Fitch affirms Perusahaan Gas Negara at 'BBB-'; outlook stable

(Singapore/Jakarta-29 April 2014) -- Fitch Ratings has affirmed Indonesia-based PT Perusahaan Gas Negara's (PGN) Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'BBB-' and its National Long-Term rating at 'AAA(idn)'. The Outlook is Stable. At the same time the agency had assigned a senior unsecured long-term rating of 'BBB-' to PGN.

PGN's ratings are a notch below its standalone credit profile of 'BBB' because it is constrained by the rating on its 57% majority shareholder, the Republic of Indonesia (BBB-/Stable). PGN's ratings reflect its dominant market position in natural gas distribution in Indonesia, strong pricing power and adequate financial flexibility to accommodate expected investments in upstream oil and gas assets. Its standalone rating is constrained by the regulatory uncertainties prevalent in Indonesia.

'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.

Strong Pricing Power: PGN's credit profile benefits from its strong cost pass-through ability, allowing the company to maintain robust cash profit margins per unit of gas sold. Natural gas's lower cost and PGN's market share of about 80% in Indonesian natural gas distribution will allow the company to continue passing through increases in its procurement costs. The next most viable alternative, high-speed diesel, remains about 3x to 4x more expensive than natural gas in Indonesia. About 98% of PGN's client base is commercial and industrial users, whose prices are set on commercial terms.

We expect the profitability per unit of gas sold to fall slightly in the next few years from about USD3.9 in 2013. The decline would be driven by lower profits because of an increasing share of more expensive liquefied natural gas (LNG) in PGN's supply mix and weaker margins in its business units in East Java, where the availability of gas outstrips demand.

Cost Increases: PGN's procurement costs increased by more than 35% in 2013 and we expect a similar increase in 2014 because the procurement costs of some of its legacy contracts will be adjusted to better reflect market prices. Further increases are expected in 2015, reflecting a higher share of more expensive LNG in its supply mix. However, Fitch expects more stability in its procurement costs after 2015.

Upstream Investments: The company has spent about USD1bn to date, including USD250m in 2013, to increase its upstream asset base. The ratings also factor in its sizable budget for moving these assets into production. The agency also does not rule out PGN making further opportunistic investments to further its strategy of vertical integration.

Risks attached to oil and gas exploration are higher than those of PGN's gas transmission and distribution businesses. However, Fitch believes PGN will contain additional risks via involving or retaining experienced operators in its upstream ventures and by acquiring assets that are already producing or near to production. Given Fitch's expectation of PGN generating over USD1bn of EBITDA per year, the company can accommodate large upstream M&A before its ratings are threatened.

Regulatory Risks: The standalone rating remains constrained by regulatory uncertainties and emerging market risks in Indonesia. Since 2011, PGN has faced gas price revisions on its long-term contracts that were supported by the regulator. PGN could also incur a one-off tax if it is required to hive off its distribution operations into a separate subsidiary to comply with regulations issued in 2009.

Financial Flexibility: Fitch expects PGN to maintain its funds from operations (FFO) net leverage (incorporating potential investments in upstream oil and gas assets) below 1.0x in the medium term. The company had unrestricted cash and equivalents of USD1.3bn at end-2013 and generated strong cash flows from operations of USD830m in 2013 (free cash flows of between USD100m and USD680m from 2011 to 2013). The company would however require additional external funding to support its capex and investment spend in 2014. Fitch expects debt levels to increase from the USD1bn at end-2013, which will likely place PGN in a net debt position, compared with a net cash position at end-2013. The higher indebtedness and resultant impact on credit metrics are incorporated in its current ratings. (ends)