Fitch Affirms Soechi Lines at 'B'; Places Bond on RWN on Tender Offer

(Fitch Ratings - Jakarta - 01 Dec 2020)-- Fitch Ratings has placed the rating on the US dollar notes guaranteed by Indonesia-based tanker operator PT Soechi Lines Tbk (Soechi) on Rating Watch Negative, after Soechi said it launched a cash tender offer to buy back a portion of the notes using proceeds from a secured loan facility. Simultaneously, Fitch has affirmed Soechi's Long-Term Issuer Default Rating (IDR) at 'B'. The Outlook is Stable.

The USD200 million 8.375% senior unsecured notes due 2023 are rated 'B' with Recovery Rating of 'RR4'. The notes are issued by Soechi's wholly owned subsidiary Soechi Capital Pte. Ltd., and guaranteed by Soechi and all its operating subsidiaries.

Under the terms of the tender, Soechi will offer 70 cents per dollar of the notes, which are trading at around 60 cents. Soechi is planning to use USD100 million from a new secured term loan facility to buy back the notes. The tender offer is accompanied by a consent solicitation process to amend certain restrictive covenants on the US dollar notes, primarily aimed to allow drawdown of secured debt to buy back the notes. The new loan facility requires at least USD100 million of notes to be repurchased in order for the loan to be disbursed.

The new loan facility will also provide USD77 million to Soechi to refinance its syndicated loan maturity in 2021, which is independent of the tender and consent solicitation process.

The RWN on the US dollar notes reflects the likelihood of below-average recoveries (less than 31%) and notching-down of the bond rating if Soechi replaces the majority of the unsecured notes with proceeds from the new secured loan in its capital structure.

Fitch does not consider the cash tender offer as a distressed debt exchange (DDE). We do not think that the transaction is being conducted to avoid bankruptcy or a payment default, a condition for it to be termed a DDE under Fitch's criteria. The new loan facility will allow Soechi to address its 2021 maturities, irrespective of the result of the tender process. The next major maturity is in January 2023 for the US dollar notes and we believe management will take steps, such as seeking refinancing over the next 12-18 months, to address it.

A healthy shipping business profile characterised by protection from foreign competition and steady demand from key customer PT Pertamina (Persero) (BBB/Stable) gives Soechi revenue visibility and should support the company's refinancing efforts.

KEY RATING DRIVERS

Strong Shipping Business Fundamentals: Soechi's fleet capacity under time-charter contracts was sustained at a high level of 98% at end-June 2020 (end-September 2019: 97%). The average duration of the time-charter contracts, weighted by capacity, was less than 2 years, but contracts are often renewed.

Soechi is the one of the largest independent tanker operators in a fragmented domestic shipping industry with many small players. Industry participants enjoy protection from foreign competition through cabotage laws for domestic transportation - which mandate the use of Indonesia-flagged vessels and limit foreign ownership to 49% in joint ventures - and domestic tanker demand is likely to continue growing over the longer term driven by increasing fuel consumption. These market characteristics also result in relatively stable day-rates.

Shipyard Remains a Drag: Soechi has invested around USD200 million in its shipyard, which began operations in 2012. Weak newbuilding order flow and construction delays have affected shipyard performance and we estimate that the shipyard incurred an EBITDA loss of around USD2 million in 2019. Revenue fell by 61% to USD3 million in 9M20 and we expect the EBITDA loss to widen this year.

The shipyard has only one shipbuilding order worth less than USD3 million scheduled to be delivered in 2021. We have assumed more shipbuilding orders from 2021, likely to be granted by the government, and a gradual increase in ship-repair revenue. However, the shipyard may continue to be unprofitable for the next two to three years without substantial revenue growth.

Old Fleet, Small Size: The average age of Soechi's fleet (weighted by capacity) is around 20 years, against a typical useful ship life of 30 years. The company's fleet age matches its strategy of operating older ships, which is the norm in Indonesia's market. However, older vessels usually earn shorter time-charter contracts than more recently constructed vessels, are generally more costly to maintain and are subject to lower utilisation rates due to more maintenance required and more operational issues. Soechi's fleet of 31 ships as of September 2020 is also small relative to global peers.

