Fitch Affirms Indika Energy at 'BB-'; Outlook Remains Negative

(Fitch Ratings - Singapore/Jakarta - 20 Aug 2021)-- Fitch Ratings has affirmed PT Indika Energy Tbk's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'BB-'. The Outlook remains Negative. Fitch has also affirmed the Indonesia-based mining company's outstanding senior unsecured notes at 'BB-'.

The Negative Outlook reflects our expectation of a likely resurgence in Indika's leverage post-2021 as coal prices decline from 2021's record levels and normalise from 2022, in addition to investment plans to diversify non-coal earnings, despite keeping leverage below the negative sensitivity in 2021. Indika announced early this year that it could invest up to USD1 billion in non-coal assets, while divesting some coal assets, to increase non-coal revenue to over 50% by 2025.

A revision of the Outlook to Stable hinges on the extent of de-leveraging beyond our base case expectation in 2021 and 1H22, on a continuation of strong coal prices against our assumptions. This could improve its financial buffer for planned investments, reducing risks to its financial profile. Fitch expects Indika's financial profile to strengthen materially in 2021, with an EBITDA of around USD740 million (2020: USD244 million) and net leverage below 2.0x (2020: 8.9x) supported by strong thermal coal prices.

Key Rating Drivers

Investment-Led Leverage Increase: Indika expects investments in new projects of about USD150 million a year in 2022-2024. Fitch factors this into the base case and expects meaningful returns from these projects only from 2024. So we forecast Indika's funds from operations (FFO) net leverage to rise to 3.0x in 2022, peaking at 3.7x in 2023, based on our conservative coal price assumptions, before improving gradually. Indika is likely to continue evaluating further new investments and divestures of existing assets. Fitch will consider these as event risks.

Diversification Strategy Prudent: Fitch views Indika's strategy as prudent over the long term, even though it may raise Indika's interim execution risks and financial risks until the non-coal projects are operational. These projects are in greenfield gold, renewable energy and electric vehicle sectors in which Indika hitherto has had no exposure.

The diversification could help Indika maintain its good access to funding markets to offset any material tightening for coal-related entities in the medium term from increasing ESG considerations. Fitch currently does not consider ESG issues to be significant enough to constrain Indika's ratings.

Coal Underpins Credit Profile: We expect Indika's 91%-owned key mining subsidiary, PT Kideco Jaya Agung to account for around 50% to 80% of Indika's annual EBITDA until earnings from its new investments commence. We also expect most of the remaining earnings in the same period to be from Indika's 70% owned contract mining and engineering subsidiary, PT Petrosea TBK. Fitch considers the impact of ongoing divesture of the 51%-owned coal barging subsidiary, PT Mitrabahtera Segara Sejati Tbk (MBSS), credit neutral given the small scale.

Kideco Stake to Remain; Drives Earnings: Indika has the option of either reducing its stake in Kideco by 25% upon the renewal of Kideco's coal concession in 2023 or to pay around USD220 million to the former shareholders of Kideco to maintain its 91% stake. Fitch's rating case assumes Indika would maintain its stake in Kideco over the medium term. Kideco is a mature coal asset with excess production capacity and a proven record of managing costs during price downturns. Fitch expects Kideco's EBITDA to increase to over USD600 million in 2021 (USD161 million in 2020) driven by robust coal prices.

Consolidated Earnings to Moderate: Fitch expects Indika's EBITDA to moderate to USD490 million-550 million from 2022 to 2025 from around USD740 million in 2021, as we expect lower medium-term earnings from Kideco. We expect Kideco's EBITDA to moderate to around USD375 million in 2020 and around USD250 million-330 million in the following years due to our assumption of moderating coal prices. (see Fitch Ratings Raises Short-Term Global Metals and Mining Price Assumptions, dated 26 May 2021, at www.fitchratings.com/site/pr/10164249).

Stable Petrosea Earnings: Fitch expects Petrosea to generate EBITDA of USD120 million-130 million a year until 2025 (USD113 million in 2021). Its 2021 EBITDA is likely to benefit from higher contract mining rates driven by strong coal prices, which would offset lower than expected volumes. We expect contract mining to account for over 75% of Petrosea's EBITDA, and engineering and construction (E&C) and port management for the rest.

