 70% of the value of the Company's assets. The Company's strategy of focusing on the energy sector in and outside Israel, accompanied by an extensive plan for the realization of assets, is expected to grow exposure to the energy sector and gives rise to uncertainty regarding the future composition of the portfolio. In our assessment, the Company's credit risk has grown over the past year, due to an increase in debt mainly attributable to a major investment in the acquisition of Ithaca Energy Inc. as well as higher dividend distributions to the shareholders than in previous years, which exceeded our estimates. These factors, along with a decrease in the value of gas shares, have increased the Company's leverage ratio, measured as the ratio of financial debt to value of assets (LTV), 1 which as of the date of this report is 1 The adjusted debt consists of the Company's total standalone financial debt together with the debt of wholly owned headquarter companies and several external guarantees to subsidiaries. The value of investments was calculated according to the market value of marketable holdings and the book value of nonmarketable holdings, using discount factors on the book value. 2 16/10/2017 Delek Group Ltd. Monitoring Report

3 around 50%. While this ratio is still appropriate for the rating level, the Company is nevertheless exposed to share volatility, with emphasis on its energy holdings. We assign great weight to the Company's policy, as presented to us, according to which it will act to substantially reduce the financial debt by the end of 2018, even if there should be a delay in material realizations, including through the sale of marketable securities and a reduction in dividends to the shareholders, if necessary, to compensate for the increase in the risk level of the holdings portfolio, as mentioned above, and maintain the present rating level. Midroog takes into account that share volatility could raise the current leverage ratio to within a range of 50%-55%. The forecast cash flow in the years is based primarily on the realization of assets, mainly the sale of the remaining stake in Tamar as well as the sale of Phoenix Holdings Ltd. (Aa3.il/stable, "Phoenix Holdings"). We assume that the sale of Phoenix Holdings faces challenges, noting that the transaction with Sirius Ltd. ("Sirius") for the sale of the Company's shares in Phoenix Holdings for NIS 2.5 billion 2 is contingent on further approvals. We expect the sale of Tamar to take place during , with the cash flows resulting from this sale to be used, according to our base scenario, inter alia to repay debts of Delek Drilling according to a cascade of priorities, the payment of tax, current investment needs of Delek Drilling and the distribution of profits. We estimate that all of the above will leave the Company with a cash flow from the sale of Tamar in 2019 at the earliest, totaling NIS billion. The rating is negatively impacted by a weak interest coverage ratio, in view of a low level of current dividends from investees relative to financing costs. Under our base scenario, the coverage ratio of dividends and other revenues (excluding Realizations) net of administrative and general expenses to financing expenses is projected to be below 1.0 in the short and medium term. We estimate that the main dividend providers will be Delek Energy Systems, Delek Israel and Delek Motors, and that dividends and other revenues to be received (excluding Realizations) will be in the range of NIS million per year. The Company's reliance on Realizations makes it difficult to forecast the expected debt service sources, due to the uncertainty of their realization, which depends on exogenous factors that affect the timing, scope and terms of the Realizations. On the other hand, the Company's rating is favorably supported by high financial flexibility, based on a high component of marketable holdings and unencumbered assets as well as a reasonable leverage level. We believe the Company is also able to raise additional debt on Delek Energy, in view of a moderate leverage level. The Company's level of liquidity is insufficient under the scenario without realizations, being based primarily on committed credit facilities and our estimate of dividends from investees as well as the portfolio of marketable securities. This scenario considers basic sources and applications. The stable rating outlook is supported by our assessment that the Company, according to its declared policy and based on past experience, will substantially reduce the financial debt in the short term, 2 From this consideration for the sale, NIS 208 million was paid in advance to the Delek Group for the sale of 4.9% of the shares of Phoenix Holdings held by the Company, which amount will not be refunded even if the entire transaction is not approved. 3 16/10/2017 Delek Group Ltd. Monitoring Report

