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DeutscheBankMarketsResearchEmergingMarketsChileIGCorporateCreditEnergyCompanyEmpresaNacionaldePetroleoDate12September2017Initiatingon'47BondIssuancewithaSELLratingDeutscheBankSecuritiesInc.DISCLOSURESANDANALYSTCERTIFICATIONSARELOCATEDINAPPENDIX1.MCI(P)083/04/2017.XavierOlaveResearchAnalyst(+1)[e-mail]Analyst(+1)[e-mail]geoftheUSD600mnENAPCL4.5%’47noteswithaSELLrecommendation;weseethebondastherichestontheLatAm30-yearsectoronarelativevaluebasis,despitethecompany’srelativelyweakcreditfundamentals(offsetbygovernmentsupport)On9/11/2017,ENAP(Baa3/BBB-/A)issued(atadiscountpriceofUSD97.13)USD600mn144A/RegSseniorunsecuredinternationalnoteswithacouponrateof4.5%(yieldof~4.7%withamaturityofSeptember2047).Weareinitiatingcoverageofthenewissuewitha‘SELL’rating.Thenewissue’sz-spreadof~230bpisthetightestamongthecompany’speergroupinEmergingMarkets(inthe30-yearbondsector).Thenewissuepriced40bp+insideitsnearestChileancorporatepeersamongthe30-yearmaturitysubsegment(TransmissioncompanyCeleoRedesOperacion;CELEO)andonly~40bpwiderthanChileanminingSOECodelco(CDEL),whichistheparamountstrategicstate-ownedassetinthecountry.Issueisrelativelyexpensiveversusstronger,largerLatAmenergypeersInthe30-yearmaturitysector,thenewENAPissuanceisapproximately170bpinsidetheaveragez-spreadfor30-yearLatAmenergySOE’swithbetterstand-alonecreditfundamentalsandsizeandscale(Petrobras,Ecopetrol,Pemex).Evenexcludingnon-IGratedPetrobras,thenewissuecamein~150bpinsidetheaveragez-spreadforEcopetrol(soliddeleveragingtrajectorydespiteoilreserveoverhang)andPemex(lowoilpricesensitivitydespitefallingproductionandhighercosts/expenses).(PleaseseethePDFversionofthereportfortherelativevaluechartsandfinancialmodel)Stronglinkagetosovereignremainscompany’smaincreditstrength;financialperformancehasweakenedrecentlyENAPisChile’snationaloilcompany(whollystate-owned)andthesecondlargeststate-ownedenterpriseintermsofrevenues.GiventhelackofhydrocarbonresourcesinChile,thecompany’spositionasthechiefimporterofrefinedproductionsandtheownerofallofChile’srefiningcapacitymakesthecompanyakeycogforthecountry.Upuntil2015thecompanyhadbeenshowingimprovingcreditfundamentalsfollowingaveryweakperiodintheearly2010’s(2012grossleveragereachedapproximately100x).Leveragemetricshaveweakenedfromarecordlowof5.1xin2015,inchingupto5.8xin2016andthenafurtherstep-upto6.6xintheLTMJune2016period.SecondquarterresultsshowedcontinuedrelativeweaknessIntermsofrecentfinancialperformance,inthesecondquarterthecompanyreporteda4.5%yoydeclineinEBITDAdrivenbyweakerrefiningmarginscoupledwithincrementalcostsduetoamaintenancestoppage.ForthelastfourquartersthecompanyhasreportedaFCFburn,andweexpectthecompany’scashburnleveltobesignificant,giventheinvestmentsinpowergeneration.Inourview,FCFislikelytoremaininthenegativeterritoryandDistributedon:12/09/201720:09:25GMT0bed7b6cf11c12September2017IGCorporateCredit,EnergyEmpresaNacionaldePetroleoPage2DeutscheBankSecuritiesInc.leveragetobemaintainedataminimum6xlevels(weakfortheratingcategory),whichshouldkeepbondsupplyriskrelativelyelevated,inourview.Intermsofoperatingperformance,inthesecondquarterthecompanyretaineditsdominantmarketpositioninChile,representing30%ofthecountry’senergymatrixandsatisfying60%ofChileandemandforrefinedproducts.EBITDAcameinatUSD152mn,(-1%onasequentialbasis,-14%onaYoYbasis)onthebackofweakerrefiningmarginsfromrelativelyhigherfeedstockpricesandincrementalcostsduetothemaintenancestoppageatoneofitsthreerefineries(BioBio).Asaresult,EBITDAmarginsdroppedby315bpsyoy,to10%–therefiningmargindeclinedto8%(downby5%YoY)mainlyduetohigherfeedstockpricesDebthasremainedrelativelystable,thoughithaspicked-uprecently;Expectslightincreasepost-issuanceasmostoftheproceedswillbeusedforrefinancingpurposesGrossdebthasrisenfromUSD3.8bntoUSD4.1bnasof2Q17;thecompanyintendstouse70%ofthenewissue’sproceedstorefinanceexistingdebtwiththeremaindergoingtowardsfundingworkingcapitalneeds,capexandgeneralcorporatepurposes.Proformafortheissuance,LTM2Q17grossleveragewouldriseto6.9xversus6.6xcurrently.Weexpectthecompanywillcontinuetoburncashinthenearterm(1H17CapexreachedUSD333mn(2Q17CapexatUSD177mn,+13%sequentially)asitinvestsinpowergeneration,thoughthecompanycouldbenefitfromcontinuedcrudeoilpricedeclines.ThecompanyremainscommittedtomaintainIGrating,andinourviewthiscouldprovelikelydespiterecentfinancialweakness(duetosovereignlinkage).Inourview,leverageislikelytoremainatcurrentlevelsinthenearterm.Managementexpectsdeleveragingtotakeplaceasitselectricityprojectsmature,anditisstillawaitingtheUSD400mncapitalinjectionbytheChileanGovernmentthathasbeenpromisedsince2013(itwasapprovedbytheSenateinJune2017).Asthecapitalizationhasnotmaterializedinto3Q17,wearenotsurprisedthatthecompanyhadtotaptheinternationalcapitalmarketstofunditsFCFdeficit.12September2017IGCorporateCredit,EnergyEmpresaNacionaldePetroleoDeutscheBankSecuritiesInc.Page3Figure1:Z-spreadvs.Rating(EMCorporates–30YearSector)PEMEX6.625'35CFELEC6.125'45ECOPET7.375'43PETBRA7.25