Fitch Affirms Pelindo III at 'BBB-'; Outlook Stable

(Fitch Ratings - Sydney/Jakarta - 22 Mar 2021)-- Fitch Ratings has affirmed Indonesia-based port operator PT Pelabuhan Indonesia III (Persero)'s (Pelindo III) Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB-'. The Outlook is Stable. Fitch has also affirmed Pelindo III's senior unsecured rating and existing senior unsecured notes at 'BBB-'.

RATING RATIONALE

The rating affirmation reflects the strong linkage of Pelindo III to the Indonesian sovereign (BBB/Stable) and the propensity for government support when required. It also reflects our expectation that the container throughput recovery will benefit from Pelindo III's domination of domestic cargo as well as the company's strong market position and limited exposure to competition and transhipments.

Pelindo III's 'bb+' Standalone Credit Profile (SCP) reflects a strong market position, limited exposure to competition and transhipments as well as resilience through economic cycles. The SCP also factors in moderate flexibility in setting tariffs and management's capex plan. The company had a cash balance of IDR3.9 trillion at end-2020, and it has no near-term refinancing needs. Pelindo III's Fitch-adjusted net debt/EBITDAR average over the next five years of 3.8x in Fitch's rating case is below our positive trigger, but we do not upgrade its ratings due to the uncertainty over the impact of Covid-19 on throughput and revenue.

Government-Related Entity Assessment

Strength of Linkages: Fitch assesses Pelindo III's status, ownership and control by the sovereign as 'Strong'. The state owns 100% of the company, appoints Pelindo III's commissioners and board members, and controls investment plans and capex decisions. We also consider the support record and expectations for state support to Pelindo III as 'Strong'. Tangible support has not been provided because of the company's generally sound financial profile. However, we expect Pelindo III to receive support from the government, if needed, as we believe the company plays an important role in the country's economic development.

State's Incentive to Support: Fitch assesses the socio-political implications of a potential default by Pelindo III as 'Moderate'. A default by Pelindo III would damage the government's reputation. However, Fitch believes it would not result in any severe disruption to Indonesia's trade activities as the country's port infrastructure would remain intact and other operators may step in to run Pelindo III's ports. Our assessment of the financial implications of a potential default by Pelindo III is 'Strong'. This is because Pelindo III is regarded as one of the key state-owned enterprises (SOEs) in Indonesia and any default by the company would reduce investors' confidence in the sovereign as well as other SOEs.

KEY RATING DRIVERS

Limited Competition, Resilient Volume - Revenue Risk (Volume): Midrange

Pelindo III operates the primary ports of call within its served region, which includes Surabaya, the second-largest city in Indonesia by population. Pelindo III has a dominant container market share in its operating area with limited competition. Its traffic is mainly origin and destination (O&D) with very limited transhipment cargo. Pelindo III's container throughput has proven resilient through economic and business cycles, including rising by 2% during the global financial crisis in 2009 and 1% during Indonesia's commodity sector downturn in 2015. The concessions for most of its ports have 30-year terms ending in 2045. Land access to Pelindo III's ports is largely limited to road transport. Pelindo III's largest port, Tanjung Perak, has a draft of 12 metres and can handle containerships of up to 4,000 TEUs. However, the increase in sizes of ships deployed by shipping lines may challenge the port's infrastructure over the longer term.

Moderate Pricing Flexibility - Revenue Risk (Price): Midrange

Pelindo III's tariffs are commercially negotiated with shipping associations but require consultation with the Ministry of Transport. This limits the company's pricing flexibility, evident from the largely flat tariffs for international shipments at its major ports in the past. However, tariffs on domestic containers have been increasing. Once fixed, the tariff structure will remain valid for at least two years. Pelindo III's mainly O&D cargo profile underpins its pricing power and operating margin. However, a lack of minimum guaranteed revenue or long-term take-or-pay contractual arrangements could limit the ports' revenue stability in an economic downturn.

Significant Capex Plan - Infrastructure Development and Renewal: Midrange

Pelindo III's container capacity utilisation rate remains high at about 70% (based on yard capacity) despite capacity additions over the past few years. Fitch expects Pelindo III to incur total capex of IDR16 trillion over 2021-2025, above the IDR15 trillion cash flow from operations over the same period under Fitch's rating case. As such, we expect Pelindo III to rely on external debt to fund the planned capex and dividend distributions. The timing of the execution of the capex plan is flexible as it is mainly for expansion and any delay will not materially affect existing operations.

