Fitch Affirms Hutama Karya at 'BBB-'/'AA+(idn)'; Outlook Stable

(Fitch Ratings - Singapore/Jakarta - 10 Apr 2023)-- Fitch Ratings has affirmed Indonesian government-related construction company PT Hutama Karya (Persero)'s (HK) Long-Term Issuer Default Rating (IDR) at 'BBB-'. The Outlook is Stable. Fitch has also affirmed HK's USD600 million government-guaranteed notes at 'BBB'. At the same time, PT Fitch Ratings Indonesia has affirmed HK's National Long-Term Rating at 'AA+(idn)' with a Stable Outlook.

HK's IDR is notched down once from the sovereign rating (BBB/Stable). This is underpinned by our assessment of its linkage strength with the state and the government's incentive to provide support under Fitch's Government-Related Entities (GRE) Rating Criteria, which results in an aggregate support score of 35. HK has received consistent, strong state equity injections over the years for its Trans Sumatera project.

The USD600 million notes are rated the same as the bonds issued by Indonesia due to the unconditional and irrevocable guarantee by the sovereign. The government bonds are, in turn, rated in line with Indonesia's Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'BBB'.

HK's 'b-'/'bb(idn)' Standalone Credit Profile (SCP) reflects its weak financial profile with thin interest coverage. However, this is counterbalanced by limited refinancing risks.

'AA' National Ratings denote expectations of a very low level of default risk relative to other issuers or obligations in the same country or monetary union. The default risk inherent differs only slightly from that of the country's highest rated issuers or obligations.

Key Rating Drivers

'Very Strong' State Linkage: Fitch regards HK as having a very strong linkage with the government based on our assessment of its 'Very Strong' status, ownership and control, and support track record factors. HK is the only Indonesian construction company that is wholly owned by the state. The government controls its investment decisions, strategy and operations and closely oversees its board of directors and board of commissioners.

Consistent Tangible Support: The government continues to extend tangible support to HK through recurring equity injections, debt guarantees, construction support and asset securitisation. HK is the only state-owned contractor that has received over IDR80 trillion in state injections since 2015, including IDR31.4 trillion in 2022 (2021: IDR25 trillion) for construction of the state-mandated Trans Sumatera toll road. The government also guarantees HK's debt for the project. We estimate that over 70% of HK's debt at end-2022 was government guaranteed.

'Strong' Financial Implications of Default: Fitch believes a default by HK would affect the ability and cost of raising funding for the sovereign and other GREs. This is because the government guarantees a significant share of HK's debt, giving rise to reputational risk as a default would undermine investor confidence in the state's ability to support other GREs. The assessment also reflects the size and extensiveness of HK's borrowings.

'Moderate' Socio-Political Importance: We think a HK default would have moderate socio-political implications as it is one of the key state-owned contractors mandated by the government to build strategic infrastructure. However, its importance is lower than that of providers of basic essential services, such as food or energy. Other GREs are also available to step in and substitute for HK's construction services, if needed, over the medium-to-longer term, limiting the potential disruption on national infrastructure projects.

State Injections Support Near-Term Leverage: HK's EBITDA net leverage dropped to 4.2x by end-2022 (2021: 10.4x) due to higher EBITDA and an ample cash balance from the sizeable state injection. We forecast EBITDA net leverage to stay low in 2023 based on our expectation of a IDR29 trillion equity injection that will sustain HK's large cash balance. However, EBITDA net leverage is likely to deteriorate in 2024 as HK uses its cash for construction projects. Our leverage calculation incorporates HK's substantial supply-chain financing (SCF) and long-term payables, which we classify as debt.

Stable Order Book: Fitch projects a stable order book with new contracts of IDR20 trillion-25 trillion in 2023 and IDR15 trillion-20 trillion in 2024 (2022: IDR20 trillion). This translates into an expected order book-to-revenue ratio of 1.5x-2.0x in 2023-2024 (2022: 1.8x). HK aims to finish the first stage of the Trans Sumatera construction by 2024. The company is in the advanced stage of discussions with the government on the funding mechanism for the second-stage construction.

Weak Interest Coverage: HK's weak financial profile is undermined by its thin interest coverage. We project EBITDA interest coverage to remain low at around 1.0x in 2023-2024 (2022: 1.4x) under our assumption of a 10%-15% EBITDA margin in 2023-2024 (2022: 17%). Rising interest rate risks are adding pressure on HK's coverage. This will be partly offset by our expectation of lower outstanding debt in the near term due to debt reduction on asset recycling and capital injections.

Negative FCF, Capex Flexibility: Free cash flow (FCF) is likely to stay negative in 2023-2024 as HK finishes the first-stage construction of the Trans Sumatera toll road. We expect capex to remain elevated at IDR20 trillion-25 trillion in 2023 (2022: IDR16 trillion) and IDR15 trillion-20 trillion in 2024. HK's negative FCF has been funded by government injections and debt financing. HK said its capex for the Trans Sumatera toll road will be mostly contingent on pre-approved government equity injections.

HK has the flexibility to scale back capex if there is limited visibility around the timing and value of government support. It is also considering several asset-recycling initiatives, including divestment of the Medan-Binjai and Bakauheni-Terbanggi Besar toll-road sections to the Indonesia Investment Authority. Proceeds from the asset sales, if they materialise, will alleviate cash flow pressure. HK now has a larger asset base for divestment as more sections of the toll road have started operating.

