Fitch Affirms Perusahaan Gas Negara at 'BBB-' and 'AA+(idn)'; Outlook Stable

(Fitch Ratings-Singapore/Jakarta-11 April 2019)-- 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-'. 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 'AA+(idn)'. The Outlook is Stable.

PGN's IDRs are one notch below those of its immediate parent, PT Pertamina (Persero) (BBB/Stable) based on our assessment of the strong linkages between PGN and Pertamina, as per our Parent and Subsidiary Rating Linkage criteria. PGN's national ratings also are based on the Parent and Subsidiary Rating Linkage criteria.

Fitch continues to assess PGN's standalone credit profile at 'BBB-' on the international scale. PGN's standalone credit profile will depend on new gas pricing regulations, which are expected to be implemented in the middle of this year.

AA' National Ratings denote expectations of very low default risk relative to other issuers or obligations in the same country. The default risk inherently differs only slightly from that of the country's highest rated issuers or obligations.

KEY RATING DRIVERS

Strong Linkages with Parent:  We have used a top-down approach to rate PGN due to the strong strategic and operational linkages with Pertamina. The parent has positioned PGN, Indonesia's largest gas distribution and transmission company, as the holding company for the group's down- and mid-stream gas operations. PGN's acquisition of 51% of Pertamina Gas (Pertagas) from Pertamina strengthened its position domestically by raising its share of Indonesia's gas distribution volumes to about 85% from 74% before the acquisition.

Regulatory Risks: The Indonesian government expects to implement new regulations governing the returns and margins of gas distributors by July 2019. The implementation of the regulations could threaten the distribution margins of PGN, if the potential cap in prices is lower than its current selling prices. Fitch believes the new regulations are designed to help maintain low consumer prices. Fitch has not factored in the impact of these regulations as we lack details on key factors that will affect PGN's operations, and we will treat this as an event risk. See the non-rating action commentary Fitch: Execution of New Rules Key for Indonesia Gas Companies.

Pressure on Margins to Continue: PGN's distribution margins, which have been narrowing since 2013, are likely to continue to shrink in 2019 with rising gas purchase costs and state pressure to keep gas prices affordable. Selling prices to the power sector were revised down in 2017 and prices have generally stayed flat for most other industrial customers since 2013. Fitch believes this was mainly due to state pressure on PGN to keep prices low, and weaker demand in recent years. Including Pertagas, PGN's distribution margins fell to USD2.25 per million British thermal units (mmbtu) in 2018 from USD 2.4 in 2017. We expect margins to fall to about USD2.1/mmbtu in 2019.

Volumes to Fall in 2019: Fitch does not expect the increase in gas sales volumes in 2018 to be sustained in 2019 as the increase was partly driven by a temporary surge in power demand due to the Asian Games, which were held late last year in Indonesia. Including Pertagas, PGN's gas sales volumes increased to 967 million standard cubic feet per day (mmscfd) in 2018 from 898mmscfd in 2017.

Weakening Upstream Operations: The standalone credit profile of PGN's 100%-owned upstream subsidiary, PT Saka Energi Indonesia (BB+/Negative), has weakened due to its declining proved reserve life to less than five years based on its expected production. Fitch does not expect any meaningful improvement in Saka's reserve life until clarity emerges on its ownership structure. The reserve improvement in our view would depend on external reserve acquisitions, as the organic reserve replacement ratio is likely to remain below 1x.

Saka has expanded its reserves and production since inception in 2011 largely through acquisitions. Fitch expects Saka's production to decline from 2019 to about 40-45 million barrels of oil equivalent per day (mboepd), from 56mmboepd in 2018, mainly due to the expiry of its Sanga-Sanga and South-Sesulu concessions, which together accounted for over 10% of 2018 production. Fitch believes Saka's position within the new structure for state-owned oil and gas companies is misaligned as upstream operations are held under Pertamina.

Business Profile Supports Standalone Profile: PGN's earnings profile has weakened due to the continued decline in distribution margins and the weakening operating profile of its upstream operations. However, Fitch thinks that PGN's earnings mix still supports a standalone credit profile of 'BBB-'. We expect increased earnings contribution from the relatively stable transmission operations of Pertagas, to partly offset the weakening profile of its distribution and upstream operations.

PGN's consolidated transmission revenue increased to USD249 million in 2018 from less than USD3 million in 2017, driven by the acquisition of Pertagas. Earnings from the transmission operations are stable and have not been affected by adverse regulatory intervention in the recent past. The management of PGN expects transmission volumes to expand robustly by 12% a year until 2023, with some of Pertagas's projects that are under construction due to come online. Pertagas made up 20% of PGN's consolidated EBITDA in 2018, PGN's own operations, which primarily consist of distribution, made up 46% and the remaining 34% was from Saka.

Healthy Financial Profile: Fitch assumes PGN's financial profile will remain robust, with FFO net leverage below 3.0x in the next four years. This expectation also takes into account PGN acquiring the remaining stake in Pertagas it does not own in 2020 for USD1.39 billion and a decline in distribution margin to USD2/mmbtu by 2020.

DERIVATION SUMMARY

PGN's ratings are notched down from that on its parent Pertamina given the strong linkages between them, in line with Fitch's Parent and Subsidiary Rating Linkage criteria. Compared to PGN, the stronger standalone credit profiles of China-based China Resources Gas Group Limited (CRG, A-/Stable, standalone credit profile: BBB+) and ENN Energy Holdings Limited (BBB/Stable) reflect their better track record and expectation of stronger volume growth, which offsets the slight reduction expected in their dollar margins. CRG and ENN also face declining margins per unit of gas sold due to changes to city-gate level prices implemented by China's National Development and Reform Commission.

Fitch expects PGN's distribution margins to come under pressure due to state pressure to avoid passing through cost increases to customers. Fitch also expects PGN's long-term volume growth to be considerably slower than for CRG and ENN. Unlike PGN, GAIL (India) Limited's (GAIL, BBB-/Stable, standalone: BBB) gas transportation business is regulated with assured returns. In addition, GAIL's business is more diversified with petrochemical operations and gas sales. As a result, GAIL's standalone credit profile is stronger than that of PGN.

The FFO adjusted net leverage of CRG and GAIL are likely to remain below 1x in the next few years, while Fitch expects ENN's leverage to be similar to that of PGN. PGN's ratings currently are not constrained by leverage. (ends)