Fitch Affirms Saka Energi at 'B+'; Outlook Negative

(Fitch Ratings - Singapore - 08 Apr 2021)--Fitch Ratings has affirmed PT Saka Energi Indonesia's Long-Term Issuer Default Rating (IDR) at 'B+'. The Outlook remains Negative. The agency also affirmed Saka's senior unsecured US dollar bonds at 'B+' with a Recovery Rating of 'RR4'.

Saka's ratings benefit from a two-notch uplift from its Standalone Credit Profile (SCP) of 'b-', based on our assessment of moderate linkages between Saka and its parent, PT Perusahaan Gas Negara Tbk (PGN, BBB-/Stable), in line with Fitch's Parent and Subsidiary Linkage Rating Criteria.

The Negative Outlook reflects risks of further weakening of the linkages between PGN and Saka due to the absence of any affirmative support from PGN, and a continued decline of Saka's business profile in the absence of material reserve replenishments.

Fitch continues to assess Saka's SCP at 'b-', reflecting the weak operating and financial profile. We expect Saka to require PGN support to repay or refinance its US dollar notes due in 2024.

KEY RATING DRIVERS

Moderate Linkage with PGN: Fitch assesses the linkages between Saka and PGN as 'Moderate' due to the significant reputational risks for PGN in the event of a Saka default. The reputational risks are increased by the presence of a cross-default provision between PGN and Saka. Saka is fully owned by PGN and Fitch expects Saka to account for around 30% of consolidated EBITDA until 2023. In addition, Saka's branding is integrated with PGN's in its marketing and financial materials.

Fitch revised our assessment of the linkage to 'Moderate' from 'Strong' early this year, as we view PGN's instructions to Saka to repay USD77 million of the USD155 million of shareholder loans due in January 2021 as evidence of weakening support. The request came amid Saka's tight liquidity, potentially large tax penalties on acquisitions and a challenging operating environment. Saka also does not have any material loan facilities nor concrete funding plans from PGN to address its 2024 bond maturity. Fitch previously expected PGN to support Saka via extending its loan maturities.

Legal Linkages Remain Moderate: We believe Saka currently qualifies as a material subsidiary, as defined in the bond documentation of PGN's USD1.35 billion notes, and a default by Saka will trigger a cross-default provision in PGN's bonds, which mature after Saka's USD625 million notes due in 2024. However, Fitch considers this as 'Moderate' legal linkages as PGN's bond documents are somewhat vague about defining a material subsidiary, giving PGN some discretion. Continued deterioration in Saka's asset profile and earnings could further weaken its materiality to PGN.

Saka Misaligned in Group Structure: Saka's position in PGN's structure remains uncertain and a lack of continued capital support increases uncertainty about PGN's commitment to Saka. The level of Saka's operational integration and strategic importance to PGN has weakened since mid-2018, following the restructuring of state-owned oil and gas companies, which transferred the state's 57% ownership of PGN to PT Pertamina (Persero) (BBB/Stable).

Weakening Operating Profile: Saka's operating profile remains weak, with its proved reserves of 55 million barrels of oil equivalent (boe) (proven and probable (2P) reserves: 81 million boe) as of June 2020, resulting in about four to five years of proved reserve life (2P reserve life: 7 to 8 years), based on the company's expected production over the next three to four years. Significant increases in reserve life are contingent on reserve acquisitions, as we assess that Saka's organic proved reserve replacement is likely to remain well below 1x because it has low probable reserves against proved reserves.

Weaker Financial Profile: Fitch estimates Saka's leverage (net debt/EBITDA) weakened to 8.6x in 2020 (2019: 3.4x), based on our weaker production forecast and lower oil prices against 2019. Fitch expects leverage to improve but remain between 3.8x and 4.5x from 2021 to 2024. We estimate Saka's EBITDA to have declined to below USD100 million in 2020, and will recover to between USD200 million and USD230 million a year until 2024. We have included the USD361 million in shareholder loans in Saka's debt.

Large Investments Unlikely: Saka is unlikely to make large investments until its ownership structure is finalised. Saka's production dropped to 25.7 thousand boe per day (mboepd) in 9M20 from 34.4 mboepd in 2019, as Saka cut production in response to weaker demand amid the coronavirus pandemic and low energy prices. Saka's earnings derive some stability from the sizable share of earnings from long-term fixed-price gas contracts.

