Fitch Affirms Hutama Karya at 'BBB-'; Outlook Stable

(Fitch Ratings - Singapore/Jakarta - 15 Apr 2021)--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 support score under our Government-related Entities (GRE) Rating Criteria is 35. This along with the seven-notch gap between HK's Standalone Credit Profile (SCP) and the Indonesian sovereign rating (BBB/Stable) translates into an IDR that is notched down once from the sovereign rating.

The ratings reflect our view of HK's strategic importance to the Indonesian government's infrastructure development programme as the builder of Indonesia's longest (and one of the most strategically important) toll road in Sumatra. HK's IDR is one notch below the sovereign rating, in line with the GRE Rating Criteria, based on our assessment of strong linkages between HK and the government, and the government's incentive to provide support.

Leverage will remain high in the mid-term but we do not expect rating pressure, as the bulk of HK's loans are guaranteed by the government. This limits HK's refinancing risk. Nonetheless, we have lowered the national rating SCP to 'bb(idn)' from 'bb+(idn)' because of the high leverage; the international SCP is unchanged at 'b-' given HK's satisfactory liquidity.

'AA' National Ratings denote expectations of a low level of default risk relative to other issuers or obligations in the same country or monetary union.

KEY RATING DRIVERS

Robust Ownership, Continuous Support: Fitch assesses HK's status, ownership and control as 'Very Strong'. HK is the only construction company wholly owned by the government, which controls investment decisions, strategy and operations and closely oversees HK's board of directors and board of commissioners. The government has continued to provide tangible support - via equity injections, asset securitisation and construction support - to underpin HK's order book growth and toll-road investments.

In 2020, the government injected a total of IDR 11.0 trillion in equity into HK, which is higher than our initial expectations of IDR3.5 trillion. We expect this support to continue, as and when necessary. HK is pivotal to the government, investing in Indonesia's longest toll road in Sumatra. This incentivises the government to provide support by improving connectivity in Sumatra to increase economic growth.

Higher Orders in 2021: We believe HK's new contract volumes will increase in 2021 because of more projects to be tendered, after the coronavirus pandemic affected construction in 2020. HK's new contracts in 2020 were only IDR13 trillion (-48%), a stark contrast to our earlier expectations of IDR18 trillion. However, the government has renewed its emphasis on infrastructure development, reflected in the higher allocation for infrastructure in the State Budget 2021 of IDR414 trillion (+47%).

We expect HK's new contracts to increase to IDR18 trillion in 2021 and IDR20 trillion in 2022. This translates to a healthy ratio of order book to revenue of 2.0x to 2.2x in the next two years. For HK's key project, the trans-Sumatra toll road, the company obtained a total of IDR55 trillion new contracts in 2016-2020, or 60% of total contracts won during the period. The government also guarantees all of HK's debt taken for the toll road.

Leverage to Remain High: We expect leverage - measured as net debt/EBITDA and including supplier chain financing and long-term trade payables - to remain high at about 15x over the next two years as HK races to finish the toll road sections stipulated in stage one of the concession. HK has substantial supplier chain financing and long-term payables to third parties, which we have classified as debt. We estimate that a substantial 73% of HK's debt, including supplier chain financing and long-term payables, was guaranteed by the government at end-2020.

National SCP Lowered: Fitch has lowered HK's national rating SCP to 'bb' from bb+', due to the high leverage and weaker coverage compared with national rated peers at the same level. Even so, we have maintained our view of HK's international rating SCP at 'b-' despite weak metrics, as we expect solid banking relationships and timely government equity injections to support liquidity.

Capex Flexibility: The company says its capex, which largely stems from the trans-Sumatra toll road, will be mostly contingent on pre-approved government equity injections. It has the flexibility to cut capex in the event of diminishing visibility on the timing and value of government support.

'Moderate' Socio-Political Implications of Default: Infrastructure development is a cornerstone of the government's economic growth and urbanisation agenda. HK was appointed to build the trans-Sumatra toll road by presidential decree. However, the road is not an essential service, such as the provision of food or utilities, hence our 'Moderate' assessment. We also believe that a HK default will only temporarily disrupt its infrastructure projects because other GREs are available to step in as contractors, if required, over the medium to longer term.

'Strong' Financial Implications of Default: Fitch believes that a HK default will affect the ability of the sovereign and other GREs to raise funding, as the company's debt is government-guaranteed, and there is reputational risk. HK's funding resources has expanded with the USD600 million bond issue, but the government guarantee also means that there will implications for the government in the event of default.

Stronger Government-Ties Not Anticipated: We do not expect HK's socio-political importance or its financial importance to the government (as measured by our financial implications of default score) relative to larger and more strategic GRE's to improve in the medium term. This is because of the replaceable nature of its construction business and HK's lower significance in debt markets than more strategic GREs considered proxy financing vehicles for the government. Therefore, we have removed the associated positive rating sensitivity.