Reliance on US Dollar Fixed-Rate Bullet Notes - Debt Structure: Midrange

All of Pelindo III's consolidated debt is raised by the parent company and carries fixed rates. The debt comprises mainly US dollar bullet bonds, which present significant refinancing risk, although this is mitigated by the company's demonstrated access to capital markets and long concession tenor. Pelindo III has no near-term refinancing needs with its US dollar bonds due in 2023 and 2024. The US dollar notes do not contain restrictive financial covenants, and Fitch expects leverage to increase in the near term. Pelindo III previously relied on natural hedging to manage its foreign-exchange risk. However, the company suffered a foreign-exchange loss in 2018 due to the sharp depreciation of the Indonesian rupiah against the US dollar. Management has now put in place an active hedging strategy to manage the company's foreign-exchange exposure, which seeks to moderate these losses.

PEER GROUP

PT Pelabuhan Indonesia II (Persero) (Pelindo II, BBB/Stable; SCP: bbb) is the largest container port operator in Indonesia, followed by Pelindo III. Pelindo II benefits from stable rental income from joint ventures and is thus better placed than Pelindo III. Both companies are undertaking heavy expansion plans to support the development of Indonesia's maritime industry, but Pelindo II has lower average leverage at 3.5x than Pelindo III over the five-year forecast period under Fitch's rating case, and a 'Stronger' volume risk assessment compared with a 'Midrange' assessment for Pelindo III.

Adani Ports and Special Economic Zone Limited (APSEZ, BBB-/Negative; underlying credit profile: bbb) is the largest commercial port operation in India. APSEZ benefits from a diverse port portfolio, royalty income from sub-concession and long-term cargo, which accounts for about 60% of total traffic. APSEZ is the concession holder of Mundra port. APSEZ benefits from stronger volume risk influenced by the strategic location of Mundra port as the gateway to north-western India, supported by its state-of-the-art infrastructure, operational efficiency and integrated logistics solution. APSEZ also benefits from stronger infrastructure development and renewal due to an internally funded capex plan. This translates to lower average leverage of 3.1x compared with Pelindo III's of 3.8x.

RATING SENSITIVITIES

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

- Sustained deterioration of Fitch-adjusted net debt/EBITDAR above 5.0x under Fitch's rating case could lead to a lowering of the SCP;

- Weakening of linkages with the government of Indonesia;

- Downgrade of the Indonesian sovereign rating.

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

- Sustained improvement of Fitch-adjusted net debt/EBITDAR below 4.0x under Fitch's rating case could lead to an upward revision of the SCP;

- Strengthening of linkages with the government of Indonesia;

- Upgrade of the Indonesian sovereign rating.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Sovereigns, Public Finance and Infrastructure 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 three 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].

CREDIT UPDATE

Pelindo III's container volume decreased by 24% to 342,500 twenty-foot equivalent units (TEU) in May 2020, from the monthly average of 2019, on the government's large-scale social restriction policy between March and May 2020. The government has eased the policy since June 2020, leading to a recovery of Pelindo III's throughput in 4Q20 to 96% of pre-pandemic quarterly throughput.

Overall, the Pelindo III's total container throughput fell by 6.4% to 5.1 million TEU in 2020, compared with Indonesia's GDP contraction of 2.2%. Domestic container traffic accounted for almost 60% of total container throughput, which provides a cushion for uncertainty surrounding the pandemic and global economic recovery.

FINANCIAL ANALYSIS

The Fitch base case forecasts container throughput to recover to the pre-pandemic level in 2022 and increase subsequently by 0.8x GDP and 1.0x GDP in 2025. We assume container tariff will track Indonesian inflation. We also assume a cash operating expense CAGR of 8.7% in 2020-2025. The Fitch base-case assumptions also include total capex of IDR16 trillion in 2021-2025 and a dividend payout of 30% of net income. As a result, the Fitch-adjusted net debt/EBITDAR will average at 3.3x with maximum of 3.5x in 2022 and 2023.

The Fitch rating case assumes throughput recovery to the pre-pandemic level in 2023, one year longer than the base case and management's assumption. We assume the throughput will rise by 0.8x GDP thereafter. We assume container tariffs will increase by 2% each year. We forecast the cash operating expense CAGR at 8.5% in 2020-2025. Rating case capex and dividend assumptions are in line with the Fitch base case. As a result, the Fitch-adjusted net debt/EBITDAR will average at 3.8x in 2021-2025 under the rating case with a peak of 4.1x in 2025.

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

Pelindo III's IDR and senior unsecured ratings are one notch below the rating of its 100% shareholder, Indonesia.

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.