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

(Fitch Ratings - Jakarta/Singapore - 19 May 2023)-- Fitch Ratings has affirmed PT Indika Energy Tbk's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) and rating on the outstanding notes at 'BB-'. The Outlook on the IDRs is Stable. At the same time, Fitch Ratings Indonesia has affirmed the National Long-Term Rating at 'A+(idn)' with a Stable Outlook.

The affirmation and the Stable Outlook reflect Fitch's expectations that Indika's financial profile will remain strong over the next three years, even as we factor in lower coal-price assumptions along with an increase in the company's diversification investments to raise non-coal revenue. High coal prices over the past two years have supported improvement in Indika's financial profile, reflected in its net cash position at end-2022 (2021: EBITDA net leverage 0.7x).

The net cash position also enhances Indika's flexibility to manage bond maturities over the next three years despite investments, and mitigates the risks from tightening of funding access for thermal coal companies. The ratings continue to reflect its position as a leading Indonesian coal producer and the modest cost position of its coal mining operations at its 91%-owned subsidiary, PT Kideco Jaya Agung.

'A' National Long-Term Ratings denote expectations of low default risk relative to other issuers or obligations in the same country. However, changes in circumstances or economic conditions may affect the capacity for timely repayment to a greater degree than is the case for financial commitments denoted by a higher rated category.

Key Rating Drivers

Large Cash Buffer Supports Investments: We expect Indika's large cash balance of USD1.2 billion at end-March 2023 to support its investments over the next three years. Indika plans to invest about USD450 million during 2023-2025 in mainly new business ventures, as the company works towards its target of 50% of revenue from non-coal businesses by 2025 (2022: 12%, 2021: 13%). Indika's existing operations, including Kideco, Tripatra and Indika Indonesia Resources, have modest capex requirements, averaging at about USD50 million-100 million a year in 2023-2025.

Earnings to Moderate: Fitch expects Indika's EBITDA to decline to USD300 million-360 million in 2024- 2026, from about USD540 million in 2023 (2022: USD 1.27 billion), as we factor in lower coal-price assumptions, a new royalty and tax structure under their converted IUPK (special mining business permit) licence and a reduction in coal production to about 30 million tonnes per annum (mtpa) (2022: 34.8mtpa) over the medium term, in line with management guidance. We forecast EBITDA of USD20 million-45 million from new investments in 2023-2024 with most businesses still ramping up operations.

We expect Indika's EBITDA after 2024 to start rising modestly. We factor in EBITDA of USD117 million in 2025 and USD157 million in 2026 from Indika's new businesses, mainly the Awakmas gold project, Interport and the EMITS solar project.

Coal Mining Business Remains Key: We expect Kideco to continue to underpin Indika's credit profile over the next two to three years, contributing robust cash flow to the group until earnings from its new investments ramp up. We expect Kideco to contribute about 85% of the group's EBITDA in 2023, before declining to about 67% in 2024 and 60% in 2025 as Indika's diversification projects contribute more.

Evolving Business Profile: Indika's business profile should evolve over the next two to three years as it works towards increasing non-thermal coal earnings. Some of Indika's investments are in emerging industries, which means its position in those evolving competitive landscapes will affect Fitch's assessment of the future credit profile. Still, Fitch believes that Indika's strategy to diversify beyond thermal coal should help mitigate the challenges arising from tightening funding access for thermal coal players from increasing environmental, social and governance (ESG) considerations.

Risks to Diversification Targets: We expect non-coal revenues to gradually rise closer to Indika's target during 2025-2026, on lower thermal coal prices and as revenue from Indika's new projects starts to pick up. Even so, the risk to Indika's target of 50% non-coal revenue remains; a slower ramp up than Fitch expects of new businesses or higher coal prices could delay the revenue diversification target.

Manageable Execution Risk: We expect the execution risks of Indika's diversification in greenfield investments to be largely manageable, given its cautious approach. The company has also been partnering with strategic investors, with more experience in the respective industries when entering a new and evolving industry. Management also has a solid record of managing commodity downcycles, Consequently, we treat the new investments as neutral to Indika's credit profile.

Kideco's Strong Operations: Indika benefits from Kideco's long record of stable volumes, robust cost position and ability to curtail operating costs during periods of low coal prices. Kideco was able to sustain its EBITDA per tonne above USD4, even during the previous market downturn in. We expect Kideco's EBITDA per tonne to range around USD18 in 2023 and thereafter be around USD6-10 over the next three years.