Customer Concentration, but Low Risk: Pertamina and its shipping subsidiary are Soechi's largest customers and accounted for 71% of revenue in 9M20. This exposes Soechi to the risk of Pertamina not renewing or granting contracts, or defaulting on its payments. However, we believe these risks are significantly alleviated by Soechi's longstanding relationship with Pertamina (Soechi's predecessor companies have been contracted by Pertamina since 1981), Pertamina's robust credit profile, and Soechi's strong market position and capex policy, which is tied to the likelihood of new contracts.

Higher Leverage, Negative FCF Likely: Soechi has not acquired any vessels in 2020 and is focused on using free cash flow (FCF) to increase its cash balance and cut net debt. The proposed tender offer, if successful, will allow the company to reduce outstanding debt and we estimate its 2020 FFO-adjusted net leverage ratio could fall to around 3.5x (2019: 4.4x). However, we expect Soechi to resume fleet growth from 2021 after three years of contraction, which is likely to result in negative FCF and push leverage up to 4x. If the tender offer fails, we estimate Soechi's leverage at around 4x in 2020-21.

Parent-Subsidiary Linkage Assessment: Fitch assesses overall linkages between Soechi and its parent PT Soechi Group (PT SG), which holds a 79.9% stake, as weak based on weak legal and moderate operational ties. We therefore assess Soechi based on its standalone credit profile. We assess the parent, which has a much smaller shipping fleet and EBITDA than Soechi, to have a weaker credit profile. There are no guarantees from Soechi to PT SG or cross-default clauses covering debt at the parent. There are no loans to the parent, and dividends and related-party transactions are relatively small. There are also some checks on related-party transactions under the local listing regulations and the US dollar bond indenture.

Potential Rating Constraint: Soechi's rating may be affected if PT SG's standalone credit profile deteriorates significantly, as Soechi's rating will be constrained to two notches above the consolidated credit profile, including PT SG, as per Fitch's criteria. .

DERIVATION SUMMARY

Soechi's rating can be compared with PT Buana Lintas Lautan Tbk (BULL, B+/Negative), which is a very close peer focusing on oil transportation business in Indonesia. BULL had a fleet of 33 ships as of end-1H20, with an average age (weighted by capacity) of around 17 years. BULL's fleet capacity with exposure to spot rates was around 25% as of end-1H20 and Pertamina is the largest customer. Soechi's fleet size is now smaller than BULL's, and we estimate its leverage to also be weaker in 2020 compared with BULL's FFO adjusted net leverage of around 3x.

Soechi can also be compared with PAO Sovcomflot (BB+/Stable), whose rating benefits from a one-notch uplift from its standalone credit profile of 'bb' due to strong support from the Russian government (BBB/Stable). Sovcomflot is one of the global leaders in maritime transportation of hydrocarbons and in servicing of offshore exploration and oil and gas majors. The company owns and operates 140 vessels, which are fairly young with an average age of 11 years. Its customer base is diversified and consists of large international and Russian oil and gas companies. In addition to a significantly stronger business profile, Sovcomflot's FFO adjusted net leverage of 3.8x in 2019 was lower than Soechi's.

KEY ASSUMPTIONS

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

- Soechi's deadweight tonnage to increase at a CAGR of 6% over 2021-2023

- Tanker day rates to stay flat over 2021-2023

- Average EBITDA margin for shipping segment of 51% over 2021-2023 (2020E: 55%)

- Average annual revenue from shipyard of USD8 million over 2021-2023 (2020E: USD7 million), EBITDA loss to narrow to USD4 million in 2021 from USD7 million in 2020

- Average annual capex, including upfront docking charges, of around USD70 million over 2021-2023 (2020E: USD15 million)

The recovery analysis assumes that Soechi would be liquidated in case of bankruptcy. We have also assumed a 10% administration claim.

Liquidation Approach

- Our liquidation value of around USD275 million is lower than our previous assessment of around USD300 million and includes our estimate of recoveries from Soechi's current assets related to working capital and fixed assets related to the shipyard, in addition to its shipping fleet. The overall liquidation value is broadly in line with the extrapolated appraisal value of the fleet, based on the latest appraised value of USD208 million for selected ships contributing 73% of the fleet capacity as of end-June 2020.

