Fitch Affirms Indika Energy at 'BB-'; Outlook Stable

(Fitch Ratings-Singapore-28 November 2019)-- Fitch Ratings has affirmed the Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) on PT Indika Energy Tbk at 'BB-'. The Outlook is Stable. Fitch has also affirmed the company's outstanding senior unsecured notes at 'BB-'.

The affirmation of Indika's ratings and Stable Outlook reflects Fitch's expectation that the company would be able to reduce its leverage, measured by FFO adjusted net leverage, to below 3.0x from 2020 and sustain a credit profile commensurate with the 'BB-' rating, due to positive free cash flow (FCF) as a result of increased coal production and volume growth at its coal contracting and barging businesses.

The ratings reflect the moderate cost position of Indika's mining operations, market position as one of Indonesia's largest coal miners, and improving integration via its coal contracting operations and adequate liquidity. Indika also aims to reduce its earnings exposure to Indonesian thermal coal, which could incur investments. Fitch does not expect these investments to materially weaken Indika's leverage, although Indika's rating headroom has reduced following the downward revision of Fitch's coal price assumptions (see "Fitch Ratings Updates Mid-Cycle Metals and Mining Price Assumptions" published on 6 November 2019).

KEY RATING DRIVERS

Reduced Rating Headroom: Fitch expects Indika's FFO net leverage to increase to around 4.1x in 2019, and remain between 2.5x and 3x from 2020. The increase in leverage in 2019 (2018: 1.9x) was due to weak coal prices, higher capex spend and increased cash taxes, partly due to the strong profitability in 2018.

Fitch expects some improvement in Indika's leverage from 2020 due to higher production volumes of its 91% owned subsidiary PT Kideco Jaya Agung, which should offset the impact of lower unit profitability on total cash flows, as well as reduced capex intensity. Fitch also expects the earnings of the group's 70%-owned coal-mining contractor, PT Petrosea Tbk, and its 51% owned coal barging company, PT Mitrabahtera Segara Sejati Tbk (MBSS), to increase over the next three to four years. The improved earnings will be driven by the group channelling more overburden removal and coal transport volumes from Kideco through Petrosea and MBSS.

Lower Coal Prices Reduce Profitability: Indika expects Kideco's production to increase in 2020 and 2021 to over 35 million tonnes, from 34 million tonnes in 2018 and a similar amount expected in 2019. The increased output would partly counter the lower unit profitability on cash generation due to weaker expected coal prices. Fitch expects Kideco's EBITDA per tonne to decline to around USD6.7 in 2019, and to around USD6.1 in 2020 (2018: USD14) as global coal prices decrease. Kideco produced up to 40 million tonnes in 2014 and has adequate infrastructure capacity to ramp up production, without incurring much capex.

Strong Kideco Profile: Kideco is among Indonesia's five-largest coal miners, with annual production of around 34 million tonnes, accounting for over 70% of Indika's consolidated EBITDA in 2018. Fitch estimates that, in terms of energy-adjusted mining costs, Kideco is in the second quartile of the global seaborne thermal coal cost curve. According to CRU, factoring in Kideco's total cash costs, including its relatively high tax structure, Kideco's position is around the third quartile.

Kideco's reserve life is also adequate for the rating at over 15 years based on its expected production. Kideco's financial profile is extremely robust, with no debt or major capex, resulting in a majority of its cash generated paid as dividends. Kideco had EBITDA of USD479 million in 2018 (2017: USD526 million) and paid dividends of USD225 million (2017: USD300 million).

Concession Renewal Risk: Kideco's mining licence expires in 2023. Fitch does not foresee any major risks to renewal and assumes the licence will be successfully converted to a new format and extended. Fitch does not expect and potential changes to the concession structure to have a significant impact on Indika's operating and financial profile, due to the importance of concessions to state revenue and Indonesia's coal industry. We will consider any significant negative developments in concession renewals, including non-renewal, as event risk.

Integrated Business Model: Fitch expects both Petrosea and MBSS to benefit from increasing volumes from Kideco, which should minimise the impact of volatile coal prices on these companies. Petrosea's credit profile benefits from a strong customer profile, which includes Kideco and the low-cost miner PT Bayan Resources Tbk (BB-/Stable), which together accounted for over 70% of Petrosea's overburden removal volumes. Fitch expects Petrosea to contribute to about 30% of Indika's consolidated EBITDA in 2020 (19% in 2018) and MBSS to account for around 8% of Indika's consolidated EBITDA (4% in 2018).

We do not expect Petrosea and MBSS to make a meaningful contribution to Indika's dividend income in the coming few years, although they are not likely to require Indika's financial support in the near to medium term. Indika has fully owned operations in infrastructure and energy engineering and construction projects under the Tripatra group, which we expect to generate annual EBITDA of about USD30 million-40 million during the period.

Low Risk in Quota Approvals: Fitch's expectation of higher output by Indika depends on the quotas it receives from the state. Fitch thinks the risk of Indika failing to meet the output expectation is low given its compliance with requirements in supply to the domestic market, which we think are a key determinant for quota approvals. Fitch also does not anticipate any significant drop in Indonesia's total production targets, as taxes and royalties from coal are important to the state.

Price Cap on Domestic Sales: Coal companies are required to sell coal in the domestic market at price limits set by the state until end 2019. Fitch does not rule out the continuation of a similar mechanism after 2019, although the impact on the expected credit metrics of Indika is not likely to be material as benchmark coal prices are likely to remain at or below capped levels.

Diversification Strategy: Indika has invested in an USD115 million in a fuel storage facility, most of which would be incurred in 2019, as part of its attempt at business diversification. Apart from this, Fitch has not factored in any major investments in diversification projects in our financial forecasts. Earnings contribution from Indika's diversification investments is likely to be limited over the medium term.

DERIVATION SUMMARY

Indika's ratings are driven by Kideco's moderate cost position, production flexibility, reasonable reserves and large capacity, which require little capex. PT Bayan Resources Tbk (BB-/Stable) is rated at the same level, reflecting its comparable operational risk profile to Indika. Bayan has a lower cost position and larger reserves than Indika and has a healthier financial profile with minimal debt. However, Bayan has faced operational disruptions owing to bottlenecks in its transport infrastructure, which constrain its ratings. Indika's operations are more integrated and have a stronger track 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 also has more integrated operations than GEAR. Indika's higher ratings reflect its larger scale of earnings, stronger operational track record and more integrated operations. GEAR's ratings are constrained until it is able to generate higher earnings. (ends)