S-OIL Corporation -- Moody's: Insolvency of S-OIL's JV affiliate is credit negative

"S-OIL could face contingent liabilities because of moral obligations and subject to the position of HK Silicon's creditors, given that it is the second-largest shareholder and a JV partner of the insolvent affiliate," says Mic Kang, a Moody's Vice President and Senior Analyst.

"However, Moody's expects the company's credit profile to remain consistent with the current rating, because such potential liabilities would be manageable," adds Kang.

On 29 November, HK Silicon, a manufacturer of polysilicon for solar power, applied for a receivership at a court in Korea, because of its increasing leverage and interest expenses, weak profitability, and its failure to issue new shares to investors. It could take about a year for the court to decide whether HK Silicon would remain a going-concern or be liquidated.

S-OIL acquired the stake in HK Silicon for KRW265 billion in June 2011 to become a JV partner with a smaller local company called Osung LST Company Limited (unrated), in order to diversify its business into renewable energy, such as solar.

As of 30 June 2012, HK Silicon's debt amounted to KRW354 billion, which accounted for around 9% of S-OIL's debt.

On the other hand, S-OIL currently does not have any legal obligations -- such as intercompany lending, guarantees, and transactions -- related to HK Silicon, based on its public filings with the Korea Stock Exchange.

Even if S-OIL incurs impairment losses on its investment in HK Silicon, its cash flows would not be affected because such losses would be non-cash in nature.

Moody's believes that S-OIL has a solid financial buffer against unfavorable developments in its business conditions. Its average ratio of funds from operation to debt was 42%, while retained cash flow (RCF)/debt stood at 32%, from 2010 to 1H 2012.

In addition, Moody's expects that over the next couple of years S-OIL's adjusted RCF/debt ratio will remain above 15% on a sustainable basis, a level consistent with its underlying credit strength.

However, if S-OIL provides significant financial support to HK Silicon -- a situation that is unlikely, given S-OIL's recent public announcement that it would not make additional investments in the affiliate -- then its credit profile could be under pressure.

S-OIL's final Baa2 rating includes an uplift of two notches from its underlying credit strength, owing to the expected parental support from Saudi Aramco (unrated), a fully state-owned company of the Kingdom of Saudi Arabia (Aa3 stable), and the strong institutional support for the refining sector in Korea.

The principal methodology used in rating S-OIL was the Global Refining and Marketing Rating Methodology, published in December 2009. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

S-OIL Corporation (S-OIL) is the third-largest oil refining and marketing company in Korea, with a refining capacity of 669,000 barrels per day, or around 23% of the national refining capacity. In addition, S-OIL operates its paraxylene plants with a production capacity of 1.60 million metric tons per annum (MTA), and BTX plants with 0.93 million MTA of production capacity. It also has a lubricant plant with a production capacity of 38,000 barrels per day.

Listed on the Korean Stock Exchange, it is 35% owned by Aramco Overseas Company and 28.4% owned by Korea-based Hanjin Group.

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