We expect Petrosea to partner Indika for E&C works in new investments wherever possible. This should offset lower than expected contract mining volumes on its earnings in the next two to three years due to increased industry competition. The group also has further room for integration between Kideco and Petrosea, as Petrosea's contract mining accounts for less than 40% of Kideco's volumes.

Operating challenges at Tripatra: Fitch expects a considerable drop in the cumulative earnings contribution of Indika's E&C arm, Tripatra, from 2020 to 2024. Tripatra has generated about USD30 million-40 million of EBITDA a year over the past three to four years. Project losses due to a major change in scope of one of its main contracts, should result in considerable EBITDA losses until 2022. Fitch also expects a slower recovery in earnings post-2023 on a slower pick up in Indonesian oil and gas projects in the medium term.

Licence Renewals: Fitch expects the mining licence of Kideco to be extended upon expiry in 2023 without any major adverse effect on the credit profile, and will consider any significant negative development in concession renewals, including non-renewal, or materially higher royalties as event risks. Indonesia in 2020 clarified some aspects pertaining to the renewal, including the continuation of acreage and the extension of licences over two 10-year periods, but has not yet clarified revised royalty structures.

Derivation Summary

Indika's ratings are driven by Kideco's moderate cost position, production flexibility, reasonable reserves and large existing capacity, which require little capex. The similar ratings of PT Bayan Resources Tbk (BB-/Stable) reflect its lower cost position, larger reserves and a healthier financial profile with considerably lower sensitivity to price and volume assumptions than Indika. Bayan has faced operational disruptions due to bottlenecks in its transport infrastructure, which constrain its ratings. Indika's operations are more integrated and have a stronger record of uninterrupted production.

The energy-adjusted cost position of Indika's mining operations is stronger than that of Golden Energy and Resources Limited (GEAR, B+/Stable). Indika's operations are also more integrated than that of GEAR. Indika's higher ratings reflect its large scale of earnings, robust operational record and more integrated operations. GEAR's ratings are constrained until it can sustainably improve the scale of operations for the group.

Key Assumptions

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

- Kideco's average coal selling prices to increase to USD52.5/tonne in 2021 (USD38/tonne in 2020). Prices gradually fall to USD45/tonne in 2022, and USD43/tonne in 2023 and 2024;

- Kideco's coal mining volume increases to 36 million tonnes per annum (mtpa) in 2021 (33mtpa in 2020), and 34mtpa until 2025;

- Kideco's strip ratios to stay at around 5.4x-5.6x over the next five years, and cash production costs of around USD31/tonne to USD34/tonne;

- Petrosea EBITDA of USD118 million in 2021 and about USD120 million to USD140 million thereafter;

- MBSS sold in 2021 for USD40 million;

- New investment spend of USD150 million a year from 2022 and 2024;

- Capex for existing operations of USD80 million-85 million in 2021 to 2025 (mostly driven by Petrosea).

RATING SENSITIVITIES

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

- Fitch does not expect an upgrade in the near term because of the Negative Outlook;

- The Outlook will be revised to Stable if Indika can sustain FFO net leverage below 3.0x and FFO fixed-charge cover above 3.5x, and exercises financial prudence in execution of its non-coal related diversification investments.

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

- FFO net leverage is sustained above 3.0x and FFO fixed-charge cover less than 3.5x; and/or

- Indications of an overly aggressive approach in achieving its non-coal related diversification strategy.

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: Indika's liquidity profile is comfortable as it does not have any major debt maturities until November 2024, when its USD575 million senior unsecured notes are due. As of June 2021, Indika had other debt maturities of less than USD100 million a year until 2025.Indika has USD1.25 billion of its total consolidated debt of USD1.6 billion due in 2024 and 2025.

Fitch thinks Indika would not strictly require additional funds for the new investments until 2024, due to strong cash generation and healthy cash balances. Indika had cash of USD615 million as of June 2021.

Issuer Profile

Indika is an integrated coal company in Indonesia and owns 91% of Kideco, one of the country's largest coal mines. The majority of the group's earnings are from Kideco and contract mining operations at Petrosea. Indika is diversifying away from coal over the long run.

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.

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.