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

(Fitch Ratings - Singapore - 12 Aug 2021)--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 its 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 our 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.

PLN's 'bb+' Standalone Credit Profile (SCP) has low headroom, as we expect FFO-based net leverage of around 5.5x (2021: 4.2x) due to high capex plans. An extended tariff freeze has also increased PLN's reliance on the government to meet any income shortfalls.

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. The state provided equity of IDR5 trillion in 2020 and IDR6.5 trillion in 2019 and guarantees about a fifth of PLN's borrowings.

'Very Strong' Incentive to Support: Fitch regards the socio-political implications of a default by PLN, which accounts for 72% of Indonesia's power generation capacity and is its sole power wholesaler, as 'Very Strong'. A default would cause nationwide power disruption, as PLN would find it difficult to procure feedstock for power generation or to procure power from independent producers. Its default would also have 'Very Strong' financial consequences, as PLN is a key borrower and an active bond issuer; its cost of debt is used as a benchmark for local GRE issuers.

Pandemic-Related Demand Uncertainty: Fitch expects domestic electricity demand to rise by around 2% in 2021, tempered by the recent resurgence in Covid-19 infections and the extension of nationwide lockdowns into August 2021. Electricity demand fell by 0.8% in 2020 (2019: growth of 4.7%) due the pandemic-led economic slowdown that decreased commercial and industrial demand, but this was partly offset by higher residential demand, which offtakes more than 40% of PLN's total volume.

The state is providing tariff relief until 4Q21, but has set aside funds to cover under-recoveries by PLN, which will be disbursed monthly along with subsidy payments.

Reliance on Subsidies and Compensation: Fitch expects PLN to remain reliant on state support to sustain its operation over the medium term. PLN could not maintain its EBITDA without subsidies and compensation income, which combined, amounted to about IDR66 trillion in 2020, against EBITDA of IDR74 trillion. The government has a record of making subsidy reimbursements to PLN, but there have been delays in the disbursement of compensation income in the last three years. We expect this to continue and reverse the improved working capital witnessed in 2020, leading to higher leverage.

PLN is able to recover operating and financing expenses, earn a predetermined margin set annually and partly cover investment costs through a combination of tariffs, which are set below cost, and reimbursement by the state. PLN also receives 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.

Tariff Freeze, Subsidies to Rise: We expect increased subsidies and compensation income in 2021, along with higher electricity sales, continued tariff relief, a tariff freeze and rising commodity prices. The sum of subsidies and compensation income dropped by 10.9% in 2020 due to a slight fall in electricity sales volume and per unit electricity-supply costs amid lower commodity prices against frozen electricity tariffs. The state has capped the price of coal and natural gas sold to PLN to contain costs, which limits its subsidy burden.

Capex to Stay High: Fitch expects PLN to incur around IDR78 trillion in capex in 2021 and for the amount to remain at around IDR70 trillion - 75 trillion a year from 2022 to support the government's nationwide generation capacity addition plan and renewable-energy transition. This is likely to keep PLN's net leverage high over the next few years. PLN plans to increase its generation capacity and strengthen transmission and distribution infrastructure, while independent power producers are likely to have a higher share in the additional generation capacity.

Low SCP Headroom: PLN's SCP reflects its monopoly in Indonesia's electricity transmission and distribution sectors, dominant position in power generation, and a time-tested regulatory framework that allows cost-plus margin return, including subsidies. The SCP is constrained by PLN's moderate financial profile. A continued tariff freeze and significant compensation delays could stretch PLN's financial profile and bear on its investment plans or SCP. We expect FCF to remain negative, with leverage at 5.5x-5.6x over the medium term.

DERIVATION SUMMARY

Vietnam Electricity (EVN, BB/Positive), like PLN, has a monopoly in the domestic electricity transmission and distribution sectors. It owns and operates the majority of installed power-generation capacity and its IDR is equalised with the Vietnam sovereign rating (BB/Positive), in line with our GRE Rating Criteria.

We assess EVN's status, ownership and control and financial implications of default as 'Very Strong', similarly to PLN. However, EVN's support record and expectations is assessed as 'Strong', compared with PLN's 'Very Strong', because government support for EVN is less consistent and less significant. Vietnam's regulatory framework also has a limited record and there are no regular tariff reviews. We assess EVN's socio-political impact of default as 'Strong', against PLN's 'Very Strong', because EVN's share of generation capacity is lower than for PLN. The financial implications of default for both PLN and EVN are 'Very Strong', as a default would affect the availability and cost of domestic and foreign financing options for the state and its GREs, given both companies are key borrowers.

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 refined products at below-market prices, which are set by the state, in a similar way to PLN. We assess Pertamina as 'Very Strong' under each sub-factor of the GRE criteria, the same as for PLN.

KEY ASSUMPTIONS

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

- Electricity sales to increase by 2% in 2021 and by 5% annually thereafter.

- Cost of oil and coal in line with Fitch's price deck; for details, see Fitch Ratings Raises Short-Term Oil and Gas Price Assumptions, dated 15 June 2021, and Fitch Ratings Raises Short-Term Global Metals and Mining Price Assumptions, dated 26 May 2021. We expect the natural gas price to move closer to the USD6/million British thermal units capped price based on new regulations.

- Tariff to be unfrozen from 2023 and to rise annually by 0.5%-1.0% thereafter.

- Compensation income accrued in 2020 to be received in instalments over the next two years.

- Continued appropriate reimbursements for selling electricity below cost.

- Capex of IDR78 trillion in 2021 and average annual capex of approximately IDR70 trillion-75 trillion thereafter.

- Annual dividend payout of IDR1 trillion.

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 Commentary of 22 March 2021:

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.

- Public Finances: An improvement in the government revenue ratio in the next few years closer to the level of 'BBB' category peers, 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, closer to those of 'BBB' category peers.

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

- Public Finances: A continued increase in the overall public debt burden over the next few years to levels well beyond our current forecasts, for example, resulting from failure to reduce the fiscal deficit to pre-crisis levels or further accumulation of debt by 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.

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

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 IDR55 trillion at end-2020 was adequate to meet its 2021 debt maturities of around IDR39 trillion. PLN also benefits from well spread-out debt maturities, with annual maturities of below IDR50 trillion. We expect PLN to generate around IDR60 trillion-65 trillion of annual cash flow from operations from 2022, but to remain reliant on external funding for its large annual capex plan. We believe PLN can secure adequate funding due to its close links with the sovereign.

ISSUER PROFILE

PLN is Indonesia's vertically integrated electric utility company and is wholly owned by the government. It is a monopoly power transmission and distribution player and accounts for about 72.6% of the country's total installed generation capacity of 63.1GW, in which PLN's portion amounts to 45.9GW. The company is a counterparty and purchases power from independent power producers.

SOURCES OF INFORMATION

The principal sources of information used in the analysis are described in the Applicable Criteria.

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 Indonesian 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.

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.