The rating outlook is negative.

The rating action concludes the review for downgrade initiated on 31 August 2012.

RATINGS RATIONALE

The rating action reflects Moody's concern that the improvement in Cosmo Oil's balance sheet structure -- one of the major factors that supported the Baa3 rating -- will take much longer than expected, given the persistent erosion in profitability.

Its Chiba refinery -- which was gradually returning to normal operations after incurring damages due to the March 2011 earthquake in Japan -- was suspended again in June after an asphalt leak. As a result, Cosmo Oil has incurred additional costs and losses, given the costs related to providing alternative supplies to its customers and a decrease in the volume of exports. These factors have negatively affected profitability. The company projects that its petroleum business to record ordinary losses of JPY20 billion again in FYE3/2013, following ordinary losses of JPY17.2 billion in FYE3/2012, after adjusting for the impact of inventory valuations.

The Chiba refinery, which the company's plans to gradually restart from January 2013, produces 220,000 barrels of oil per day and accounts for 40% of Cosmo Oil's total domestic production of refined products in terms of volume.

In addition, Cosmo Oil had to reduce all of its deferred-tax assets at end-June 2012 after conservatively reviewing its future earnings. The amount at the end of September 2012 has not changed from June 2012. The company reviews its deferred-tax assets every quarter based on its earnings outlook at that point of time. This reduction of its deferred-tax assets significantly affects its equity and provides an indication of earnings prospects.

Depending on the progress in restarting operations at its Chiba refinery at end-March 2013, the amount of the reduction in deferred tax assets may change for FYE3/2013. If, at end-March 2013, the amount remains the same, then its net assets will drop by about 20% from the previous fiscal year, based on the company's current projection of net losses of JPY74 billion. Given the significant impact on its equity structure, restoring its eroded equity structure by using earnings from its existing businesses will take time. Moody's expects the company's adjusted debt/capitalization ratio to exceed 70% for FYE3/2013.

Moreover, Cosmo Oil plans to close its Sakaide refinery in July 2013, although it will continue to operate it as an oil terminal and for other purposes. This move is in response to requirements under the "Law Concerning Sophisticated Methods of Energy Supply Structures". To meet the requirement, Cosmo Oil will -- besides the Sakaide Refinery -- need to take an additional action by end-March 2014. It is yet to announce its plans on this matter. Moody's expects total one-time losses and expenses of more than JPY10 billion related to the closures.

Although the refinery closures will have a positive impact on its profitability in the long-term by improving its utilization ratios, the one-time losses and expenses relating to the closures will hamper the improvement in its balance sheet structure over the next few years.

Cosmo Oil's rating factors in its stable and strong relationships with its major banks (a regional factor for Japan), and support from Japan Oil, Gas & Metals National Corporation (JOGMEC), and which provide a two-notch rating uplift from its fundamental level of creditworthiness.

Moody's believes that the support system clearly helps Cosmo Oil, given the fact that covenant waivers for its two syndicated loans were approved by a majority of creditors without any additional fees. This also occurred even though the company breached the financial covenants based on its net assets at the end of September 2012.

One of the loans is for JPY20.7 billion due in February 2013, which will be repaid as scheduled. In terms of the rest of its loans - JPY35.3 billion due in March 2017 -- the company is highly likely to breach the covenants again, based on the current outlook for its full-year results for FYE3/2013. (The financial covenants are usually reviewed at the end of July-September, the second quarter of the fiscal year, and then at the end of January-March, the fourth quarter of the fiscal year, and in view of full-year results.)

If a breach occurs after the results for FYE3/2013 are finalized, then the company needs to start negotiations with its major creditors through its main bank that acted as an arranger of the syndicated loan. Moody's believes that it will successfully resolve the financial covenants for the second loan. However, Moody's is closely observing the covenants, as the timing of the next review is critical to determining whether Japan's support system works for Cosmo Oil for the second time.

The negative rating outlook reflects Moody's concerns that Cosmo Oil's overall credit metrics could come under further pressure if it faces additional delays in restarting the Chiba refinery. The outlook also incorporates Moody's recognition that the company could face a challenge in successfully resolving the issue of its covenants again, depending on the full-year results for FYE3/2013.

A significant deterioration in Cosmo Oil's profitability due to failures in its business strategy could lead to further downgrades. The ratings would also be negatively pressured if retained cash flow (RCF)/adjusted debt remains below 3%, adjusted debt/capitalization increases to 75%, or it reports negative free cash flow over the medium term.

The outlook could revert to stable if the company can improve RCF/adjusted debt to above 5% by stabilizing earnings from its petroleum business. At the same time, it will need to keep adjusted debt/capitalization below 70% for a prolonged period.

The principal methodology used in this rating was Moody's "Global Refining And Marketing Rating Methodology," published on October 1, 2010 and available on www.moodys.co.jp.

Cosmo Oil Company, Ltd., headquartered in Tokyo, is one of Japan's major oil refiners and distributors. Its consolidated sales for FYE3/2012 totaled JPY3.1 trillion.

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Noriko Kosaka Vice President - Senior Analyst Corporate Finance Group Moody's Japan K.K. Atago Green Hills Mori Tower 20fl 2-5-1 Atago, Minato-ku Tokyo 105-6220 Japan JOURNALISTS: (03) 5408-4110 SUBSCRIBERS: (03) 5408-4100 Richard C Bittenbender Associate Managing Director Corporate Finance Group JOURNALISTS: (03) 5408-4110 SUBSCRIBERS: (03) 5408-4100 Releasing Office: Moody's Japan K.K. Atago Green Hills Mori Tower 20fl 2-5-1 Atago, Minato-ku Tokyo 105-6220 Japan JOURNALISTS: (03) 5408-4110 SUBSCRIBERS: (03) 5408-4100 Copyright 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

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