4 through the realization of assets, including the sale of marketable securities, and the reduction of dividends to shareholders if necessary to maintain the rating level. Delek Group (expanded standalone 3 ) Key Financial Indicators (NIS in millions) Net income (loss) attributable to the Company's shareholders (765) 740 Equity attributable to the Company's shareholders 3,902 4,313 4,612 4,504 5,204 5,357 Financial debt standalone and headquarter companies 8,972 7,244 7,631 7,513 6,883 7,811 Cash and deposits , Financial debt net of cash and deposits 8,519 7,240 6,678 6,871 5,830 6,909 Marketable securities , Dividends received Dividends paid to the Company's shareholders (400) (180) (460) (645) (530) (531) Detailed Rating Considerations A strategy of investments and realization that is expected to increase the risk profile of the holdings portfolio Approximately 70% of the adjusted value of the Company's assets as of the date of this report derives from holdings in the energy exploration and production sector in Israel and the world, with 55% of the adjusted value of assets comprising an indirect holding (through Delek Energy Systems Ltd. "Delek Energy") and a direct holding in Delek Drilling LP ("Delek Drilling," A1.il/stable), which holds the Tamar gas reservoir (22% directly, excluding the holding in Tamar Petroleum, plus a 40% stake in Tamar Petroleum, which holds 9.25% of the rights in Tamar), the Leviathan gas reservoir (45.34%) and the Aphrodite gas reservoir (30%). Delek Drilling has a strong business profile, based on its dominant position in Israel's natural gas reservoirs, which meet national needs and allow the State of Israel energy independence. Delek Drilling operates in a concentrated market characterized by high entry barriers and steady demand over time. The Tamar reservoir (annual production capacity of 9.4 BCM in 2016) is an income-producing asset with long-term agreements for the entire yield and high profitability, conferring on it significant and stable cash flows and a high credit profile. The Leviathan reservoir (annual production capacity of 21 BCM, out of which it was decided to invest in 12 BCM, with the remainder slated for future development) is still in the construction stages, with operations expected to commence, according to the partners' forecasts, at the end of No agreements have been signed for a significant part of the production from the Leviathan reservoir, a factor that increases the credit risk of this reservoir, especially as a significant proportion of the output in the current development stage is intended for export. The funding received for the development of the Leviathan reservoir and 3 Excluding data of Delek Energy Systems Ltd., an 88.2%-held subsidiary. 4 16/10/2017 Delek Group Ltd. Monitoring Report

5 Noble Energy's experience in the development of gas reservoirs are risk mitigating factors with respect to the construction of the Leviathan reservoir and compliance with the timetables. Concurrently with the development of the Leviathan reservoir, Delek Drilling is focusing on the sale of its holdings in the Tamar reservoir, which it is required to do by 2021 under the gas agreement that was approved by the Israeli government. In August of this year Delek Drilling completed the sale of 9.25% of the rights in the Tamar reservoir to Tamar Petroleum, in a transaction embodying a value of USD 10.5 billion for the reservoir (100%, after payment of a Senior royalty). Following the offering, Delek Drilling continues to hold 40% of Tamar Petroleum, although the agreement between Delek Drilling and Tamar Petroleum stipulates that Delek Drilling's voting rights in Tamar Petroleum may stand at a maximum of 12% of the total voting rights in the company. Delek Drilling is expected to continue acting in the coming years to sell its remaining interest in the Tamar reservoir, while, concurrently, Delek Energy and the Delek Group are expected to continue acting to realize the Senior royalty from this reservoir. As part of the Company's strategy to expand its stake in the upstream energy market, mainly outside Israel, the Company completed in the second quarter of the year the acquisition of 80% of the share capital of Ithaca Energy Inc. ("Ithaca") in consideration for USD 500 million (NIS 2 billion), which is added to the 20% of Ithaca shares previously held by it. Ithaca is engaged in the exploration, production and sale of oil and gas in the North Sea and also provides operator services. Ithaca holds rights in oil and gas assets which are located in the territorial waters of the UK, chief among them oil reservoirs concentrated in the Greater Stella Area. In April 2017, production began from the Stella reservoir, the largest among the reservoirs in the area. Ithaca's risk profile is higher than the average risk profile of the Delek Group's holdings portfolio: Ithaca is a small company in international terms, with a daily output of 18,000-19,000 barrels as of the date of this report, representing a significant growth over previous years, following the start of production from the Stella reservoir. Production by the Stella facility is expected to grow to 25,000 barrels during , with the realization of the reservoir's full production potential. Ithaca is characterized by a concentration of oil reserves, with high exposure to the main reservoir in the Greater Stella Area, which, according to the resources report published by the Delek Group, is projected to be depleted by 2024 (reserves proved + probable), in view of an accelerated rate of production, which would require Ithaca to develop new reservoirs in the coming years. Ithaca is exposed over time to fluctuations in oil prices, affecting its cash flows and the value of its assets. It has relatively high debt service needs during , stemming, among other things, from the investments in the development of the Stella reservoir. Ithaca's free cash flows are expected to service a part of the debt, with the greater part of the debt likely to be refinanced. Midroog's base scenario does not assume the receipt of dividends from Ithaca in the years In accordance with the Company's strategy, the Midroog base scenario estimates that the Delek Group will sell control of Phoenix Holdings during , reduce its share in the Tamar reservoir, as mentioned above, and realize other non-core assets. Midroog considers that the strategy for the realization of these assets raises uncertainty regarding the future structure of the holdings portfolio, increases the portfolio's concentration and heightens the exposure to higher risk assets at least in the short to medium term, up to the start of production from the Leviathan reservoir and the clarification of uncertainties regarding the gas agreements of this reservoir. 5 16/10/2017 Delek Group Ltd. Monitoring Report

