Fitch Downgrades Waskita Karya to 'CCC+(idn)'

(Fitch Ratings - Jakarta - 06 Oct 2020)--Fitch Ratings Indonesia has downgrade Indonesia-based contractor PT Waskita Karya (Persero) Tbk's (WSKT) National Long-Term Rating to 'CCC+(idn)' from 'B(idn)'. At the same time, the agency has downgraded WSKT's senior unsecured note programme and the notes issued under the programme to 'CCC(idn)' from 'B-(idn)'. All ratings were removed from Rating Watch Negative (RWN), on which they were placed on 19 August 2020.

The downgrade follows Fitch's revision of WSKT's Standalone Credit Profile (SCP) to 'cc(idn)' from 'ccc-(idn)'. Fitch believes that the IDR2.5 trillion in short-term bridging loans that WSKT secured will support the company's repayment of IDR2.5 trillion of bonds due in October 2020 - IDR1,369 billion on 6 October and IDR1,150 billion on 16 October. However, liquidity pressure and refinancing risk remain high due to the company's weakened cash position and upcoming debt maturities, which include supply chain financing of IDR5 trillion in 4Q20 and bonds of IDR1.2 trillion in February 2021.

WSKT's National Long-Term Rating benefits from a three-notch uplift from its SCP for government support, driven by WSKT's support score under our Government-Related Entities Rating Criteria of 15. Fitch views that there is 'Strong' control by the government and 'Moderate' socio-political and financial implications in the event of a default. Fitch also assesses support expectations as 'Weak' as liquidity will remain under pressure following a delay in government support for the company. At the same time, the company's cash flow generation has deteriorated during the coronavirus pandemic. However, the rating uplift still reflects Fitch's expectation that the government will continue to monitor WSKT's on-going liquidity position and provide meaningful support when needed.

The bond programme and the bonds issued under the programme continue to be rated one notch below the National Long-Term Rating in light of significant prior-ranking debt. We expect WSKT's prior-ranking debt/EBITDA to be considerably above 2.5x, the threshold at which we believe the interests of senior unsecured creditors are significantly subordinated to the interests of secured or prior-ranking creditors.

In accordance with Fitch's policies, the issuer appealed and provided additional information to Fitch that resulted in a rating action that is different than the original rating committee outcome.

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

KEY RATING DRIVERS

Short-Term Liquidity Still Under Pressure: The downgrade reflects WSKT's weak liquidity and high refinancing risk. We revised WSKT's Standalone Credit Profile to 'cc(idn)' as we think the company's financial profile will continue to be under pressure over the next three to six months. While it secured funding for the October bonds, we believe that WSKT will find it challenging to continue funding its operations and investments, and to refinance debt in the short term. The economic shock from the pandemic caused its cash position fall to IDR1.4 trillion by end-June 2020 from IDR9.3 trillion at end-2019.

The pandemic has affected operations considerably, with a prolonged working capital cycle and slower cash receipts from construction projects. Aside from the October 2020 bonds, WSKT also has supply chain financing (SCF) of IDR5 trillion maturing in 4Q20 and bonds of IDR1.2 trillion due in 1Q20. We believe WSKT will be dependent on actions, such as major cash collection from projects, realisation of its toll-road divestments, and relaxation of its SCF payments, which it is now negotiating with banks on, to boost short-term liquidity. However, the company faces a tight timeframe to execute its strategies and Fitch will only take them into account after they materialise.

Negative FCF; High Leverage: Fitch believes the challenges in collecting payments due to slower project completions, including turnkey contracts, will result in negative cash flow from operations. The company received turnkey payments of IDR7.1 trillion in the year to June 2020, which it will use mainly to reduce debt although this will be temporary. Fitch projects free cash flow (FCF) will continue to be negative while leverage (net debt/EBITDA) will remain high, above 15x, and coverage (EBITDA/interest paid) will be below 1.0x in the medium term due to high investments to complete toll-road projects.

