Last night, after markets closed, Fitch downgraded Pemex to BB+ (with negative outlook) from BBB-, as we predicted.
The agency stated that “the negative outlook reflects the potential for further deterioration of the company's stand-alone credit profile to below CCC” and that, “although Pemex has implemented some cost cutting measures and received moderate tax cuts from Mexico, the company continues to severely under-invest in the upstream business, which could lead to further production and reserves decline”.
Almost in parallel, Moody's changed the outlook on the company’s ratings to negative from stable (in line with its change to the outlook on the sovereign rating), basing it on the “critical importance of the government's financial strength and support to Pemex’s Aa3.mx/Baa3 ratings”. The decision also reflected Moody’s “expectations of ongoing negative free cash flow at Pemex and declining proved reserves, despite efforts to cut costs and boost capital spending”.
In response, Pemex and Mexico’s Ministry of Finance issued statements criticising the rating agencies, describing the actions as “excessively severe”.
Maintain Hold on Pemex bonds
We maintain our Hold recommendation on Pemex’s bonds for purely technical reasons. The bonds have shown resilience because many investors hold on to their positions for the premise that, the weaker Pemex gets, the higher the likelihood that the federal government will intervene. This makes Pemex like a sovereign risk, but at a premium to the sovereign.
We believe that it is only a matter of time before Moody’s also moves Pemex’s bonds to junk, although we do not expect that to happen for a few months at the earliest. In our opinion, a Moody’s downgrade would finally convince investors that: 1) Pemex is, in fact, a deteriorating credit; 2) the government can only do so much for fear of undermining sovereign ratings and creditworthiness; and 3) once two agencies rate Pemex as junk, a flurry of forced selling will take place.
However, we believe current Pemex holders will continue to count on the government’s support and will hold on to their positions. Pemex bond prices should, therefore, trade mostly laterally, with a few ups and downs, driven by news headlines and possible future government measures.
Fitch downgrades CFELEC
Separately, Fitch also downgraded Mexico’s Federal Electricity Commission (CFE; ticker: CFELEC) yesterday to BBB from BBB+ and revised its outlook to negative from stable. Moody’s affirmed its CFELEC rating of Baa1, but also changed the outlook on the rating to negative from stable. We noted in January that investors were overlooking CFELEC’s risks.
Although CFELEC is an important government-owned quasi-sovereign, it does not have the scale and/or scope and, therefore, the strategic importance to the government that Pemex does. However, we are of the view that CFELEC is even more poorly managed than Pemex and that it is only a matter of time before it joins Pemex in the junk category.