Fitch Affirms Indonesia's PLN at 'BBB'; Outlook Stable

(Fitch Ratings - Singapore - 07 Sep 2020)--Fitch Ratings has affirmed Indonesia-based PT Perusahaan Listrik Negara (Persero)'s (PLN) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at 'BBB' with a Stable Outlook. The agency has also affirmed the senior unsecured rating on PLN's medium-term note programme, the notes issued under the programme and the US-dollar notes issued by subsidiary, Majapahit Holding BV and guaranteed by PLN, at 'BBB'.

PLN's rating is equalised with that of Indonesia (BBB/Stable), based on our expectations of a 'Very Strong' likelihood of support in line with Fitch's Government-Related Entities (GRE) Rating Criteria. PLN is an integrated electricity utility company, with a monopoly position in Indonesia's electricity-transmission and distribution sector and dominant position in power generation.

We assess PLN's Standalone Credit Profile (SCP) at 'bb+', albeit with lower headroom, as we believe the company's high capex plans and delays in receiving compensation income on account of the continued tariff freeze will see its FFO-based net leverage remain above 5.0x over the next three to four years. PLN expects to receive its entire compensation receivable - IDR45 trillion as of end-2019 - from the government by 3Q20. This should mitigate the harm caused to PLN's financial profile by the ongoing tariff freeze and drop in demand from the coronavirus pandemic. .

KEY RATING DRIVERS

'Very Strong' State Linkages: Fitch sees PLN's status, ownership and control by the Indonesian sovereign as 'Very Strong'. The state fully owns PLN, appoints its board and senior management, and directs and approves its investments. We also see the support record as 'Very Strong' and believe there is a high likelihood of state support for PLN, which receives subsidies under an exceptionally strong framework in return for meeting the state's public-service obligations - a key driver of PLN's business profile.

The state provided equity of IDR5.0 trillion in July 2020 and IDR6.5 trillion in 2019. PLN has also received state support in the form of direct loans, two-step loans from multinational agencies, equity injections and guarantees on bank loans for some of its investment projects. We expect such support to continue considering PLN's investment plans. The government guarantees about a fifth of PLN's borrowings.

'Very Strong' Incentive to Support: Fitch regards the socio-political implications of a PLN default as 'Very Strong', as it would lead to service disruption, since the company accounts for the majority of Indonesia's power-generation capacity. A default would also make it difficult for PLN to source feedstock for power generation and jeopardise the confidence of private-sector investors in power availability. In addition, it would have a 'Very Strong' financial effect on the state, as PLN is one of Indonesia's key borrowers and an active international and domestic bond issuer.

Demand Resilient Against Pandemic: We estimate that PLN's 2020 electricity sales volume will decline by about 2.0%. The company reported a 2.7% yoy decline in power demand in 2Q20, which included period of lockdown to curb the spread of the coronavirus. Lower demand from commercial and industrial customers was partly offset by increased demand from residential customers, which offtakes more than 40% of PLN's total sales volume. The government has also provided tariff relief and has extended the tariff freeze until the end of the year in light of the pandemic.

Reliant on Subsidies, Compensation: Fitch expects PLN to remain reliant on state support to sustain its operation over the medium term, as electricity is likely to continue being sold below cost to most customers. The state sets PLN's tariffs below electricity-supply costs, on average, and supports the company through reimbursements that allow it to recover operating and financing expenses, earn a predetermined margin that is set annually and partly cover investment costs. PLN's EBITDA would be negative if not for the subsidies and compensation income, which combined amounted to about IDR74 trillion in 2019, against EBITDA of IDR73 trillion.

The state has set aside funds to cover PLN's cost under-recoveries in light of the various tariff reliefs provided on account of the pandemic. The government has been disbursing funds monthly, similarly to the subsidy payment mechanism, mitigating pressure on PLN's Standalone Credit Profile (SCP) from delayed pandemic-related compensation. The state plans to move to a targeted subsidy payment mechanism directly to customers, but we have not factored this into our rating case because we expect delays in its implementation.

Weak Commodity Prices to Ease Subsidies: The pandemic-led fall in commodity prices - primarily thermal coal - should cut PLN's generation costs. Government regulations to lower the price of natural gas for selected industries to support the domestic economy will also bring down PLN's cost of fuel. This, together with lower electricity sales, is likely to see lower subsidies in 2020, though it will be partly negated by tariff relief and the continuation of the tariff freeze.

Subsidies, including compensation income, rose by 4% in 2019 due to higher electricity sales volume and per unit electricity supply costs against frozen electricity tariffs; the government froze electricity tariffs charged by PLN from July 2017 to end-2019, a period that included general and presidential elections, to support industrial competitiveness and household disposable income. This increased subsidies to IDR74 trillion in 2019, from IDR53 trillion in 2017.

