GCR Downgrades Ardova Plc Ratings, Outlook Negative

Following a decision to finance its acquisition with borrowings, GCR Ratings has downgraded Ardova Plc.’s national scale long-term and short-term Issuer ratings to B-(NG) and B(NG) respectively, from A-(NG) and A2(NG) previously.

Over the next 24 months, GCR Ratings has indicated an expectation that the integrated energy company will record net losses. Ardova’s earnings has deteriorated in the last 18 months, according to the rating note.

Despite an increase in revenue, its profitability has been under pressure after large borrowings to finance the acquisition of Enyo Limited. To strengthen its position, the management has hinted at a plan to inject equity capital in 2023.

This becomes necessary as the company has low cash holdings.

The rating agency also downgraded the long-term Issue rating of the company’s N25.3 billion Series 1 Senior Unsecured Bonds to B-(NG), from A-(NG) previously with the outlook revised to negative.

According to GCR, the multi-notch rating downgrade of Ardova Plc reflects the sharp and unexpected increase in debt level over the last 18 months to finance its various expansion projects.

This has also been compounded by much weaker earnings and liquidity, all of which have severely impacted its financial profile, the rating note stated.

In coming to its conclusion, GCR said it has factored shareholder support from Ardova’s parent, Prudent Energy and Services Limited into the ratings, reflecting its operational integration within the wider group.

“GCR has negatively adjusted the risk score of Ardova’s leverage and capital structure to reflect sharp deterioration in leverage metrics arising from increased debt level amid weak earnings”.

The company’s debt jumped over six times to N58.6 billion in the financial year 2021 -against an expectation of around N30 billion – and remained high at N55.1 billion in financial 2022.

Whilst analysts had factored in the N25.3 billion in bonds that were issued in 2022, the additional N26 billion in bank debt pushed gross debt well above expectation, according to the rating note.

The rating firm said the increased debt was utilised to finance the acquisition of Enyo Retail and Supply Limited and to fund other expansion projects within its newly established subsidiaries.

“While these projects are capital-intensive which benefits are expected to accrue over the medium term, earnings were adversely impacted during the intervening period”.

Consequently, net debt-to-earnings before interest tax depreciation and amortization (EBITDA) rose sharply to 26.3x at financial 2021, and was negative at financial 2022 versus 1.1x in 2020.

The company’s operating cash flow coverage of gross debt registered at 14% in 2022 on the back of strong working capital release due to improved creditor terms.

GCR said this is expected to unwind quickly as inventories are sold and suppliers are settled, reflecting high cash flow volatility.

Interest cover on the other hand is expected to remain within historical weak bounds of 0.5x to 1.0x on the back of poor earnings, according to the rating note.

Given the current economic environment, GCR said it expects the debt position to remain high over the medium term, with weak leverage metrics, thus significantly constraining the ratings.

“Management has hinted at a possible equity injection in two of the new subsidiaries of Ardova before the end of financial 2023 which may support an improvement in capital structure. However, such support will need to be substantial to reduce gearing risks”, GCR stated.

Concurrent with the rise in debt, Ardova’s earnings have deteriorated over the last 18 months with a negative EBITDA of N0.5 billion after declining to N1.5 billion in financial 2021 versus N5.2 billion in 2020) notwithstanding an increase in revenue over the period.

Thus, the company’s EBITDA margin fell to 0.7% and negative 0.2% in 2021 and 2022 respectively, from 2.9% in the financial year 2020.

Analysts attribute this to rising inflation, volatility in product supply, and government interferences on product pricing as the bulk of sales (over 70%) is derived from the regulated and low-margin product, petrol.

“This remains a key risk to Ardova’s earnings until product prices are fully deregulated.”

While GCR expects revenues to grow by 12% to 14% over the near term largely driven by higher volumes, especially from lubes and LPG, analysts stated that the EBITDA margin is projected to remain low between 1% and 1.5% over the medium term.

The rating note said this expectation due to inflationary pressures and sustained pricing rigidity, thus, project a further net loss over the next 24 months.

“The company’s liquidity profile is pressured by weak projected cash flows and low cash holdings, which are not sufficient to meet the short-term debt of N9.1bn in financial 2023 and an estimated N10bn in financial 2024 respectively”.

However, it said a portion of inventories has been factored into the calculation, as it comprises primarily fast selling petrol, which raises our liquidity ratio to around 1x over the next 12 to 18 months.

GCR notes that the company has access to a wide pool of financiers with whom it has maintained a good relationship over the years, but the increased likelihood of default on short-term obligations is negatively viewed.

The accorded ratings are supported by Ardova’s relatively good competitive position within the Nigerian oil and gas downstream sector, and the strong support from its parent company, PESL.

The parental support reflects Ardova’s importance within the wider group, given the high-level strategic and operational integration into Prudent Energy & Services Limited.

Nevertheless, management and governance assessment continues to be constrained by the weaker corporate governance at the Group level. The negative outlook reflects GCR’s concerns that the company’s high debt level is unsustainable, given the expected weak earnings over the near term.

This is because operating conditions are expected to remain challenging given inflationary pressures. #GCR Downgrades Ardova Plc Ratings, Outlook Negative