Fitch Revises Outlook on Bukit Makmur Mandiri Utama to Negative; Affirms at 'BB-'

(Fitch Ratings - Singapore - 04 May 2020)--Fitch Ratings has revised the Outlook on Indonesia-based PT Bukit Makmur Mandiri Utama's (BUMA) Long-Term Foreign-Currency Issuer Default Rating (IDR) to Negative from Stable and has affirmed the IDR at 'BB-'. Fitch has also affirmed the company's outstanding senior unsecured notes at 'BB-'.

The Outlook revision reflects our expectations that BUMA's weakening credit metrics will lower its rating headroom; this follows a revision of our volume and price assumptions. We expect the company's overburden removal volume to decline in 2020, before modestly improving in 2021, as coal miners cut production volume amid the challenging economic conditions caused by the coronavirus pandemic.

The Negative Outlook also reflects the execution risk associated with the company's plan to add new customers to offset its expected decline in volume following the loss of its contract with PT Kideco Jaya Agung at the end of 2020. Fitch has also lowered its pricing forecasts for BUMA following the revision of our coal-price assumptions; see Fitch Ratings Cuts Some Metals, Mining Price Assumptions on Coronavirus Hit, dated 6 April 2020, at www.fitchratings.com/site/pr/10117162.

BUMA's rating reflects its leading position as Indonesia's second-largest mining contractor, with a market share of about 15% and a satisfactory operational record with customers. The rating also reflects the concentration risk the company faces, with about 80% of its volume coming from only three counterparties, and the highly cyclical nature of the domestic coal contracting industry.

KEY RATING DRIVERS

Volume Slowdown: Fitch expects overburden volume to decline by about 10% in 2020, from 380 billion cubic metres (bcm) in 2019, due to the consequences of the coronavirus pandemic, before improving in 2021-2023. We expect most Indonesian coal miners to cut production due to weak demand on account of the pandemic, leading to BUMA's volume decline. Furthermore, one of BUMA's key customers, Kideco, which we expect to contribute about 5%-6% of 2020 volume, will not extend its contract with BUMA beyond 2020 on expiry.

New Contracts Wins Key: BUMA expects part of the lost volume to be covered by rising coal production at some of its key customers from 2021. We, however, expect BUMA to be increasingly dependent on new customers to drive volume growth. We believe BUMA will become more selective in choosing customers, after facing operational issues with some newer customers in 2017-2019. Nevertheless, we think the company is exposed to execution risk in signing new customers, especially if market conditions remain challenging.

Weakening Credit Metrics: We forecast BUMA's FFO net leverage to rise to 4.0x in 2020, which is above our negative rating sensitivity of 3.3x, driven by volume and price weakness. Leverage should improve to around 3.0x in 2021, supported by a recovery in mining volume to close to 2019 levels and a marginal improvement in realisation, reflecting our expectations of coal-price changes. The volume improvement, in our view, hinges on the company's ability to win new contracts. About 70% of BUMA's coal-mining contracts are linked to coal prices and are affected by coal-price movements.

Lease Adjustments: Fitch has revised its treatment of leases and now accounts for all leases, including financial leases, as operating expenses, in line with our revised Corporate Rating Criteria. Fitch now treats depreciation from leased assets and interest on financial leases as operating costs, and deducts these from EBITDA, while excluding financial leases from debt. Consequently, Fitch recalibrated upgrade and downgrade thresholds following the change in criteria, taking into account BUMA's business profile and other financial factors.

The above adjustments result in BUMA's EBITDA margin falling to 19.3% in 2019, compared with 33.7% in 2018. In comparison, BUMA's (unadjusted) EBITDAR margins, which excludes lease-related adjustments, weakened to 30.3% in 2019 (2018: 35.8%) due to cost pressure amid the company's weakened volume growth.

Cost Optimisation. We expect costs to fall from 2020, after peaking in 2019, as the company optimises its capacity to match the lower volume base. BUMA had already let go of 1,500 employees in 2019 and plans to continue to lower staff numbers to match its lower volume expectations. BUMA entered 2019 with a capacity, both in terms of equipment and employees, to support higher overburden removal volume, in line with its earlier expectation of robust industry-wide growth.

Lower Capex: We expect equipment capacity to remain high, but with a minimal contribution to the cost base, as BUMA plans to park its spare equipment in line with its lower volume expectation. This will reduce its repair and maintenance expenses, which we believe will lower its capex requirements over the next three years. We expect capex to be primarily maintenance related and remain at around USD100 million a year over 2020-2022. BUMA expects capex during its next equipment-replacement cycle, in around 2023-2024, to be lower due to its Certified Machine Rebuild programme, which extends the life for certain equipment at about 70% of the market price.

Customer Concentration: We expect BUMA's customer concentration to further increase, to only five counterparties, after its contract with Kideco ends this year. BUMA's counterparties dropped to six from seven after it stopped operations at the Pada Idi site in mid-2019. About half of its revenue comes from PT Berau Coal, with the portion further increasing until it signs new contracts to diversify its customer base.

We believe the risk associated with customer concentration is partly mitigated by BUMA's long relationships with key customers and high contract renewal rates. We take the non-renewal of Kideco's contract as a one-off case that was part of Kideco's strategy to gradually migrate to the coal-mining services of its associate. Coal miners also generally prioritise payments to mining contractors to ensure the continuity of operations.

Strong Market Position: BUMA's key customers - Berau Coal, PT Adaro Indonesia (BBB-/Stable) and PT Indonesia Pratama, a subsidiary of PT Bayan Resources Tbk (BB-/Stable) - which we expect to contribute about 80% of BUMA's 2020 volume, have an efficient cost position. Berau Coal and Adaro also have a more than 15 year relationship with BUMA. We expect BUMA to maintain its position as Indonesia's second-largest coal-mining contractor.

DERIVATION SUMMARY

BUMA's closest rated peers are PT ABM Investama Tbk (B+/Negative) and Emeco Holdings Limited (B+/Stable). BUMA's one-notch differential to ABM's rating is justified by its stronger business profile, driven by its better mine-contracting business in terms of efficiency, with higher margins and market share. BUMA also has a larger scale than ABM, in an industry where scale is important. ABM benefits from its diversified business, although the improvement in its mining-contractor business was offset by weakness in its coal-mining business in the low coal-price environment. BUMA's financial profile is also stronger than that of ABM.

BUMA has better revenue visibility than Australia-based equipment-rental company, Emeco, and a stable operating profile that stems from its long-term contracts with miners and integration in the production stage. Emeco's financial profile has improved over the last few years and is now comparable with that of BUMA. However, BUMA benefits from the stickiness of its coal-mining contracts, unlike Emeco, underscoring the one-notch differential between the two ratings. (ends)