6 Midroog takes into account the Company's declaration of its willingness to substantially reduce financial debt by the end of 2018 The Company's financial debt grew in the past year (by NIS 1.5 billion gross and by NIS 1.2 billion net of cash and deposits), mainly due to the investment in the acquisition of Ithaca as well as a substantial dividend distribution to the shareholders expenses which were moderated by dividends received from Delek Energy and the gas partnerships. The ratio of the Company's adjusted financial debt as of June 30, 2017 to the value of its assets as of the date of this report (LTV) is around 50%, being negatively impacted, in addition to the grow in the financial debt, also by a decrease in the past year in the value of the shares of Delek Energy and Delek Drilling. Midroog expects the Company over time to reduce the financial debt, in view of the relatively high likelihood of the realization of material assets by the Company in the foreseeable future ( ), in keeping with its policy and with the restrictions to which it is subject and also given the strong implementation capabilities demonstrated by it thus far. Two principal realization transactions are on the agenda: Tamar and Phoenix Holdings. In the base scenario, the cash flows to be received by Delek Drilling from the sale of Tamar will be used, among other things, for the payment of withholding tax, repayment of the balance of the Tamar bond and repayment of one half of the Series A bond of Delek Drilling, according to the terms of these bonds. In addition, we estimate that in the coming years, the development of the Leviathan reservoir will require the investment of extensive resources by the Delek Drilling, which will be financed in part from the partnership's own sources as well as from bank loans. We assume that the partnership's own sources used for funding the development will stem from the current cash flow from Tamar and/or from the sale of Tamar, as well as from the seller's loan provided in the sale of the "Karish" and "Tanin" reservoirs. Accordingly, we estimate that the sale of the remaining stake in Tamar by Delek Drilling will generate a cash flow of NIS billion for the Delek Group. As to the sale of Phoenix Holdings, the memorandum of understanding recently signed with Sirius sets a value of NIS 2.5 billion for the Company's holdings, while the potential buyer has paid earnest money in an amount of NIS 200 million for the acquisition of a 4.9% interest. It should be emphasized that the Company's plan to dispose of material assets is subject to uncertainty, in view of exogenous factors that affect the timing, scope and terms of the realization, including conditions in the capital market, regulatory approvals and the like. Among other things, the transaction for the sale of Phoenix Holdings requires the approval of the director of Capital Market, and it is difficult to assess the chance of the transaction to be approved. Consequently, and considering the grow in the financial debt, Midroog expects the Company to act, based on its policy as presented to Midroog, to significantly reduce the financial debt already in the short term, by the end of It has several options available to it for this purpose, even in the absence of significant realization during this time (referring to the sale of Phoenix and/or to the sale of the remaining stake in Tamar), such as the realization of financial investments in shares, the realization of the Senior royalty on the Tamar reservoir, as well as the sale of other non-core assets. Based on statements by the Company, Midroog likewise expects, in the event that the Company's plan for the realization of non-core assets is not realized in a manner resulting in the diminution of the debt in the short term, that it will act concurrently to reduce shareholders' dividends, to the extent required for reducing the debt and maintaining the Company's current rating level. 6 16/10/2017 Delek Group Ltd. Monitoring Report