Tax Penalty Update: Saka expects to receive a tax refund of US40 million in 2H21 from the Indonesian tax authority after an appeal of a previous case involving an asset acquisition. A Supreme Court ruling in a different litigation required Saka to pay the tax authority USD127 million in 2020 as taxes on the 2014 acquisition of Hess Indonesia Pangkah Limited, which held a 65% participating interest in the Pangkah production-sharing contract (PSC). There is potential for an additional USD127 million in penalty for delayed payment.

DERIVATION SUMMARY

Saka's credit profile is comparable to other small independent oil and gas companies rated globally. The ratings of PT Medco Energi Internasional Tbk (B+/Stable), GeoPark Limited (B+/Stable), Frontera Energy Corporation (B/Stable) and Kosmos Energy Ltd. (B/Rating Watch Negative) are constrained to the 'B' category or below, given the inherent operational risks associated with small scale and low diversification of their oil and gas production profiles.

Saka's 'b-' SCP, reflects its limited reserve life, lower production size and weak financial profile. Its operational and financial profile remains considerably weaker than that of Medco, resulting in the two-notch difference between Medco's rating and Saka's SCP.

We expect Saka's credit profile to be somewhat comparable to that of Kosmos, as both are of similar size, and have high leverage and limited liquidity. Frontera's ratings reflect its smaller production scale of around 45 mboepd, comparable reserve life of 6.6 years and better credit metrics than Saka.

KEY ASSUMPTIONS

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

- Oil price of USD41/bbl in 2020, USD58/bbl in 2021, and USD53/bbl thereafter. (See Fitch Ratings Raises Short-Term Oil and Gas Price Assumptions, dated 17 March 2021 at https://www.fitchratings.com/site/pr/10155643);

- Oil and gas production at 24 mboepd in 2020 and to remain at about 30 mboepd until 2024 when proved reserves expire;

- Additional cash tax on the acquisition of some of its assets of USD255 million, of which 50% was paid in 2020 and 50% in 2021;

- Tax refund of USD40 million in 2H21

- Annual capex of USD118 million in 2020, and between USD140 million and USD200 million thereafter

- Saka will be able to refinance all debt due, allowing it to maintain a minimum USD50 million operating cash balance.

Recovery Rating Assumptions:

- Saka would be reorganised as a going-concern in bankruptcy rather than liquidated;

- A 10% administrative claim.

Going-Concern Approach

The going-concern EBITDA estimate is based on the average EBITDA we expect over 2021 and 2024, stressed by 30% to reflect risks associated with oil price volatility, and possible challenges in maintaining production from operating fields, or other factors.

An enterprise value multiple of 4.0x is used to calculate post-reorganisation valuation and reflects a mid-cycle multiple for oil and gas and metals and mining companies globally. The multiple used is less than the lowest observable multiple of 4.5x, reflecting limited proved reserve life.

We have assumed that the shareholder loans and the US dollar notes rank pari passu, resulting in a recovery rate corresponding to a 'RR3' Recovery Rating for the unsecured notes. However, we have rated the senior unsecured bonds at 'B+'/'RR4' because Indonesia falls into Group D of creditor friendliness under our Country-Specific Treatment of Recovery Ratings Criteria, and the instrument ratings of issuers with assets in this group are subject to a soft cap at the issuer's IDR and Recovery Rating of 'RR4'.

RATING SENSITIVITIES

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

- The Outlook maybe revised to Stable, upon clear evidence of adequate support from PGN, which can lead to a strengthening of Saka's operating profile, and upon clarity on Saka's position with the group structure, in which case Fitch may continue assess that linkages between PGN and Saka as well as Saka's SCP remain unchanged.

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

- Weakening of linkages with PGN in the absence of significant additional support from PGN, and clarity on Saka's position within the group structure;

- Weakening of Saka's SCP, including but not limited to declining reserves or production in the absence of reserve acquisitions, or a weakening of its liquidity position.

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

Liquidity Support from PGN Required: Saka will require additional funding to meet its financial commitments, based on our forecasts. Fitch expects that Saka would not be able to repay its remaining shareholder loans of USD361 million due in January 2022, and would require PGN to continue extending these loans. Apart from the shareholder loans, Saka does not face any near-term debt maturities, with its bonds falling due in 2024. Still, Fitch expects the company to require PGN's support to repay its 2024 bond maturities.

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.

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. (ends)