Fitch Affirms Star Energy's Notes at 'BB-'; Outlook Stable

(Fitch Ratings - Singapore/Jakarta - 05 May 2021)--itch Ratings has affirmed Star Energy Geothermal (Wayang Windu) Ltd.'s (SEGWW) USD580 million fully amortising 6.75% senior secured notes due 2033 at 'BB-'. The Outlook is Stable.

RATING RATIONALE

The renewable energy project benefits from long-term contracts to use geothermal resources and sell electricity to Indonesian state-owned power company PT Perusahaan Listrik Negara (Persero) (PLN, BBB/Stable). The take-or-pay nature of the electricity sales contract (ESC) with PLN eliminates most volume and merchant price risks. Fitch expects the supply of geothermal resources to be reliable, subject to appropriate and timely well maintenance and drilling of new wells.

The Covid-19 pandemic has not significantly affected SEGWW's financial results for the year ended 31 December 2020 because of the take-or-pay clauses under the existing ESC with PLN. SEGWW has also not experienced significant disruptions to its power plants or business continuity management plan as a result of various government-implemented lockdowns and social distancing requirements.

SEGWW's financial profile under the Fitch rating case shows an average annual debt-service coverage ratio (DSCR) of 1.29x with a minimum of 1.12x. The low level of excess cash generation would limit the ability to fund necessary capex, if it needs to be accelerated, or other unexpected costs. The metrics are appropriate for a 'BB-' rated facility of this type under Fitch's Renewable Energy Project Rating Criteria.

KEY RATING DRIVERS

Robust Operating Record, Inherent Volatility in Resource Supply: Operation Risk - Weaker

SEGWW has ample operating experience and a strong record with very high average availability and capacity factors (excluding an outage in 2015) for both of its generation units since they started operations. However, SEGWW's operation of the units could expose the company to the risks of cost overruns and operational underperformance.

The power plant suffered an extended outage in 2015 due to a landslide that damaged a steam pipeline, although SEGWW has made considerable changes to reduce the probability of such an event recurring. SEGWW completed countermeasure works at all high-risk areas in 2019.

Operating costs in 2020 were higher than in 2019, driven mostly by higher depreciation and amortisation of new assets that were previously booked as assets under construction. SEGWW has a detailed capital investment plan for drilling new wells and maintaining existing wells. The external technical consultant, GeothermEx, has reviewed and is satisfied with the plan. However, GeothermEx has also advised that there is considerable uncertainty on capex timing given the nature of the geothermal assets. In the latest round of make-up well drilling, the plant achieved additional steam supply that was better than targeted at a cost lower than budgeted.

The lack of a detailed operating cost analysis by a third-party technical advisor constrains our assessment. For major drilling programmes (capex exceeding USD100 million over two years), a reserve account will prefund 25% of the well drilling costs, for each half-year period, over the next two years. The reserve account will also cover planned major maintenance costs for six months.

Resource Supply Validated by Consultant: Revenue Risk - Volume - Midrange

The volatility and decline in steam supply inherent in the geothermal resource introduces supply risk to electricity generation, but SEGWW has managed to keep the steam depletion rate lower than previously forecast through a well-intervention programme and drilling of make-up wells. By end-2020, SEGWW's steam supply was 34 kg/s above the target and 49kg/s above the steam requirement of 450kg/s. The existing geothermal resources are sufficient to support 280MW of electricity generation for 30 years or 390MW of electricity generation for 20 years, according to GeothermEx's report in February 2018.

Curtailment risk is limited by the take-or-pay nature of the ESC under which PLN is required to pay for 95% of the rated capacity of each of the two generators if it is not dispatched.

Supportive Long-Term Power Purchase Agreement: Revenue Risk - Price - Stronger

The electricity tariffs are largely fixed under the ESC. The price for electricity produced by Unit 1 may be renegotiated after 2030, but SEGWW would be required to add USD50 million to the debt reserve account from 2028. This will provide a cash cushion if the renegotiation does not yield similar or better terms.

The tariffs are indexed using straightforward, broad-based publicly available indexation formulas. The tariffs are denominated in US dollars but partially indexed to the US dollar-rupiah exchange rate, such that SEGWW's revenue in US dollars will decline if the rupiah depreciates against the US dollar. However, the cash flow impact of lower revenue is partially offset by lower operating costs in US dollar terms because most of the operating costs, such as labour, are denominated in rupiah. SEGWW does not enter into foreign-exchange hedges, leaving it exposed to exchange-rate risk.

