Fitch Affirms Wijaya Karya at 'BB-'/'A-(idn)'; Negative Outlook

(Fitch Ratings - Singapore/Jakarta - 08 Sep 2021)-- Fitch Ratings has affirmed Indonesia-based contractor PT Wijaya Karya (Persero) Tbk's (WIKA) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at 'BB-'. At the same time, Fitch Ratings Indonesia has affirmed WIKA's National Long-Term Rating at 'A-(idn)'. The Outlook is Negative.

The affirmation reflects our view that WIKA's liquidity and refinancing risk will be manageable in the medium term, although its ability to reduce its high leverage, measured as seasonally adjusted net debt/EBITDA, has been hampered by the prolonged Covid-19 pandemic, which disrupted its operations.

Fitch believes WIKA remains one of the country's important government-related entities (GRE) in the construction sector. It has the largest order book and a better credit profile than other GRE contractors. WIKA has an aggregate score of 15 based on our GRE rating criteria due to our assessment of the government's strength and incentive to provide support. This results in WIKA's IDR and National Long-Term Rating benefitting from a three-notch uplift to its Standalone Credit Profile (SCP) of 'b-' and 'bbb-(idn)', respectively.

'A' National Ratings denote expectations of a low level of default risk relative to other issuers or obligations in the same country or monetary union.

Key Rating Drivers

Manageable Refinancing: WIKA's debt-maturity profile improved after the refinancing of a IDR5.4 trillion Komodo bond and short-term bridging loans in 1Q21 into longer-term maturities. Its IDR15 trillion debt maturities in the next 12 months are short-term bank loans that we expect to be rolled over, based on the company's record. We believe WIKA will maintain its debt funding access through solid banking relationships, with 56% of its loans from state-owned banks.

Delayed Deleveraging: Stricter movement restrictions and operational disruptions due to rising Covid-19 cases in June-August 2021 will slow WIKA's recovery compared with our earlier forecast. We expect slower construction progress and a long working-capital cycle to keep WIKA's leverage above 7.0x by 2022. The government may also reallocate its infrastructure budget towards the pandemic. We expect WIKA to receive material cash inflows from projects in progress, such as the High Speed Railway and other toll roads, before end-2021 after a delay.

Fitch expects the easing of restrictions from September 2021 will support WIKA's recovery from 4Q21, aided by strong new contracts of IDR10.6 trillion in 1H21 (1H20: IDR3.4 trillion). We think WIKA's strong market position and revenue/order book of 5.9x in 2020 will help it recover when the pandemic eases. Nonetheless, the Negative Outlook reflects the uncertainty over its recovery. The latest wave of Covid-19 infections, which will likely affect economic activity in 3Q21, means that GDP growth may not meet our current forecast of 4.8% in 2021.

'Strong' Status, Ownership and Control: The Indonesian state, WIKA's largest shareholder with a 65% stake, mainly via the Ministry of State-Owned Enterprises, has strong influence over its investment decisions, strategy and operations. The government also holds a golden share that gives it veto power over the appointment and dismissal of board members, distribution of profit and M&A.

'Weak' Support Record: Fitch believes that government support, while ongoing, has been insufficient to sustain WIKA's credit profile during the pandemic. WIKA's leverage has been increasing steadily since 2019 as the company continued to execute projects while having to draw on external loans to cover slower cash receipts, which contributed to the lowering of WIKA's SCP in 2020 from 'b'.

The government last bolstered WIKA's liquidity via a IDR4 trillion equity injection in 2016. However, the company has since relied on external funding for its projects, including its strong relationships with state-owned banks. We believe the government will continue to prioritise infrastructure to boost economic growth once the pandemic eases, although there is a risk the government could reallocate some of the infrastructure budget to pandemic relief measures, which could slow contract wins for WIKA.

'Moderate' Support Incentive: We think a default will have 'Moderate' socio-political implications as other GREs or private contractors can act as substitutes for WIKA's services, although there may be temporary disruptions due to WIKA's IDR82 trillion order book at end-June 2021, including 54% in National Strategic Projects. WIKA's debt size also has 'Moderate' financial implications as a default would have a modest effect on the availability and cost of debt for other GREs while potentially reducing the state's access to key infrastructure-related funding.

Derivation Summary

WIKA can be compared with Indonesian peers PT Hutama Karya (Persero) (HK: BBB-/AA+(idn)/Stable; SCP: b-/bb(idn)) and PT Indonesia Asahan Aluminium (Persero) (Inalum, BBB-/Stable; SCP: b-), as well as Chinese construction company Shanghai Construction Group Co., Ltd. (SCGC; BBB+/Stable; SCP: bbb-).

