Fitch Affirms Indonesia's PGN at 'BBB-'; Outlook Positive

(Fitch Ratings-Singapore-17 April 2017)--Fitch Ratings has affirmed Indonesia-based PT Perusahaan Gas Negara Tbk's (PGN) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at 'BBB-' with a Positive Outlook. The agency has also affirmed PGN's senior unsecured rating and the rating on its USD1.35 billion 5.125% bonds due 2024 at 'BBB-'. At the same time, Fitch Ratings Indonesia has affirmed PGN's National Long-Term Rating at 'AAA(idn)' with a Stable Outlook.

Fitch has downgraded PGN's standalone rating to 'BBB-' from 'BBB' because of higher business risks. PGN's lower pricing power is reflected in its gas distribution margin decline of 10% yoy in 2016 - to come in at USD2.7 per million British thermal unit (mmbtu). The company was not able to fully pass through its higher average gas-procurement cost, which increased due to a higher proportion of liquefied natural gas (LNG) in the sales mix. Fitch expects these factors to shrink PGN's margin further in the medium term. The company's gas distribution volumes also came in flat, hit by weak industrial demand. However, Fitch assesses PGN's financial profile to be stronger than its standalone rating of 'BBB-'.

'AAA' National Ratings denote the highest rating assigned by the agency in its National Rating scale for that country. This rating is assigned to issuers or obligations with the lowest expectation of default risk relative to all other issuers or obligations in the same country.

KEY RATING DRIVERS
Diminished Pricing Power: Slower economic growth in Indonesia has resulted in muted gas demand from most industries, other than the power sector. PGN's 2016 gas sales volume came in flat at 803 million standard cubic feet per day (mmscfd), though off-take by the power sector increased by 3% in the year. Consequently, PGN faces lower pricing power to sustain its sales volume growth. Moreover, PGN is also likely to support the government's effort to bolster Indonesia's industrial expansion. This has restricted PGN's ability to fully pass through its higher gas cost to customers, although PGN can fully pass through its costs under current regulation.

Spread to Shrink Further: PGN's gas distribution spread, a key determinant of its operating cash generation, declined to USD2.7/mmbtu in 2016, from USD3.0/mmbtu in 2015. The decline was primarily due to a higher proportion of the more expensive LNG in the gas mix and the lower renegotiated tariff for PLN's power plant. We expect PGN's spread to narrow further based on increasing LNG volumes in the sales mix amid a gradual oil price recovery, which would raise its blended gas cost.

Muted Distribution Volume Growth: PGN reported flat gas distribution volumes of 803mmscfd in 2016 due to weak industrial demand, against Fitch's expectation of a 5% increase. There are signs of a moderate pick-up in the country's economic sentiment. However, Fitch has revised down its volume growth forecast to average at around 1% per year over 2017-2021, reflecting its slower economic growth forecast for Indonesia.

Lower Capex Estimates: PGN plans to incur capital expenditure of USD2.9 billion over 2016-2020 versus its previous budget of USD3.4 billion. The company realigned its capex programme to focus on key projects - given its expectation of lower pick-up in gas distribution volumes. Upstream capex has also been delayed and Fitch expects it to pick up from 2018. PT Saka Energi Indonesia, PGN's wholly owned subsidiary for its upstream investments, acquired a 38% stake in Sanga-Sanga gas production block in November 2016.

Upstream Investments Drive Growth: Fitch expects PGN to drive growth from its upstream investments in oil and gas exploration and production, given the muted forecast for its gas distribution business. Saka Energi manages 10 production sharing contracts in Indonesia and one shale gas block in the US. Fitch expects the upstream business segment to contribute about 20% to PGN's top-line in the next three to four years, up from around 11% currently.

Robust Financial Profile: Fitch expects the company's FFO-adjusted net leverage to increase to around 3.4x by 2019, based on the agency's assumptions of a further decline in spread. However, Fitch believes PGN's credit metrics will remain strong for its standalone 'BBB-' rating.

Regulatory Risks: PGN is susceptible to regulatory intervention aimed at restricting its influence on Indonesia's gas market. Fitch will treat regulatory developments that affect PGN's profile as an event risk, even though PGN's standalone credit profile incorporates the country's general regulatory risks.

Moderate Linkages with Sovereign: Fitch assesses the linkages between PGN and the Indonesian sovereign (BBB-/Positive) as moderate. Fitch will provide a one-notch rating uplift to PGN's ratings if its standalone rating were to be lower than that of the sovereign, provided linkages remain intact, based on the agency's Parent and Subsidiary Rating Linkage criteria.

DERIVATION SUMMARY
PGN's standalone rating of 'BBB-' is well-positioned relative to peers. Dollar margin on the sale of gas has remained broadly stable for China-based China Resources Gas Group Limited (CRG, BBB+/Stable, standalone: BBB) and ENN Energy Holdings Limited (BBB/Stable), with city-gas operators able to pass-through changes to city-gate level prices implemented by China's National Development and Reform Commission, albeit with a time lag. This compares with PGN's limited cost pass-through ability to sustain volumes and support government's efforts, despite the absence of regulatory restrictions.

Indonesia's weak industrial expansion has led to low gas demand growth. Both CRG and ENN continued to expand their operational footprint and increase gas sales volume and new connections in 2015, despite China's slower gas demand growth. We note that China's overall gas consumption growth recovered in 2016. Fitch expects gas sales for CRG and ENN to increase at a low double-digit percentage pace.

Unlike PGN, GAIL (India) Limited's (GAIL, BBB-/Stable, standalone: BBB) gas transportation business is regulated with assured returns. This along with business diversification into petrochemical and gas sales supports GAIL's 'BBB' standalone profile.

At national level, PGN's 'AAA(idn)' rating compares well with its closest peer - PT Telekomunikasi Selular (Telkomsel, AAA(idn)/Stable), given Telkomsel's strategic importance as Indonesia's largest mobile operator by subscribers and its huge lead over its closest competitors. (ends)