Fully Amortising Debt: Debt Structure - Midrange

The seniority, full amortisation and fixed coupon of the USD580 million bonds are features of a debt structure that would be assessed as a 'Stronger' attribute under Fitch's key rating driver assessment of renewable projects. SEGWW may have to pay higher coupon rates if it issues debt to fund the development of Unit 3, and the new debt would be required to meet a projected DSCR of 1.3x. The existing notes may not have security over the new assets, and may not have access to the cash flow from Unit 3 for debt service, if this additional debt is structured as a new debt tranche instead of additional notes issued from the current tranche.

The six-month debt service reserve account (DSRA) is a feature of a 'Midrange' debt structure. The lock-up regime at 1.1x look-back DSCR is not particularly robust and is weaker than that of some peers. The debt amortisation results in steady deleveraging, but the annual cash flow and DSCRs are volatile. Overall, Fitch assesses the debt structure as 'Midrange'.

PEER GROUP

Fitch rates the US dollar secured bonds issued by Star Energy Geothermal (Salak-Darajat) Restricted Group's (SEGSD RG) at 'BBB-' with a Stable Outlook. SEGSD RG's rating is higher than that of SEGWW as it benefits from economies of scale, a longer operating history, lower capex required per unit of its capacity and stronger reserve requirements within its debt structure. SEGSD RG's rating case DSCR is much higher at 1.63x, supported by a lower initial debt load, despite SEGWW's higher tariffs.

SEGSD RG benefits from economies of scale from operating 648MW of installed capacity and diversification across nine generation units in two sites. In comparison, SEGWW operates only two units in a single site with 227MW installed capacity. The Darajat operations, which is a dry steam reservoir, have cost advantages over Wayang Windu. On a per MW basis, SEGSD RG has lower capex than SEGWW. This is because the restricted group operates only five of the nine turbine units, with the remaining four units operated and maintained by PLN. However, SEGWW benefits from higher tariffs.

SEGSD RG's debt structure benefits from a stronger reserve feature (major maintenance reserve account (MMRA) equal to a third of total capex in next three years) compared with that of SEGWW, where the MMRA is equal to planned maintenance costs for the next six months and prefunding of 25% of the major drilling programme for each half-year period over the next two years. In addition, SEGSD RG's distribution lock-up ratio of 1.15x 12-month backward-looking DSCR is higher than SEGWW's 1.10x.

RATING SENSITIVITIES

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

- Projected average DSCR above 1.35x in Fitch's rating case.

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

- The projected average DSCR dropping below 1.25x in Fitch's rating case as a result of production declines or interruptions, operating difficulties, additional debt or other factors.

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.

TRANSACTION SUMMARY

SEGWW is part of the Star Energy Group, the largest geothermal energy producer in Indonesia and the third largest in the world. SEGWW has the exclusive right to use geothermal resources in the Wayang Windu area in West Java, Indonesia, about 40km south of the city of Bandung. SEGWW operates two power generation units with a combined gross installed capacity of 227MW. Unit 1 is 110MW and began commercial operations in June 2000, while Unit 2 is 117MW and started in March 2009

CREDIT UPDATE

SEGWW continued to maintain its strong operational performance, evidenced by its high availability factor of 99.79% in 2020 - marginally better than management's projection of 99.30%. The availability factor in 2019 was lower due to shutdown and turnaround (SDTA) maintenance of Unit 1, which was completed in 12 days, against the target of 14 days.

Net capacity picked up to 96.58% in 2020, from 95.43% in 2019, due to curtailment of PLN and Unit 1 SDTA in 2019. However, the curtailment risk is limited given the take-or-pay arrangement of the ESC under which PLN is required to pay for 95% of the rated capacity if it does not take all the electricity nominated.

FINANCIAL ANALYSIS

The Fitch base case assumes a capacity factor of 97% for both generation units, and uses management's forecast for operating expenses and capex. SEGWW has an average annual DSCR of 1.40x and a minimum DSCR of 1.33x under the base case.

The Fitch rating case assumes a capacity factor of 95% for both units, which is equal to the lowest level in recent years. We also assume that major overhauls of the power plants are performed every three years (as they have been historically), compared with every four years in management's assumptions. Our rating case also applies a 15% stress to management's assumptions for operating expenses and a 5% stress to capex.

The Fitch rating case results in an average annual DSCR of 1.29x and a minimum DSCR of 1.12x. The achieved coverage level reflects the higher lifecycle capex risks associated with geothermal facilities compared with other renewable projects, and is appropriate for a 'BB-' rating, although it is above the 'BB-' threshold of 1.20x for concentrated solar power projects in Fitch's 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)