DERIVATION SUMMARY

We compare HK with Indonesian peers such as PT Indonesia Asahan Aluminium (Persero) (Inalum, BBB-/Stable) and PT Pupuk Indonesia (Persero) (PTPI, AAA(idn)/Stable), and Chinese construction companies such as China Railway Group Limited (CRG, A-/Stable), in our assessment of government support.

Inalum like HK is rated using a top-down approach at one notch below the sovereign rating. Inalum also has an aggregate GRE support score of 35 and its SCP is more than four notches below the sovereign rating. The key difference is that we believe Inalum's default would have 'Very Strong' implications on the cost and availability of financing for the Indonesian government and other GREs. This is because we believe investors view Inalum as a proxy financing vehicle for the state. This offsets Inalum's lower scores for ownership and support track record compared to HK.

CRG is rated using a top-down approach at two notches below China's sovereign rating (A+/Stable). Its aggregate GRE support score is 30 points and its SCP of 'bb+' is more than four notches away from the sovereign rating. We believe that HK ranks slightly ahead in importance to the government due to its 100% ownership, guaranteed debt and cornerstone role in Indonesia's infrastructure programme.

However, we assess the socio-political and financial implications of a CRG default as 'Strong', compared with 'Moderate' and 'Strong', respectively, for HK. Fitch believes a CRG default would result in significant disruption to China's railway services and development plan, which is pivotal in the country's urbanisation. It could also have a significant impact on 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 and it will be difficult to find substitutes in the short to medium term. The company is also an active domestic and international bond issuer, and we believe that a default could harm access to capital markets for the Chinese sovereign and other GREs.

HK's National Long-Term Rating of 'AA+(idn)' can be compared with PTPI's 'AAA(idn)' rating. PTPI's rating is equalised with that of its parent, the Indonesian government, due to their strong operational and strategic linkages. PTPI is the government's sole agent in producing and distributing subsidised fertilisers to eligible farmers through a public-service obligation scheme. HK has strong strategic and operational ties with the government, but toll roads are less politically and socially important. Hence, we believe that the government will provide PTPI with a greater degree of support than HK.

HK's SCP of 'b-' is comparable with that of domestic peer PT Wijaya Karya (Persero) Tbk (WIKA, BB-/A-(idn)/Negative; SCP: b-) and Tutor Perini Corporation (TUT, B+/Stable). TUT has much larger EBITDA scale and more geographically diversified projects compared with HK, which has high exposure to the trans-Sumatra toll road. Moreover, TUT has much lower leverage with stronger positive free cash flow generation. As a result, we believe the two-notch difference between both companies is warranted.

Both WIKA and HK have high leverage with limited geographical diversification, as most projects are in Indonesia. We expect WIKA to have a larger order book and lower leverage in the medium term. However, we believe HK has better capex flexibility and new contract visibility due to the government support of the trans-Sumatra toll road. Moreover, we believe that HK has less refinancing risk due to only 16% of its total long-term debt and bonds maturing after 2024. So, we believe that both companies can be rated at the same level in the international scale. However, we see HK's higher leverage and weaker coverage compared with that of WIKA as warranting a two-notch differential in the national scale, leading to HK's SCP at 'bb(idn)' against WIKA's at 'bbb-(idn)'.

KEY ASSUMPTIONS

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

- New contract wins of between IDR18 trillion-20 trillion in 2021-2023;

- EBITDA margin of 9%-11% in 2021-2023;

- Capex of around IDR10 trillion-15 trillion in 2021-2023;

- Government equity injection of between IDR10 trillion-20 trillion in 2021-2023 to support investments related to trans-Sumatra projects.

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 to HK.

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

Adequate Liquidity; Long Maturity Schedule: HK's liquidity is supported by a cash position of around IDR11.1 trillion as of end-December 2020, which was driven by the government's equity injection of IDR11 trillion in 2020. This is sufficient against short-term debt (including SCF) of IDR7.3 trillion and around IDR4 trillion of Fitch-estimated negative free cash flow (FCF) net of government equity support in 2021, because we believe its working capital loans of around IDR3.0 trillion will be rolled over annually in the normal course of business.

The company's negative FCF is also supported by its uncommitted and undrawn loans of nearly IDR21 trillion, most of which is available to fund construction and working capital. This, along with the absence of major near-term debt maturities, mitigates liquidity risk. A significant portion of its long-term bank loans has a seven-year grace period, where principal repayments do not start before 2024. In addition, only 8% of its IDR15 trillion in total outstanding bonds will mature before 2025.

HK generates substantial negative FCF every year, and depends on external financing and government equity injections to execute its mandate to construct the trans-Sumatra toll road. We believe that liquidity will remain adequate with government support, as well as HK's solid domestic banking relationships and proven access to the domestic capital markets, despite its weak metrics.

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 due to its linkages to the state.

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)