Fitch Rates Geo Energy's Proposed USD Notes 'B+(EXP)'
Wednesday, September 27 2017 - 11:26 AM WIB
Geo Energy Resources Limited (Geo, B+/Stable) and its key subsidiaries will unconditionally and irrevocably guarantee the proposed senior unsecured notes. Geo Coal is a wholly owned subsidiary of Geo. The notes will rank pari passu with other senior unsecured borrowings of Geo and its subsidiaries. The final ratings on the proposed notes are contingent upon the receipt of documents conforming to information already received.
Geo's 'B+' rating reflects its small scale of operations, low cost position, minimal off-take and operational risks, comfortable financial profile and liquidity. Geo has recently announced plans for investing in an e-commerce venture. We do not expect this unrelated business to have a significant impact on Geo's business and financial profile as it is in the initial stages and the company's proposed investment is minimal. However, any significant investment that increases the business risk profile of Geo and/or weakens its financial profile may negatively impact its rating.
KEY RATING DRIVERS
Small Scale of Operations: Geo has proved reserves of around 80 million metric tonnes (MMT), total reserves of around 95MMT and produced around 6MMT of coal in 2016. We expect the company to ramp up production volumes to around 10MMT in 2017 and around 15MMT in 2018. Geo's current operations are also concentrated, with its two key co-located mines in Indonesia accounting for the majority of its reserves and production; the concessions for these mines expire in 2022.
However, we expect Geo to make further investments to boost reserves and production, and extend its concession period. Geo's commitment to expand its operations and reserves is also supported by a mandatory obligation to repurchase the notes 3.5 years after issue unless the company fulfils a specified minimum reserves level and maintains producing mines with a specified concession life.
Exposure to Cyclical Coal Industry: Geo remains vulnerable to the commodity cycle, as its earnings and cash flow are linked to the thermal coal industry. Thermal coal prices have come off a peak in late 2016, reflecting China's policies aimed at managing coal prices. Fitch expects some production uptick in response to higher prices, which should lead to some moderation in prices over the medium term. This is reflected in our price assumptions (see Updating Fitch's Mid-Cycle Commodity Price Assumptions, dated 2 March 2017). However, these risks are partially mitigated by Geo's position as a low-cost producer.
Low-Cost Position: Geo has a competitive cost position, with its low cash cost of production for its two key mines, PT Sungai Danau Jaya (SDJ) and PT Tanah Bumbu Resources (TBR) (mid-range calorific value (CV) of coal at 4,000 - 4,200 kcal). The company also benefits from well-connected infrastructure and logistics for its key mines. We expect the low-cost position to support Geo's stable profitability and operating cash flows over the medium term.
Asset-Light Model: Geo has entered into production contracts for its SDJ mine with PT Bukit Makmur Mandiri Utama (BUMA, BB-/Stable), the second-largest coal mining contractor in Indonesia. The company intends to follow this asset-light model over the medium term, thereby limiting any large capex for its mines. Geo has also entered into off-take agreements simultaneously with a commodity trading company, minimising operational and off-take risks. Coal off-take agreements expose Geo to customer concentration and resultant counterparty risks. At the same time, the mid-range CV of coal from its key mines, the flexibility to sell directly (in the case of any default under the off-take agreements), and Geo's relationships with end-buyers offset these risks to a large extent. Geo is in the process of entering into coal mining contracts with BUMA and off-take agreements with advance funding options for the TBR mine.
Investments to Continue: We expect Geo to continue investing over the medium term to augment its coal reserves and production scale. Geo acquired TBR (proved reserves of around 41MMT and total reserves of around 45MMT) for a purchase consideration of USD90 million in June 2017. TBR's location, adjacent to SDJ, is likely to help ramp up production swiftly and also provide synergies. Fitch expects Geo to acquire additional mines/mining concessions in the near term. Geo may focus primarily on producing - or nearly producing - mines of acceptable CV, limiting the risks relating to development of the acquired mines. Any investments in new coal mines expose Geo to additional risks, while we derive comfort from the company's track record and previous experience as a coal-mining contractor before divesting the business in early 2016.
Comfortable Financial Profile: Fitch anticipates Geo's operational cash flows will improve, driven by rising coal volumes, its competitive cost position and our coal-price assumptions. This is likely to support investments in the near to medium term. Credit metrics are likely to remain comfortable, with FFO net leverage of around 1.5x (2016:0.2x) and FFO fixed-charge cover of over 5x (2016: 8.6x) over the medium term. This factors Fitch's assumptions of continuing moderate investments of around USD250 million over the next three years (excluding TBR); in the absence of these investments, we expect Geo to achieve a net cash position after 2018.
DERIVATION SUMMARY
Geo's rating of 'B+' reflects its small scale of operations, low cost position, minimal off-take and operational risks, comfortable financial profile and liquidity. By comparison, China's Yanzhou Coal Mining Company Limited (B/Stable) is constrained by its aggressive financial profile and weak liquidity. Geo's comfortable financial profile and relatively lower cost position results in the higher rating despite Yanzhou's much larger and diversified operations with an improved cost position. PT ABM Investama Tbk's (ABM, BB-/ Stable)'s rating is one notch higher than Geo's due to its more diversified and integrated business despite ABM's marginally weaker financial profile compared with Geo's. (ends)