Fitch Revises Outlook on Geo Energy to Negative; Affirms at 'B'

(Fitch Ratings - Singapore - 30 April 2019)-- Fitch Ratings has revised the Outlook on Geo Energy Resources Limited to Negative from Stable and has affirmed the Long-Term Issuer Default Rating (IDR) at 'B'. Fitch has also affirmed Geo Coal International Pte. Ltd.'s USD300 million 8% senior unsecured guaranteed notes due 2022 at 'B'/'RR4'.

The Outlook revision reflects Geo's gradually deteriorating operating profile, with declining reserves and reserve life in the absence of acquisitions, as Geo relies on inorganic growth to improve reserves given the nature of its existing mines. The company continues to evaluate acquisition opportunities, though nothing has been finalised yet. We believe Geo has an adequate financial profile - with a cash balance of USD197 million as of end-2018 to fund its intended acquisitions and moderate credit metrics, with FFO net leverage of 2.2x - to support its rating. 

Key Rating Drivers

Declining Reserves; Small Scale: Fitch believes Geo's small and declining reserve base is likely to challenge the continuity of its operation in the absence of acquisitions. Geo's operating reserve of 72 million tonnes (mt) comprised of 26mt at PT Sungal Danau Jaya (SDJ) and 46mt at PT Tanah Bumbu Resources (TBR) in 2018. The company will exhaust its operating reserve in seven years, as Fitch expects production of around 10mt (2018: 7mt) over the medium term (the company expects production of around 13mt per annum). The company has two other mines, but one is still in the exploratory phase and the other has a weak cost position, making it unviable in our view considering our coal-price assumptions.

Risk of Early Redemption: Geo's US dollar notes will trigger a put option in April 2021 if it fails to meet minimum coal-reserve conditions. We do not believe Geo will achieve the minimum reserve requirements in the absence of a coal-asset acquisition, which would result in early redemption and expose the company to refinancing risk, based on our forecasts.  We do not expect significant risk to bond repayments if this was to occur based on our coal-price and production-volume assumptions over the next two years. We estimate the cash balance, including cash flow from operation, to largely suffice, with only minimum refinancing required, if any.

Slightly Improving Credit Metrics: We expect Geo's credit metrics to remain adequate for its rating, with a slight improvement over the next two years based on our forecast for modestly higher production volume to around 8mt and our coal-price assumptions. Coal production during 2018 was lower than Fitch's previous expectations on account of a delay in the commencement of production at the TBR mine, weak coal prices in 2H18 and, in our view, the challenges from Geo's small reserves. This saw FFO adjusted gross leverage rise to 6.4x during 2018 (2017: 4.0x) and FFO adjusted net leverage rise to 2.2x (2017: 0.5x).

Moderate Sensitivity to Coal Prices: Geo's cost position benefits from its low average strip ratio of less than 4.0x for its key mines (2018: 2.9x). The low calorific value of Geo's coal compared with the Indonesian average lowers its selling price and increases its sensitivity to a fall in coal prices against other Fitch-rated coal-mining peers, like PT Golden Energy Mines Tbk (GEMS, B+/Positive), PT Bayan Resources Tbk (BB-/Stable) and PT Indika Energy Tbk (BB-/Stable). Geo's EBITDA per tonne fell only marginally to USD10 in 2018 (2017: USD11). We estimate its EBITDA per tonne to range between USD8-6 over the next three years given our coal-price assumptions.

Low Off-Taker and Contractor Risk: Geo has life-of-mine contracts for its two key operating mines on all coal produced, minimising off-take risk, and has entered into an offtake agreement with Macquarie Bank Limited (A/Stable) for its TBR mine, which is wholly owned by Macquarie Group Limited (A-/Stable). Geo has prepayment facilities with off-takers for both mines, supporting working-capital management. Geo is exposed to customer concentration, but we believe the commoditised nature of its product offsets this risk. Its coal production and over-burden removal contracts for both mines is with one of Indonesia's largest mining contractors, PT Bukit Makmur Mandiri Utama (BB-/Stable), limiting contractor risk.

Regulatory Risk; Exposure to Commodity Prices: Geo is exposed to regulatory risk, which can affect production volume and realisation. Indonesian regulations, which apply until end-2019, require coal producers to supply 25% of their production to the domestic market and cap the price of coal supplied to the Indonesian power sector at USD70/tonne, based on coal with a calorific value of 6,322kcal. Geo did not comply with its domestic market obligations during 2018 and may not comply in 2019, which could prevent it from increasing production volume, as the state approves any additions annually. We do not expect the coal-price cap to significantly affect Geo's earnings in light of our price assumptions, although the company remains exposed to commodity cycles. In addition, the licenses of Geo's key SDJ and TBR mines expire in 2022. The risk from the limited remaining license period is partly mitigated, since the company expects a further 10-year extension, as provided by law.

Derivation Summary

Geo's has a weak operating profile due to its small size, which distinguishes it from other rated Indonesian coal-mining companies. GEMS has a significantly larger reserve base and higher production levels (2018: 22mt) than Geo. The Positive Outlook on GEMS reflects our expectations of higher production volume in the next year or two. GEMS also has a stronger financial profile than Geo, which explains the rating difference between the two entities.

Indika has stronger operations, with larger production (2018:34mt) and reserves (2018: 422mt), a stronger cost position and a better financial profile, reflecting its two-notch difference with Geo. (ends)