Derivation Summary

HK is rated one notch below the sovereign rating. This is comparable with Indonesia's mining industry holding company PT Mineral Industri Indonesia (Persero) (MIND ID, BBB-/Stable), Indonesian fertiliser company PT Pupuk Indonesia (Persero) (PTPI, AAA(idn)/Stable) and China Railway Group Limited (CRG, A-/Stable).

MIND ID is similarly rated on a top-down basis, one notch below the sovereign's rating. However, we believe MIND ID's default would have 'Very Strong' implications on the cost and availability of financing for the Indonesian government and other GREs. This is because investors consider MIND ID a proxy financing vehicle for the state due to its significant US dollar bond size.

PTPI's rating is equalised to that of the state. A default by PTPI would have 'Very Strong' socio-political implications, compared with 'Moderate' for HK, as it would adversely affect the distribution of subsidised fertiliser, jeopardising the country's food security.

We rate CRG using a top-down approach at two notches below China's sovereign rating (A+/Stable). CRG's aggregate GRE support score is 30 points and its SCP of 'bb-' is more than four notches below the sovereign rating. We believe HK ranks slightly ahead in importance to the government due to its 100% ownership and significant, consistent state support record.

However, we assess the socio-political and financial implications of a CRG default as 'Strong', compared with 'Moderate' and 'Strong', respectively, for HK. A CRG default would disrupt China's railway services and development plan, which is pivotal to the country's urbanisation. It could also disrupt China's geopolitical goals, as railway construction plays an important role in China's foreign policy. CRG is one of two leading contractors in China's railway development, making it difficult to find substitutes. The company is also an active domestic and international bond issuer and we believe a default could harm access to capital markets for the Chinese sovereign and its GREs.

HK's international and national SCPs are higher than the ratings of Indonesia-based garment manufacturer PT Pan Brothers Tbk (CCC-/CCC-(idn)). Pan Brothers faces near-term liquidity pressure with the maturity of its syndication loan in 4Q23. We expect Pan Brothers to continue facing challenges in obtaining additional bank facilities due to banks' diminished appetite in lending to the Indonesian textile sector. HK's liquidity and refinancing risks are more manageable in light of its long-dated debt maturities and better funding options with established access to state-owned banks.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

- New contract wins of IDR20 trillion-25 trillion in 2023 and IDR15 trillion-20 trillion in 2024

- EBITDA margin of around 10%-15% in 2023-2024

- Annual capex of IDR20 trillion-25 trillion in 2023 and IDR15 trillion-20 trillion in 2024

- Government equity injection of around IDR29 trillion in 2023 to support investments related to the Trans-Sumatera project.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- Positive rating action on the sovereign, provided there is no significant weakening of the likelihood of the government extending support to HK

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- Negative rating action on the sovereign

- Weakening likelihood of support from the Indonesian government

For the sovereign rating of Indonesia, the following sensitivities were outlined by Fitch in our ratings action commentary of 14 December 2022:

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- External Finances: A sustained decline in foreign-exchange reserve buffers, resulting, for example, from outflows stemming from a deterioration in investor confidence or large foreign-exchange interventions.

- Macroeconomic: A weakening of the policy framework that could undermine macroeconomic stability, for instance, resulting from continued monetary financing of the deficit in the next few years.

- Public Finances: A material increase in the overall public debt burden closer to the level of 'BBB' category peers, for example, resulting from failure to reduce the fiscal deficit to pre-crisis levels or accumulation of debt by publicly owned entities.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- Public Finances: A marked improvement in the government revenue ratio in the next few years closer to the level of 'BBB' category peers, including from better tax compliance or a broader tax base, which would strengthen public finance flexibility.

- External Finances: A material reduction in external vulnerabilities, for instance, through a sustained increase in foreign-exchange reserves, a further decline in the dependence on portfolio flows or lower exposure to commodity price volatility.

- Structural: Significant improvement of structural indicators, such as governance standards, closer to those of 'BBB' category peers.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Large Cash Balance: HK's liquidity and refinancing risks are alleviated by regular state injections, long-dated debt maturities and adequate funding access. It had about IDR34 trillion of available cash, which was sufficient to cover the IDR4 trillion in short-term debt, including the SCF. Its significant cash balance at end-2022 was bolstered by the IDR31.4 trillion state equity injection. The absence of major near-term maturities helps to ease the pressure on HK's financial flexibility. Over 80% of HK's debt at end-2022 will only mature from 2027.

HK has established lending relationships with various banks, including syndications. We estimate that more than 45% of HK's outstanding bank loans at end-2022 were from state-owned banks. HK also occasionally taps into the domestic bond market, raising around IDR1.3 trillion in domestic bonds and sukuk in 2022.

Issuer Profile

HK, 100%-owned by the government, is one of the largest engineering and construction companies in Indonesia with an order book of IDR42 trillion at end-2022. Construction-related service is the largest business segment, contributing 80% of 2022 revenue. It also has toll-road operations, sale of goods or building materials, and sale and rental of properties.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

HK is rated one notch below the Indonesian sovereign based on our GRE assessment.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. (ends)