WIKA has a GRE score of 15 and its SCP benefits from a three-notch uplift, while HK and Inalum are rated using a top-down approach of one notch below the sovereign's 'BBB' rating in light of their GRE support scores of 35. We believe Inalum's default would have 'Very Strong' implications on the cost and availability of financing to the Indonesian government and other GREs because we think investors consider Inalum a proxy financing vehicle for the state due to its significant US dollar bond size.

We assessed HK's status, ownership and control, and support record factors as 'Very Strong', compared with WIKA's 'Strong' and 'Weak', respectively, to reflect the government's greater role and influence in HK's operations. The government guarantees a substantial portion of HK's debt, in addition to frequent and consistent support for its toll roads.

SCGC has the same GRE score as WIKA, but is rated with two notches of uplift from its SCP, while WIKA has three notches. A default by SCGC would disrupt construction projects in Shanghai, but social consequences would be limited, due to the city's high urbanisation rate and highly competitive construction sector. WIKA's default would have a higher impact on Indonesia's national infrastructure development plan.

WIKA's 'b-' SCP is comparable with HK's SCP of 'b-' and US-focused contractor Tutor Perini Corporation's (TUT, B+/Stable) rating. Both WIKA and HK have been hurt by the pandemic and face cash flow pressure. WIKA has a larger operational scale and ability to deleverage in the medium term. However, this is balanced by HK's favourable long-dated maturity schedule, which results in lower refinancing risk.

WIKA and TUT have strong positions in their niche markets and comparable operating EBITDA scale in the medium term. WIKA has a higher profit margin, but we believe TUT will have stronger free cash flow generation. This, along with our expectation of TUT's much stronger financial profile over the next three years, results in a two-notch gap in the assessment of the companies' credit profiles.

On the national rating scale, WIKA's SCP of 'bbb-(idn)' is comparable with Indonesian tower company PT Bali Towerindo Sentra Tbk's (Bali Tower, BBB+(idn)/Positive) rating. Bali Tower's better margins and earning visibility due to its non-cancellable long-term contracts, and lower leverage result in the two- notch difference with WIKA.

Key Assumptions

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

- New contract wins of around IDR26 trillion in 2021 and IDR42 trillion in 2022 (2020: IDR23 trillion)

- EBITDA margin, including share of profit from joint operations, of 10%-12% in 2021-2024 (2019: 9.8%)

- Aggregate capex and investments of around IDR4.1 trillion in 2021

RATING SENSITIVITIES

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

The following may lead to a revision of the Outlook to Stable:

- Improvement in WIKA's interest coverage (EBITDA/interest paid) to above 1.5x on a sustained basis

- Ability to generate positive operating cash flow on a sustained basis

- Stronger likelihood of support from the Indonesian government

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

- Interest coverage decreases below 1.5x on a sustained basis

- Further liquidity pressure that results in elevated refinancing risks

- Weakening likelihood of support from the Indonesian government

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

Sufficient Liquidity, Manageable Refinancing Risk: We believe WIKA has sufficient liquidity to manage its refinancing risk within the next 12-24 months, including its supply-chain financing obligations. WIKA had available cash of IDR7.6 trillion at end-June 2021, with undrawn short-term bank facilities of IDR3 trillion. WIKA's IDR15 trillion debt maturing in the next 12 months is made up entirely of short-term loans that can be rolled over annually with no maturing long-term loans or debt instruments.

We believe WIKA will maintain its access to funding due to its status as the country's largest SOE contractor and its close relationships with banks, particularly SOE banks. WIKA is also about to issue a total of IDR2.5 trillion in bonds and sukuk in September 2021, which will be used to refinance some of its short-term debt into longer maturities.

Issuer Profile

WIKA, 65%-owned by the state, is the largest GRE contractor in Indonesia with an order book of IDR82 trillion at end-June 2021. WIKA's construction business is split into four segments - infrastructure and building, industry, energy and industrial plants, and property.

Summary of Financial Adjustments

- Share of profit from joint operations is included in EBITDA, as this forms part of WIKA's core operations

- Supply-chain financing due to be paid in more than 90 days is considered debt, as this effectively extends the usual trade payable cycle

-We deduct IDR4 trillion from year-end cash, which is the difference between year-end cash and average cash balance between the first and third quarters. This is to iron out seasonal working capital variances that affect leverage

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)