7 The Company's leverage ratio may fluctuate due to volatility of gas shares and other marketable holdings in the energy sector. Midroog's base scenario sets the Company's LTV ratio in the range of 50%- 55% and assumes that the Company will be positioned at the lower limit of this range, inter alia given the expectation that reduction of the debt will also lessen the Company's exposure to share prices. Increased credit risk due to weak visibility of current cash flows from investees and strong reliance on the sale of holdings Midroog's base scenario sets the amounts of current dividends and other revenues of the Company from investees (excluding realization) in the range of NIS million per year. This amount consists primarily of the repayment of seller's loans, a Senior royalty from the Tamar reservoir and dividend payments from Delek Israel and Delek Motors. The coverage ratio of current revenues other than from the realization of assets (current dividends and other revenues) net of administrative and general expenses to financing expenses (NIS 350 million per year) is weak (below 1.0) and weighs on the rating. Company liquidity in the scenario without realization based mainly on committed credit facilities and forecast dividends Midroog's basic liquidity scenario takes into account the Company's main sources and applications of funds projected from June 30, 2017 to the end of 2018 (six quarters), excluding any assumption of realization or debt issues in the capital market, as follows: Main sources: Cash totaling NIS 450 million (including utilization of committed credit facilities in the amount of NIS 300 million); Committed and available credit facilities 4 totaling NIS 750 million; dividends and other revenues received from investees in the amount of NIS 1,300 million (of which NIS 630 million were declared in the third quarter of 2017); receipts of NIS 400 million from the repayment of seller's loans, and an advance payment of NIS 200 million on the Phoenix Holdings sale transaction. Main applications: Interest and headquarter expenses amounting to NIS 560 million; repayments on bonds and long-term loans amounting to NIS 1,700 million (six quarters ahead); shareholders' dividend declared in the amount of NIS 260 million, and sundry payments for a total of NIS 400 million. Based on our assumptions as described above, sources and committed facilities in the next six quarters will total NIS 3.1 billion, while current applications will total NIS 3.0 billion, yielding a sources-to-applications ratio of 1.0. Said basic scenario does not consider any dividend distribution to the shareholders. In addition, the Company has a portfolio of marketable securities of international energy companies with a value as of June 30, 2017 of NIS 708 million. We note that the Company has a relatively high burden of repayments in 2019, including principal payments of NIS 1.1 billion, and we expect the Company to maintain over time cash balances and committed credit facilities amounting to no less than the annual debt service amount. High financial flexibility based on marketable securities and a large component of unencumbered assets The Company's financial flexibility is above par for the rating and is reflected mainly in a wide array of unencumbered assets, mostly marketable assets, including non-core marketable securities, such as the 4 The majority of these credit facilities are committed for a period of at least one year. 7 16/10/2017 Delek Group Ltd. Monitoring Report

