Fitch Downgrades Waskita Karya to 'BBB+(idn)' and Notes to 'BBB(idn); Outlook Negative

(Fitch Ratings - Jakarta - 29 May 2020)--Fitch Ratings Indonesia has downgraded PT Waskita Karya (Persero) Tbk's (WSKT) National Long-Term Rating to 'BBB+(idn)' from 'A(idn)'. The Outlook is Negative. At the same time, the agency has downgraded WSKT's senior unsecured note programme and the notes issued under the programme to 'BBB(idn)' from 'A-(idn)'. A complete list of rating actions is at the end of this press release.

The downgrade reflects WSKT's weakening financial profile, given its high leverage and weak interest coverage, as a result of weak profitability from lower new contract achievements and a longer working-capital cycle. Meanwhile, the Negative Outlook reflects Fitch's expectation that WSKT's liquidity may continue to be under pressure should the economic impact from measures to curb the spread of the coronavirus be extended. Prolonged economic weakness could lead to delays in tenders and payment delays from customers due to disruption in its construction, particularly as most of WSKT's projects are on a turnkey basis, where payments are only received fully when the projects are completed. The payment delays have also extended the company's working-capital cycle.

Waskita's final rating of 'BBB+(idn)' incorporates a four-notch uplift from its standalone credit profile (SCP) of 'bb(idn)' due to the company's strong linkages with its majority shareholder, the Indonesian sovereign (BBB/Stable).

The programme and the bonds issued under the programme will continue to be rated one notch below the company's National Long-Term Rating of 'BBB+(idn)' in view of significant prior-ranking debt. We expect Waskita's prior-ranking debt/EBITDA to be considerably above 2.5x, the threshold where we believe the interests of senior unsecured creditors are significantly subordinated to the interests of secured or prior-ranking creditors.

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

KEY RATING DRIVERS

Financial Profile Weakens: The SCP reflects the company's high leverage and weak coverage metrics. We believe that the coronavirus pandemic will further weaken WSKT's financial profile, which has contributed to the downgrade in SCP to 'bb(idn)' from 'bbb-(idn)', as construction is delayed due to labour and supply disruptions. This will result in slower contract execution and delayed payments from project owners, which could extend its working-capital cycle, as projects take longer to be completed.

We expect WSKT's leverage, measured by net debt/EBITDA, to be above 13x in the medium term (2019: 14.4x) while interest coverage (EBITDA/Interest Expense Paid) will remain below 1x in 2020-2021 (2019: 0.9x). WSKT is likely to find it challenging to deleverage in the current environment as the company will have to continue executing its massive order book and toll road investments, which require additional funding.

Weakening Order Book: We expect growth in WSKT's order book to slow as tenders will be limited amid the pandemic. We estimate new contract wins to decline by 5% to IDR25 trillion in 2020, assuming WSKT wins major projects such as the Balikpapan-Penajam Toll Road and Malolos-Clark Railway. These two projects are worth a combined IDR17 trillion. WSKT won new orders of IDR3.1 trillion in 1Q20.

Our rating case assumes that social distancing measures tied to the pandemic will ease in 2021, at which time major tenders will resume. This could boost WSKT's new contracts to IDR30 trillion-40 trillion in 2021-2023. However, a prolonged pandemic may prompt the government to re-allocate resources away from infrastructure projects to combat COVID-19, which would reduce the number of contracts up for tender, which is reflected in the Negative Outlook.

Turnkey Payments; Negative FCF: We expect the company's cash flow from operations (CFO) to continue to be positive in 2020 (2019: IDR6.3 trillion), despite the pandemic, as we expect WSKT to receive turnkey payments of IDR12.6 trillion in 2020 for major projects like the Jakarta Cikampek Elevated II Toll Road. The company has received turnkey payments of IDR7.1 trillion in the year to April 2020, which it will mainly use to reduce debt, although this will be temporary. Free cash flow (FCF) will continue to be negative due to high investments to complete on-going toll road projects and leverage will remain high.

We expect WSKT to receive most of the remaining turnkey payments in 2H20 from projects such as LRT Palembang and the Cinere Serpong Toll Road. However, we assume working capital will be negative when WSKT's revenue returns to growth in 2021 as the pandemic eases.

Strategic Importance to Government: WSKT's strategic importance to the government stems mainly from its position as the largest contractor of toll-roads in Indonesia and its role as one of the largest investors in toll-road concessions. More than 70% of WSKT's IDR166 trillion of new contracts between 2015 and 2018 consisted of national strategic projects (NSPs), with over 80% of NSPs being toll roads. WSKT has invested in more than 1,000km of toll-road concessions, with 11 completed operational projects and a further seven under construction.

State Ownership, Tangible Support: The Indonesian government owns 66% of WSKT primarily via the Ministry of State Owned Enterprises, and has strong influence over investment decisions, strategy and operations. The government holds a 'golden share' that allows it to veto important decisions regarding the appointment and dismissal of board members, distribution of profit and M&A, among others, irrespective of the presence of minority shareholders. The government has also previously provided IDR7.0 trillion of equity injections into WSKT and certain projects.

DERIVATION SUMMARY

WSKT's Standalone Credit Profile (SCP) of 'bb(idn)' is comparable with those of its contractor peers, such as PT Wijaya Karya (Persero) Tbk (WIKA, AA-(idn)/Stable, SCP: a(idn)) and PT Hutama Karya (Persero) (HK, AA+(idn)/Stable, SCP: bb+(idn)). WSKT's SCP can be compared with the National Long-Term Rating of palm-oil producer PT Sawit Sumbermas Sarana Tbk (SSMS; (BB-(idn)/Stable).

WIKA is a large state-owned contractor, and undertakes strategically important projects for the government. However, WIKA has a lower number of turnkey contracts in its order book, and is not a major investor in toll roads compared with WSKT. Consequently, WIKA's financial profile is much stronger than WSKT's, based on leverage and coverage, justifying the multiple notch difference in the SCPs.

We expect both WSKT and HK to experience negative FCF - hence, both companies have highly leveraged balance sheets - to develop the government's vital toll road projects in the medium term. WSKT's larger scale - in terms of EBITDA and order book - is outweighed by HK's slightly better coverage, lower pressure on cash flows due to low exposure to turnkey projects, more favourable debt maturity profile. As a result, WSKT's SCP is one notch lower than that of HK.

We project the financial profiles of both WSKT and SSMS, which is rated based on the consolidated profile of its parent PT Citra Borneo Indah (CBI), to be weak due to high leverage, weak coverage and negative FCF in the medium term. WSKT has much larger scale and lower refinancing risk than SSMS due to its better funding access. CBI's profile is exposed to the commodity price cycle, while losses at other CBI businesses, large outflows from related-party transactions and acquisitions, and an inability to control costs could hamper an improvement in CBI's financial metrics. Hence, WSKT's SCP is rated at one notch above SSMS's National Long-Term Rating. (ends)