Capex to Remain High: Fitch expects PLN to incur capex of around IDR75 trillion in 2020, higher than our previous estimate of IDR54 trillion, due to more resilient demand during the pandemic than estimated. Fitch expects PLN to maintain high capex to meet rising domestic power demand, at around IDR85 trillion a year from 2021, resulting in free cash-flow deficits over the long term. PLN plans to increase its generation capacity and strengthen transmission and distribution infrastructure, although the rise in capex will be moderated by independent power producers increasing their share in Indonesia's planned additional generation capacity.

SCP of 'bb+': PLN's SCP reflects its monopoly in Indonesia's electricity transmission and distribution sectors, dominant position in power generation, and regulatory framework allowing cost-plus margins, including subsidies. The SCP is constrained by PLN's moderate financial profile. The continuation of the tariff freeze and significant compensation delays could stretch PLN's financial profile and have a bearing on its SCP.

DERIVATION SUMMARY

Vietnam Electricity (EVN, BB/Stable), like PLN, has a monopoly in the domestic electricity transmission and distribution sectors. It owns and operates the majority of installed power-generation capacity. EVN's IDR is also equalised with that of the sovereign - Vietnam (BB/Stable) - in line with our GRE Rating Criteria. We assess EVN's status, ownership and control and financial implications of default as 'Very Strong', and its support record and expectations, along with the socio-political impact of default, as 'Strong'. We assess PLN's state linkages and the state's incentive to provide support as 'Very Strong'.

State-owned PT Pertamina (Persero)'s (BBB/Stable) ratings are also equalised with those of the sovereign. Pertamina is Indonesia's national oil company, and has a near monopoly in refining and retailing of petroleum products. It accounts for over 20% of the country's crude output. Pertamina performs a government-directed public-service obligation by selling certain refined products at below-market prices, as set by the state, in a similar way to PLN. We assess Pertamina as 'Very Strong' under each sub-factor of the GRE criteria, similarly to PLN.

KEY ASSUMPTIONS

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

Electricity sales to decline by 2% yoy in 2020, then increase by an average of 6% annually thereafter.

Cost of coal and oil in line with Fitch's price deck; see Fitch Ratings Updates Metals and Mining Price Assumptions at www.fitchratings.com/site/pr/10134526 and Fitch Ratings Cuts Oil Price Assumptions on Coronavirus Hit, Oversupply at www.fitchratings.com/site/pr/10116714. The natural-gas price should move closer to USD6 per unit capped price based on new regulations.

Tariff to unfreeze from 2022 and rise annually by 5% on average.

Compensation income accrued until 2019 to be received in 2020 and later years' compensation to be received in instalments over the next three years.

Continued appropriate reimbursements for selling electricity below cost.

Average annual capex of approximately IDR80 trillion.

Minimal dividend payment in 2020 and an approximate payout of 20% of net income thereafter.

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 state support.

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

Negative rating action on the sovereign

Significant weakening of the likelihood of support, including weaker government links or lower government reliance on PLN for policy implementation. We see this as a remote prospect in the medium term.

For the sovereign rating of Indonesia, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 10 August 2020:

The main factors that, individually or collectively, could trigger positive rating action are:

-External Finances: Reduction in external vulnerabilities, for instance, through a sustained increase in foreign-exchange reserves, reduced dependence on portfolio flows or lower exposure to commodity price volatility.

-Fiscal Finances: An improvement in the government revenue ratio in the next few years, for example, from better tax compliance or a broader tax base, which would strengthen public finance flexibility.

-Structural: Continued improvement of structural indicators, such as governance standards, to closer in line with those of 'BBB' category peers.

The main factors that, individually or collectively, could trigger negative rating action are:

- External Finances: A sustained decline in foreign-exchange reserve buffers, resulting, for example, from a deterioration in investor confidence.

- Fiscal Finances: A continued increase in the overall public debt burden over the next few years to levels beyond our forecasts, for example, resulting from failure to reduce the fiscal deficit back to pre-crisis levels or accumulation in the debt of publicly owned entities.

-Macroeconomic: A weakening of the policy framework that could undermine macroeconomic stability, for instance, resulting from continued monetary financing of the deficit in the next few years.

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: PLN's cash balance of around IDR54 trillion at end-June2020 was adequate to meet its debt maturities of around IDR41 trillion over the next 12 months. PLN also benefits from well spread-out debt maturities, with annual maturities of below IDR60 trillion. We expect PLN to generate annual cash flow from operation of around IDR70 trillion from 2022. However, it will have to rely on external funding for its large annual capex plan. Fitch believes the company can secure adequate funding due to its close links with the sovereign.

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

The ratings of PLN are directly linked to the credit quality of its parent, the sovereign. A change in Fitch's assessment of the credit quality of the parent would automatically result in a change in the rating on PLN. (ends)