Kideco's reserve life is also adequate for the rating, at over 15 years based on its expected production. The conversion of Kideco's mining licence to IUPK in December 2022 has also reduced regulatory uncertainty.

Comfortable Rating Headroom: We forecast Indika's net leverage to remain below 0.1x in 2023-2026 (2022: net cash position), remaining comfortably below our negative rating sensitivity of 2.5x, driven by stable earnings from its coal mining operations, manageable investment outlays and a gradual increase in earnings contribution from new projects. In our rating case, we expect the rating headroom to be maintained despite significantly lower coal-price assumptions in line with Fitch's commodity price deck.

Derivation Summary

Indika's closest peer is PT Golden Energy Mines Tbk Tbk (GEMS, BB-/Stable). We think both Indika and GEMS have a competitive cost position with demonstrated ability to manage costs in line with coal price movements and an adequate reserve life for their key mines. We expect GEMS's scale to increase beyond Indika's, given the former's plans to continue to increase production. This is offset by Indika's stable and well-established operations with a much longer record, in our view.

We believe Indika's diversification strategy beyond thermal coal would help mitigate the challenges arising from tightening funding access for thermal coal players from increasing ESG considerations. However, we think this difference is offset by GEMS's more conservative financial profile with a consistent net cash position and limited dependence on external funding, justifying rating both at the same level.

Key Assumptions

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

- Kideco's average coal selling prices in line with Fitch's coal price deck as follows for the Newcastle 6000 index:

2023: USD190/tonne

2024: USD90/tonne

2025: USD83/tonne

2026 and beyond: USD63/tonne

- Kideco's coal mining volume to be 31 million tonnes in 2023 (2022: 34.8 million tonnes) and further reduce to 30mtpa from 2024, in line with management guidance.

- Kideco's strip ratios to stay at around 4.7x-5.8x over the next four years, and cash production costs (excluding royalty) of around USD27/tonne to USD35/tonne.

- New royalty structure to be applicable from 2023, following the conversion from a coal contract of work to an IUPK in December 2022.

- New investment spending of USD190 million-195 million a year in 2023 and 2024; EBITDA from new investments at USD20 million in 2023, USD45 million in 2024, USD120 million in 2025 and USD160 million in 2026. Our assumptions are 10%-20% lower than management guidance.

- Capex for existing operations of USD11 million-20 million a year.

RATING SENSITIVITIES

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

- Fitch does not expect an upgrade in the near term, as the company's business profile is still evolving as it transitions towards a more diversified earnings base;

- An upgrade may be considered if Indika demonstrates a record of successful execution of non-coal investments resulting in improvement of the overall business profile while maintaining a prudent financial structure.

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

- Net debt/EBITDA of above 2.5x and fund flows from operations net leverage of above 3.0x;

- Indications of an overly aggressive approach to investment for achieving its non-coal diversification strategy;

- Weakening of the overall business risk profile driven by new businesses;

- Evidence of weakened external funding access.

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

Net Cash Position Support Liquidity: Indika's net cash position supports its strong liquidity profile. The company has a cash balance of USD1.15 billion against short-term debt of USD100 million. Indika has done some early liability management, partly buying back two outstanding bonds and has USD323 million (reduced from USD575 million) senior unsecured note due in November 2024 and USD568 million (reduced from USD675 million) due in October 2025. We expect Indika's cash balance together with internal cash flow to be adequate to repay its bond maturities.

Indika will not require any funding at its coal business after the sale of its coal mining contracting and logistics businesses in 2022. We expect Kidecco to generate neutral to positive free cash flow, given its cost position and absence of any material investments requirements. It recently signed a loan of USD250 million for its Awakmas gold mine project investment, reflecting continued funding access.

Issuer Profile

Indika is an Indonesia-based conglomerate, whose main asset is Indonesia's fifth-largest thermal coal mine, Kideco, in which it owns a 91% stake. Indika also has direct and indirect ownership of 100% in Awakmas (gold mine), 100% in EMI (electric vehicles), 100% in interport (port terminal), 51% in EMITS (roof-top solar), 46% in Natura (essential oil) and 100% in Mekko (bauxite mine)

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

Indika's ESG Relevance score for Greenhouse Gas Emissions and Air Quality was changed to '4' from '3' due to Indika's revenue concentration in thermal coal, which faces the risk of declining demand in the medium term because of its high carbon footprint. Funding access for thermal coal companies has progressively tightened, which has a negative impact on Indika's credit profile and is relevant to the rating in conjunction with other factors.

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)