Fitch Downgrades Saka to 'B+'; Outlook Negative

(Fitch Ratings - Singapore - 18 Jan 2021)-- Fitch Ratings has downgraded Indonesia-based oil and gas producer PT Saka Energi Indonesia's Long-Term Issuer Default Rating (IDR) to 'B+' from 'BB'. The Outlook on Saka's Long-Term IDR is Negative.

The downgrade reflects our expectation of weakening support from Saka's parent, PT Perusahaan Gas Negara Tbk (PGN, BBB-/Stable). This follows PGN's request to Saka to repay part of the shareholder loans this month, reversing PGN's earlier decision to roll over the loans to Saka. Fitch previously expected PGN to continue to support Saka, via extending the maturities of the loans. Fitch believes the part-repayment is likely to impinge Saka's financial flexibility at a time when the company faces a likely tax penalty and a challenging operating environment.

Fitch now rates Saka on a bottom-up basis - previously a top-down approach - reflecting weaker support expectations. We apply a two-notch uplift from its Standalone Credit Profile (SCP) of 'b-', based on our assessment of moderate linkages between Saka and its parent's SCP of 'bb+', in line with Fitch's Parent and Subsidiary Linkage Rating Criteria. The two-notch uplift factors in the significant reputational risk, given a cross-default provision in PGN's US dollar notes upon a Saka default.

The Negative Outlook reflects risks of further weakening of linkages between PGN and Saka arising from absence of any affirmative support from PGN, and of a continuing decline of Saka's business profile in the absence of reserve acquisitions. Saka's position within the state-owned oil and gas company structure remains uncertain and a lack of continued capital support from PGN increases uncertainty on the parent's commitment toward Saka.

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 2024 US dollar notes.

KEY RATING DRIVERS

Weakening Linkage: Fitch has revised the linkages between Saka and PGN to 'Moderate' from 'Strong' following the reduction in tangible support. Our assessment reflects the significant reputational risks for PGN in the event of a Saka default. The reputational risks are increased due to 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 PGN's consolidated EBITDA until 2023. In addition, Saka's branding is integrated with PGN's in its marketing and financial materials.

Material Subsidiary: We believe Saka qualifies as a material subsidiary defined in the bond documentation of PGN's USD1.35 billion senior notes due 2024, and a default by Saka will trigger a cross-default provision in PGN's bonds, which mature after Saka's USD625 million notes. However, Fitch considers the cross-default provision as 'Moderate' legal linkages, as PGN's bond documents are somewhat vague in defining a material subsidiary in the event of a default and leaves some discretion to PGN. Continued deterioration in Saka's asset profile and earnings could result in the materiality of Saka further weakening.

Shareholder Loan Repayment: Fitch views PGN's request to repay USD77 million of the USD155 million shareholder loans due in January 2021 as evidence of weakening support, especially amid Saka's tight liquidity due to its scheduled capex and likely additional tax payments on acquisitions. Saka also does not have any material loan facilities nor any concrete funding plans from PGN to address its 2024 bond maturity. Fitch had previously expected PGN to continue to support Saka via extending the loan maturities.

Saka Misaligned in New Group Structure: 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). Under the restructuring, most state-owned Indonesian upstream oil and gas operations are held under Pertamina and all state-owned gas distribution and transmission companies are held under PGN.

This resulted in PGN considering a sale of its Saka stake, although there is no clarity on the timing or method for the sale. The continued indecision by Pertamina and PGN on the positioning of Saka, within the structure of the state-owned oil and gas companies, has halted Saka's ability to raise funds, expand reserves and secure future production.

Weakening Operating Profile: Saka's operating profile remains weak with its proved reserves of 55 million barrels of oil equivalent (boe) adequate for about life at about four years, based on the company's expected production. Significant increase in reserve life is contingent on reserve acquisitions, as we assess that Saka's organic reserve replacement is likely to remain well below 1x because it has weak contingent reserves against proved reserves.

However, large investments are unlikely until its ownership structure is finalised. Saka's production dropped to 25,700 boe per day (mboepd) in the 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 because the majority are via long-term fixed-price gas contracts.

Weaker Financial Profile: Fitch estimates Saka's leverage (net debt/EBITDA) weakened to over 9x 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 4.5x and 6.0x from 2021 to 2024. We estimate Saka's EBITDA fell to less than USD100 million in 2020, and will recover to between USD170 million and USD220 million a year until 2024. We have included the USD361 million in shareholder loans in Saka's debt.

One-Off Tax Payment: Saka's liquidity will weaken. A Supreme Court ruling required Saka to pay the Indonesian tax authority USD127 million in 2020 for the tax owed 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, and Saka is coordinating the payment terms with the authority. Saka holds 100% of Pangkah PSC, which accounted for 22% of its oil and gas production in 9M20.

DERIVATION SUMMARY

Saka's ratings benefit from a two-notch uplift from its SCP of 'b-', due to moderate legal, operational and strategic linkages with its parent, PGN. Saka's 'b-' SCP reflects its limited reserve life, and tight liquidity in the absence of support from PGN. Its operational and financial profile remains considerably weaker than that of PT Medco Energi Internasional Tbk (B+/Stable), resulting in the two-notch difference between Medco's rating and Saka's SCP. The Negative Outlook reflects risks of further weakening linkage with PGN arising from continued capital support, which may lead to a further deterioration of Saka's SCP.

KEY ASSUMPTIONS

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

- Oil price of USD41/bbl in 2020, USD45/bbl in 2021, USD50/bbl in 2022 and USD53/bbl from 2023 onwards. Henry Hub natural gas prices of USD2.1 per million British thermal units (mmbtu) in 2020 and USD2.45 per mmbtu from 2021 onwards (See "Fitch Ratings Cuts Long-Term Oil Price Assumptions", dated 8 September 2020, at www.fitchratings.com/site/pr/10135260);

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

- Additional cash tax on the acquisition of some of its assets of USD255 million in 2020;

- Capex of USD118 million in 2020, and between USD135 million to 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 (GC) Approach

The GC 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 both the shareholder loans and the US dollar notes to rank pari passu, resulting in a recovery corresponding to a 'RR3' for the unsecured notes. However, we have rated the senior unsecured bonds '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 issuers IDR.

RATING SENSITIVITIES

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

- The Outlook maybe revised to Stable on clear evidence of adequate support from PGN, which can lead to a strengthening of Saka's operating profile, and clarity on Saka's position within the group structure, in which case Fitch may continue assess that linkages between PGN and Saka, as well as Saka's SCP remaining 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 and/or production in the absence of reserve acquisitions, and/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. (ends)