Fitch Rates Geo Energy's USD300m Notes Final 'B+'
Monday, October 2 2017 - 01:33 PM WIB
Geo Energy Resources Limited (Geo, B+/ Stable) and its key subsidiaries unconditionally and irrevocably guarantee the 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 assignment of the final rating follows a review of the final documentation, which conforms to the draft documentation previously received. The final rating is the same as the expected rating assigned on 27 September 2017.
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.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Geo include
- Coal prices in line with Fitch's mid-cycle commodity price assumptions, adjusted for difference in calorific value (average Newcastle 6000 kcal free-on-board (FOB): USD65/MT from 2018 onwards).
- Investments of around USD100 million-130 million in the next 6-12 months
- Coal production volumes of around 9MMT in 2017 and around 15MMT in 2018.
- Dividend pay-out of around 15%-20%
Fitch's key assumptions for bespoke recovery analysis include:
-The recovery analysis assumes that Geo would be considered a going concern in bankruptcy, and that the company would be reorganised rather than liquidated. We have assumed a 10% administrative claim.
-Geo's going-concern EBITDA is based on last 12 months (LTM) December 2016 EBITDA, and includes pro forma adjustments for the EBITDA contributions from the acquired TBR mines and other similar-sized acquisitions in the next 6-12 months.
-The going-concern EBITDA estimate reflects Fitch's view of a sustainable, post-reorganisation EBITDA level upon which we base the valuation of the company. The going-concern EBITDA is 25% below the mid-cycle EBITDA based on the long-term average thermal coal price assumptions used by Fitch. The post-reorganisation EBITDA assumes some post-default operating improvement, and is at a level that may violate the intended covenants for its US dollar notes.
-Fitch generally assumes a fully drawn working-capital facility of USD40 million - the extent allowed under the intended covenants of the US dollar notes - in its recovery analysis, since working-capital debt is tapped as companies are under distress.
-An enterprise value (EV) multiple of 4x is used to calculate a post-reorganisation valuation, and reflects a derived EBITDA multiple based on a distressed valuation metric of around USD3-USD5 per ton of Geo's proved reserves - including expected acquisitions subject to adjustment. The historical EV multiple for companies in the natural resources sector ranged from 5.8x-11x, with a median of 8.7x. However, we have used a conservative multiple, due to the small size of Geo and its limited concession period.
-The waterfall results in a recovery of around 100% for the US dollar note holders. However, Fitch applies a soft cap of 'RR4' for the Recovery Ratings of Geo as all of its mining operations are located in Indonesia, a Group D country. Fitch consequently rates the senior unsecured US dollar notes at 'B+'/'RR4'.
RATING SENSITIVITIES
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
- We do not expect any upgrade, given the small size of Geo's operations, which constrains its business profile.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
- Any significant increase in business risk profile as a result of investments in businesses unrelated to coal mining.
- Any sustained weakening in operating profile including production, reserves or cost position
- FFO net leverage of over 2.5x on a sustained basis
- FFO fixed-charge cover sustained below 5x
LIQUIDITY
Adequate Liquidity: We expect liquidity to remain adequate in the absence of any major debt maturities following the issuance of the US dollar notes. The company plans to use part of the proceeds to repay its outstanding SGD100 million notes due 2018. We expect strong operating cash flows and the cash balance from the notes' proceeds to support investments in the near to medium term. (ends)