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

(Fitch Ratings - Jakarta/Singapore - 12 Apr 2022)--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 based on its support score of 35 under Fitch's Government-Related Entities (GRE) Rating Criteria and the seven-notch gap between the sovereign rating and HK's 'b-'/'bb(idn)' Standalone Credit Profile (SCP) amid high leverage but limited refinancing risks. HK's ratings reflect our view of its strategic importance to the government's infrastructure development programme.

'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

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

The government injected IDR25 trillion in equity into HK in 2021. This exceeded our initial expectation of IDR13 trillion. We expect this support to continue as and when necessary. HK is pivotal to the government due to its investment in the country's longest toll road, located in Sumatra. Improving connectivity in Sumatra to boost economic growth incentivises the government to provide support.

Increasing Orders: We expect higher new contract volume in 2022 as more projects are tendered. This follows subdued construction activity in the past two years due to the Covid-19 pandemic; new contracts in 2021 were down by 11.2% from 2020, amounting to only IDR11.5 trillion, a stark contrast to our forecast of IDR18 trillion. However, the government has renewed its emphasis on infrastructure development, reflected in the IDR365.8 trillion allocation to infrastructure in the 2022 state budget.

Our forecast is for new contracts to increase to IDR17 trillion-20 trillion annually in 2022 and 2023. This would translate into a healthy order book/revenue ratio of 1.8x-2.1x. HK obtained IDR58 trillion in new contracts during 2016-2021 for its key trans-Sumatra toll-road project, representing 56% of total contracts won during the period. The government guarantees all of HK's debt taken for the toll road.

High Leverage, Negative FCF: We expect leverage - measured by net debt/EBITDA, including supply-chain financing and long-term trade payables - to stay high, at about 10x-15x, over the next two years. We also forecast negative free cash flow (FCF) as HK races to finish the toll-road sections stipulated in stage one of its concession. HK has substantial supply-chain financing and long-term payables to third parties, which we classify as debt. We estimate that the government guaranteed more than 70% HK's debt, including supply-chain financing and long-term payables, as at end-2021.

Capex Flexibility: HK 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 should the visibility on the timing and value of government support diminish. HK is discussing the construction of section two of the toll road with the government, including its funding.

'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 would only temporarily disrupt its infrastructure projects, as other GREs are available to step in as contractors, if required, over the medium to longer term.

'Strong' Financial Implications of Default: We believe a HK default would limit the ability of the sovereign and other GREs in raising funding, as the company's debt is government guaranteed. There is also reputational risk. HK's funding resources have expanded following its USD600 million bond issue and the government guarantee creates implications for the state should HK default.

Stronger Government Ties Unlikely: We no longer expect HK's socio-political or financial importance to the government relative to that of larger and more strategic GREs to strengthen in the medium term, as measured by its financial implications of default score. This is because of the replaceable nature of HK's construction business and its lower significance in debt markets compared with strategic GREs that we consider to be proxy financing vehicles for the government.

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), as well as with Chinese construction companies, such as China Railway Group Limited (CGR, A-/Stable).

Inalum is similar to HK, as we rate it using a top-down approach at one notch below the sovereign. Inalum also has an aggregate GRE support score of 35 and its SCP is four notches below the sovereign rating. However, we believe Inalum's default would have 'Very Strong' implications for the cost and availability of financing to the government and other GREs, as we think investors view Inalum as a proxy financing vehicle for the state.

Meanwhile, PTPI's rating is equalised with that of its parent, the Indonesian government, based on strong operational and strategic linkages. PTPI is the government's sole agent in producing and distributing subsidised fertiliser 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 the government would provide PTPI with a greater degree of support than HK.

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 away from the sovereign rating. We believe HK ranks slightly ahead in importance to the government due to its 100% ownership, guaranteed debt as well as its cornerstone role in Indonesia's infrastructure programme. However, we assess the socio-political and financial implications of CRG's default as 'Strong', compared with 'Moderate' and 'Strong', respectively, for HK, as we believe its 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 its default could harm access to capital markets for the Chinese sovereign and other domestic GREs.

HK's SCP is comparable with that of its domestic peer, PT Wijaya Karya (Persero) Tbk (WIKA; BB-/A-(idn)/Negative; SCP: b-/bbb-(idn)). Both companies have high leverage with limited geographical diversification, as most projects are focused in Indonesia. We expect WIKA to have a larger order book and lower leverage in the medium term, but believe HK has better capex flexibility and new contract visibility due to government support for its flagship trans-Sumatra toll-road project. Moreover, we believe HK has less refinancing risk, as around 78% of its total debt will only mature after 2026. As a result, we rate both companies at the same level on the international scale, but believe HK's higher leverage and weaker coverage warrants a two-notch difference on the national scale.

Key Assumptions

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

- New contract wins of between IDR17 trillion-20 trillion in 2022-2023

- EBITDA margin of around 12%-13% in 2022-2023

- Capex of around IDR15 trillion-25 trillion a year in 2022-2023

- Government equity injection of around IDR20 trillion-32 trillion in 2022 and IDR10 trillion-15 trillion in 2023 to support investments related to the trans-Sumatera 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

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 IDR21 trillion as of end-2021, driven by a government equity injection of IDR25 trillion in 2021. This is sufficient to cover short-term debt, including supply-chain financing, of about IDR4 trillion. HK's negative FCF is supported by its committed and undrawn facilities of around IDR19 trillion, most of which are available to fund construction and working capital. This, along with the absence of major near-term maturities, mitigates liquidity risk. A significant portion of long-term bank loans has a seven-year grace period, where principal repayments do not start before 2024. In addition, only 17% of HK's IDR19 trillion in total outstanding bonds and sukuk at end-2021 mature before 2025.

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

Issuer Profile

HK is a national construction and investment company that is fully owned by the government of Indonesia, held through the State Ministry of State-Owned Enterprises as the Shareholders Proxy. HK is Indonesia's only fully state-owned construction companies and one of the country's largest, with an order book reaching IDR47 trillion by end-2020.

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 state linkages.

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)