8 22.5% holding in the share capital of Delek Motors (valued at NIS 600 million as of the date of this report). In our estimation, the Company's financial flexibility will allow the company to overcome it timing differences and meet its relatively high debt service requirements. We believe the Company has good access to the capital market. In addition, the Tamar Petroleum offering and the debt raised pursuant thereto support our assessment of the Group's ability to implement highly complex financial moves within a rapid timeframe. Rating Outlook Factors that could lead to a rating upgrade: Significant improvement in the visibility and stability of current cash flows from investees. Factors that could lead to a rating downgrade: Increase over time in the ratio of adjusted financial debt to adjusted value of the holdings portfolio beyond a rate of 50%. Failure to reduce the gross financial debt significantly by the end of Company Profile The Delek Group is a holding company controlling a range of companies that operate primarily in the energy sector. The Company has a controlling stake in Delek Energy Systems (88.2%), which operates in the field of oil and gas exploration and drilling through its holding in Delek Drilling LP (54.5%). The Company also has a direct holding in Delek Drilling (7.83%). The main assets of Delek Drilling are rights in the Leviathan reservoir (45.34%) and in the Tamar and Dalit drilling sites (22%), as well as a 40% stake in Tamar Petroleum. In addition, the Company has holdings in Ithaca Energy (100%, foreign private company), in Delek Israel (100%, private company), in Delek Motors (22.5%) and in Phoenix Insurance Holdings (52.3%). The Group also holds 50% of the share capital of IDE Technologies Ltd., which engages in the construction and operation of desalination plants in Israel and the world, and 100% of the share capital of IPP Ashkelon and IPP Sorek, companies that operate private power stations. The principal shareholder is Mr. Yitzhak Tshuva, who holds 60.5% of the Company's shares, while the remaining shares are held by the public. The Company's CEO is Mr. Asaf Bartfeld. 8 16/10/2017 Delek Group Ltd. Monitoring Report

9 Rating History Related Reports Delek Group Ltd. Rating Action Update, February 2017 Delek Group Ltd. Rating Action, February 2017 Delek Group Ltd. Monitoring Report, June 2016 Delek Drilling LP Rating Action, May 2017 Delek Drilling LP Initial Rating, December 2016 Tamar Petroleum Initial Rating, June 2017 Methodology for Rating Holding Companies, December 2011 Midroog Rating Scales and Definitions The reports are published on the Midroog website at General Information Date of rating report: October 8, 2017 Date of last revision of the rating: February 21, 2017 Date of first publication of the rating: May 26, 2009 Rating commissioned by: Delek Group Ltd. Rating paid for by: Delek Group Ltd. Information from the Issuer Midroog relies in its ratings inter alia on information received from competent personnel at the issuer. 9 16/10/2017 Delek Group Ltd. Monitoring Report

10 Long-Term Rating Scale Aaa.il Aa.il A.il Baa.il Ba.il B.il Caa.il Ca.il C.il Issuers or issues rated Aaa.il are those that, in Midroog judgment, have highest creditworthiness relative to other local issuers. Issuers or issues rated Aa.il are those that, in Midroog judgment, have very strong creditworthiness relative to other local issuers. Issuers or issues rated A.il are those that, in Midroog judgment, have relatively high creditworthiness relative to other local issuers. Issuers or issues rated Baa.il are those that, in Midroog judgment, have relatively moderate credit risk relative to other local issuers, and could involve certain speculative characteristics. Issuers or issues rated Ba.il are those that, in Midroog judgment, have relatively weak creditworthiness relative to other local issuers, and involve speculative characteristics. Issuers or issues rated B.il are those that, in Midroog judgment, have relatively very weak creditworthiness relative to other local issuers, and involve significant speculative characteristics. Issuers or issues rated Caa.il are those that, in Midroog judgment, have extremely weak creditworthiness relative to other local issuers, and involve very significant speculative characteristics. Issuers or issues rated Ca.il are those that, in Midroog judgment, have extremely weak creditworthiness and very near default, with some prospect of recovery of principal and interest. Issuers or issues rated C are those that, in Midroog judgment, have the weakest creditworthiness and are usually in a situation of default, with little prospect of recovery of principal and interest. Note: Midroog appends numeric modifiers 1, 2, and 3 to each rating category from Aa.il to Caa.il. The modifier '1' indicates that the obligation ranks in the higher end of its rating category, which is denoted by letters. The modifier '2' indicates that it ranks in the middle of its rating category and the modifier '3' indicates that the obligation ranks in the lower end of that category, denoted by letters /10/2017 Delek Group Ltd. Monitoring Report

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Updates and/or changes in ratings are presented on Midroog s website at which also has additional information on Midroog s Policies and/or the operation of its rating committee /10/2017 Delek Group Ltd. Monitoring Report