- Soechi had secured bank loans of USD131 million as of 30 June 2020. It also had USD200 million of senior unsecured notes. We have also considered the scenario in which the tender offer is successful and Soechi draws down USD100 million of secured loans to buy back USD140 million of unsecured notes. In that case, pro-forma numbers for secured debt as of end-June 2020 will be USD231 million and USD60 million for unsecured notes.

- The waterfall for actual debt as of end-June 2020 results in a recovery of over 50% for the note holders. However, the senior unsecured bonds are rated 'B' with a Recovery Rating of 'RR4' because, under our Country-Specific Treatment of Recovery Ratings Criteria, Indonesia falls into Group D of countries based on creditor friendliness, and the instrument ratings of issuers with assets located in this group of countries are subject to a soft cap at the issuer's IDR and Recovery Ratings are capped at 'RR4'.

- In case the tender offer is successful and secured debt is used to buy back a portion of the unsecured notes, the waterfall could result in a recovery of below 31% for the note holders, corresponding to a Recovery Rating of 'RR5'. The US dollar notes will be notched down by one notch in such a scenario.

RATING SENSITIVITIES

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

- FFO adjusted net leverage below 3.8x on a sustained basis

- FFO fixed-charge cover remaining above 3x

- No material deterioration of the operating environment

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

- Weakening of the liquidity position or a substantial deterioration of the operating environment

- FFO adjusted net leverage above 4.8x on a sustained basis

- FFO fixed-charge cover below 2x on a sustained basis

The leverage sensitivity has been tightened based on the updated rating navigator for shipping companies.

The RWN on the bond rating will be resolved based on a recovery analysis following a conclusion of Soechi's tender offer. A one-notch downgrade is likely if the majority of the US dollar notes are bought back using secured debt. Alternatively, the rating may be affirmed at 'B' with a Recovery Rating of 'RR4' if the tender offer is unsuccessful.

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

Manageable Liquidity, Some Risk: Soechi had total debt of USD326 million as of end-September 2020, compared with cash (included cash reported as restricted) of USD57 million. Of the total debt, USD89 million is due in 2021 and USD77 million of the repayments are due under a syndicated loan facility. Soechi's new term loan facility will allow it to address the syndicated loan facility repayments.

If the proposed tender offer is successful and Soechi draws additional debt under the new term loan facility to buy back the US dollar bonds, we think the company will be able to address its debt maturities over the next three years. Our estimates assume no discretionary capex and include the remaining portion of the bonds. We think residual risk related to refinancing, should operating performance be weaker than expected or if Soechi uses its cash for fleet growth, is limited.

Soechi will need to address the lumpy bond maturity in January 2023 if the tender offer is unsuccessful, although its liquidity should be sufficient in the interim. While risks remain, we expect the company to be able to find a way to address the bond maturity in the next 12-18 months. Improvement in Soechi's FCF profile from a potential cut in its discretionary capex and revenue visibility due to a high share of time-charter contracts should support its efforts.

SUMMARY OF FINANCIAL ADJUSTMENTS

Material Non-Standard Financial Statement Adjustments include:

- Cash kept as collateral for loan facilities and for US dollar bonds' interest reserve account, but reported as "restricted", has been classified as readily available as it is usable for debt servicing (2019: USD17.5 million).

- Docking expenses, which are amortised after incurrence, have been added back to EBITDA (2019: USD7.1 million). Cash expense for docking has been deducted from capex and added to operating cash flow (2019: USD5.6 million).

- "Unbilled revenues" and "estimated earnings in excess of billings on contracts" have been included in working capital - given their conceptual similarity to trade receivables. Advances and prepaid expenses have also been included in working capital. However, interest-related accrued expenses have been excluded from working capital.

- Unamortised debt transaction costs have been added back to debt (2019: USD4.2 million).

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

Soechi has an ESG Relevance Score of 4 for Management Strategy. The company made a large investment in its shipyard business but earnings generation has been significantly weaker than our and management's expectations. This indicates some weakness in management strategy development and implementation, which has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors. Further aggressive growth spending remains a risk to Soechi's credit profile.

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