Weakening New Contracts Amid Pandemic: We expect slower order book growth, as tenders from government and private parties will be limited during the pandemic. We estimate new contract wins will drop by 35% to IDR17 trillion (1H20: IDR8.1 trillion) in 2020 because the lockdown will affect both domestic and offshore projects. We do not expect social distancing measures to be loosened in the near term due to rising infections, which might hit construction progress and timeliness of its project payments. 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 tendered contracts.

'Strong' Ownership and Control: Fitch assesses WSKT's status, ownership and control as 'Strong'. The Indonesian government owns 66% of WSKT, mainly via the Ministry of State-Owned Enterprises, and has strong influence over the company's 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 Expectations: Fitch assesses the support record and expectations factor as 'Weak' to reflect our view that the delay in provision of extraordinary government support has resulted in WSKT's materially weakened financial profile. WSKT's liquidity will continue to deteriorate and refinancing risk remain high unless if the government provides further timely and material support. Fitch will reassess the rating factor if there is stronger evidence of government support to address WSKT's near-term liquidity pressures.

The government has been providing support to WSKT to bolster its liquidity, such as using its strong relationships with state-owned banks and helping in the company's toll road divestments. WSKT has been receiving equity injections, including IDR3.5 trillion of equity in 2015, and support for WSKT's subsidiary, PT Waskita Toll Road, through strategic partnerships via government-affiliated institutions. Total government support came to IDR3.5 trillion in 2017.

'Moderate' Socio-Political Implications of Default: We assess the socio-political impact of a WSKT default as 'Moderate', as infrastructure development is at the top of the government's economic agenda. Infrastructure development is not essential, like food or utilities, but we do not think the implications are 'Weak' because WSKT lends its balance sheet to government-related contracts - particularly turnkey projects - so that key projects can be completed promptly, making WSKT vital for Indonesia's infrastructure. Furthermore, WSKT has the second-largest order book among state-owned contractors, of which 70% are national strategic projects.

'Moderate' Financial Implications of Default: Fitch believes a WSKT default would have a 'Moderate' financial impact on the availability and cost of finance by other government-related entities. This is driven by WSKT's significant debt position (1H20: IDR74 trillion including SCF) and more active bond issuance compared with peers.

DERIVATION SUMMARY

WSKT's SCP reflects the company's weaker cash flow generation, which may result in challenges to fund its investments and repay its near-term maturities. We believe the execution risk of the company's strategies to boost its liquidity in a timely manner during the pandemic, such as obtaining further external debt facilities and collecting major cash inflows from its projects, heightens its refinancing risk.

KEY ASSUMPTIONS

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

- New contract wins of IDR17 trillion in 2020 and IDR23 trillion in 2021 (2019: IDR26 trillion)

- No significant cash inflows from turnkey projects and asset divestments in 2H20

- EBITDA margin of 9% in 2020 and recovering to between 14%-16% in 2021-2023

- Capex of IDR8 trillion-10 trillion in 2020-2023

- Dividend payout ratio of 20% in 2021-2022

RATING SENSITIVITIES

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

- Ability to improve its liquidity such that it is able to address its near-term debt maturities;

- Stronger likelihood of support from the Indonesian government to WSKT.

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

- Inability to service its near-term debt maturities;

- Weakening likelihood of support from the Indonesian government to WSKT

LIQUIDITY AND DEBT STRUCTURE

Weak Cash Flows: We think WSKT's liquidity, reflected by its cash position of IDR1.4 trillion at end-June 2020, is weak because cash collection deteriorated during the pandemic as construction progress slowed. The additional short-term bridging loans will be sufficient to repay bonds maturing in October 2020, but we expect WSKT to require further significant and timely external funding to support its operations and debt service obligation over the next three to six months.

SUMMARY OF FINANCIAL ADJUSTMENTS

Fitch treats WSKT's supply-chain financing (1H20: IDR7.7 trillion) as debt, as it extends the trade payable cycle significantly to around 180 days, compared with the standard 90 days.