Fitch Rates PLN's Proposed USD Notes 'BBB(EXP)'

(Fitch Ratings - Singapore - 02 July 2019)-- Fitch Ratings has assigned an expected rating of 'BBB(EXP)' to Indonesia-based PT Perusahaan Listrik Negara (Persero)'s (PLN, BBB/Stable) proposed senior unsecured US dollar notes, to be issued from its USD5 billion medium-term note programme.

PLN's ratings are equalised with those of Indonesia (BBB/Stable) to reflect the strong likelihood of support from the government, in line with Fitch's Government-Related Entities Rating Criteria. We assess PLN's standalone credit profile at 'bb+' to reflect its dominant position as a monopoly player in Indonesia's electricity-transmission and distribution sector and owner of the majority of the country's power-generation capacity along with a moderate financial profile. PLN's standalone credit profile is constrained by the need for large capex and the absence of an independent electricity regulatory framework in Indonesia.

The US dollar notes are rated at the same level as PLN's senior unsecured debt as they will constitute its direct, unconditional, unsubordinated and unsecured obligations. The final rating is contingent upon the receipt of final documents conforming to the information already received.

Key Rating Drivers

'Very Strong' State Linkages: Fitch sees PLN's status, ownership and control by the Indonesian sovereign as 'Very Strong'. The state fully owns PLN, appoints its board and senior management and directs and approves investments. We also see the support record as 'Very Strong' and believe there is a high likelihood of state support for PLN; the company receives subsidies in accordance with an exceptionally strong framework in return for meeting the state's public-service obligations. About a quarter of PLN's borrowings are guaranteed by the government.

'Very Strong' Incentive to Support: Fitch regards the socio-political implications of a potential PLN default as 'Very Strong'. The company accounts for the majority of Indonesia's power-generation capacity. It would be difficult to source feedstock for power generation in the event of a PLN default and private-sector investors' confidence in power generation would also be jeopardised. We believe a default would also have a 'Very Strong' financial effect on the state. PLN, one of Indonesia's key borrowers, is also an active international and domestic bond issuer. Its rating is equalised with that of Indonesia due to the 'Very Strong' linkages between the two and the state's incentive to support the company.

Tariff Freeze Increases Subsidies: The state sets PLN's tariffs, which, on average, are below generation costs. The company is supported through government subsidies, allowing PLN to recover operating and financing expenses, earn a predetermined margin set annually and partly cover investment costs. PLN's EBITDA would be negative if not for these subsidies, which amounted to about IDR71 trillion in 2018, compared with EBITDA of IDR65 trillion. Subsidies increased by 56% yoy in 2018 due to rising power supply costs against frozen electricity tariffs and higher electricity sales volume. The government froze electricity prices charged by PLN in early 2018 until end-2019, a period that included general and presidential elections in April 2019, to support industrial competitiveness and household disposable income. However, the state has also capped the benchmark price of coal sold to PLN to contain its subsidy burden.

Reliance on Government Support: State support will be necessary to sustain PLN's operation over the coming two to three years, as Fitch believes electricity will continue to be sold below cost and PLN will have significant negative cash flow due to large government-mandated investment plans through to 2021. PLN has also received state support other than subsidies in the form of direct loans, two-step loans from multinational agencies, equity injections and guarantees on bank loans for some of its investment projects. We have not factored the direct subsidy mechanism in our rating case as we anticipate delays in its implementation.

Moderate Standalone Credit Profile: PLN's standalone credit profile of 'bb+', including subsidies on a cost-plus-margin basis, is weaker than its state-supported 'BBB' rating. Fitch expects PLN to generate IDR45 trillion-50 trillion in operational cash flow each year over 2019-2020. However, the company will generate large negative cash flow due to its capex plan to boost generation capacity and network assets. PLN will require external funding to manage its capex target, which Fitch believes it can secure, as it is closely linked to the sovereign. Fitch estimates PLN's FFO adjusted net leverage will stay around 5.5x over the next two to three years (2018: 6.9x). (ends)