Fitch Revises Outlook on Indika to Stable; Affirms IDR at 'BB-'

(Fitch Ratings - Singapore/Jakarta - 23 May 2022)--Fitch Ratings has revised PT Indika Energy Tbk's Outlook to Stable from Negative, and affirmed its Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'BB-'. The agency also affirmed the Indonesia-based mining company's outstanding senior unsecured notes at 'BB-'. At the same time, Fitch Ratings Indonesia has published Indika's National Long-Term Rating at 'A+(idn)' with a Stable Outlook.

The Outlook revision reflects our expectation Indika will be able to maintain its leverage in line with its current rating over the next four years while it increases its diversification-related spending to raise its non-coal revenue. We expect high coal prices will continue to improve Indika's financial buffer in 2022, reducing risks to its financial profile in 2023-2024, when we expect its diversification-related investments to pick up.

We expect the execution risks of these greenfield investments to be largely manageable based on management's cautious approach. Indika's improved financial buffer and record of managing commodity downcycles can also mitigate the financial risk from the investments to an extent. We consequently treat the new investments as neutral to Indika's credit profile.

'A' National Long-Term Ratings denote expectations of low default risk relative to other issuers or obligations in the same country. However, changes in circumstances or economic conditions may affect the capacity for timely repayment to a greater degree than is the case for financial commitments denoted by a higher rated category.

Key Rating Drivers

Improved Rating Headroom: We expect Indika's cash balance to rise above USD1 billion in 2022, which will support the diversification-led investments over the next three years. We factor in about USD250 million of annual investments in 2023-2024, in line with management's guidance, as the company works towards its objective to achieve 50% of revenue from non-coal-related businesses by 2025. We expect its net debt to EBITDA to remain comfortably below our negative sensitivity of 2.5x, peaking at 1.5x in 2024, based on our coal price assumptions.

Prudent Medium-Term Strategy: We believe Indika's strategy to diversify outside the coal sector is prudent over the medium term, even though it may raise interim execution risks. The plan could help Indika maintain its relatively good access to funding markets and offset material tightening towards thermal-coal-related entities from increasing ESG considerations across funding channels. Indika's investment initiatives are in various projects in greenfield gold, renewable energy and electric vehicle sectors, where it previously had no exposure.

Kideco Underpins Credit Profile: We expect Indika's 91%-owned key mining subsidiary, PT Kideco Jaya Agung, to account for 85%-90% of Indika's annual EBITDA until earnings from its new investments commence in 2024. Kideco's contribution has increased in our forecasts as Indika is in the midst of selling its 70%-owned contract mining and engineering subsidiary, PT Petrosea Tbk, for USD146 million after divesting its 51%-owned coal barging subsidiary, PT Mitrabahtera Segara Sejati Tbk, in 2021.

Fitch thinks the two sales will have a limited impact on the group's financial profile. Fitch's rating case assumes Indika will maintain its stake in Kideco over the medium term. Kideco is a mature coal asset with a moderate cost structure, adequate reserve life, excess production capacity and a proven record of managing costs during price downturns.

Earnings to Moderate: Fitch expects Indika's EBITDA to moderate to USD450 million-550 million in 2023-2024 from about USD1 billion in 2022, as Kideco's earnings drop on our coal price assumptions. We expect Indika's post-2024 consolidated earnings to start rising, as earnings from its diversification-driven projects increase. We factor in EBITDA of USD56 million and USD152 million from the new projects in 2024 and 2025, respectively, which is 20%-30% lower than management guidance, driven by the Awakmas gold project, Interport and the EMITS solar project.

Evolving Business Profile: We expect Indika's business profile to evolve substantially in the medium term as its new investments start operations. Our evaluation of Indika's future business profile would depend on the risk profiles of the new businesses, their contribution in terms of earnings and Indika's access to their cash flows once they start operating. Some investments are in emerging industries, which means Indika's position in these evolving competitive landscapes would affect Fitch's assessment of the future credit profile.

Royalty Changes; Limited Impact: Fitch expects Kideco's mining licence to be extended upon expiry in 2023 without any major adverse effect on the credit profile, even as we factor in the new royalty and tax structure to be implemented from 2024. The new structure, announced in April 2022, is tiered, with higher royalty payments when coal prices are high but a lower tax structure would mitigate the impact on cash flows during periods of low coal prices.

Derivation Summary

Indika's ratings are driven by Kideco's moderate cost position, production flexibility, reasonable reserves and large existing capacity, which require little maintenance capex. Indika's closest peers are PT Bayan Resources Tbk (BB-/Positive) and PT Golden Energy Mines Tbk (GEMS, B+/Positive). The similar ratings of Indika and Bayan reflect their comparable production scale, although Indika has a longer and more stable operating record, which is offset by Bayan's lower cost position, larger reserves and more conservative financial profile. Bayan's Positive Outlook reflects our expectation of an improvement in its scale and a material reduction in its operating risks after the completion of its infrastructure enhancements.

We think both Indika and GEMS have a competitive cost position and adequate reserve life for their key mines. Indika's larger scale and well-established operations justify the one-notch difference in their IDRs. However, our expectation that GEMS' production scale will be similar to that of Indika in the next 12 months is reflected in our Positive Outlook on GEMS.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

- Kideco's average coal selling prices in line with Fitch coal price deck as follows for the Newcastle 6000 index:

2022: USD220/tonne

2023: USD104/tonne

2024: USD87/tonne

2025 and thereafter: USD80/tonne

- Kideco's coal mining volume to be stable at 34 million tonnes per annum through the next four years

- Kideco's strip ratios to stay at around 5x-5.5x over the next four years, and cash production costs (excluding royalty) of around USD27/tonne to USD33/tonne;

- New royalty structure to be applicable from 2024, following the conversion from a coal contract of work to an IUPK, a special mining business licence, in 2023, in line with company's interpretation of the Indonesian regulation.

- Petrosea to be sold in June 2022 for USD146 million;

- New investment spending of USD250 million a year in 2023 and 2024;

- Capex for existing operations of USD35 million in 2022 and USD12 million-15 million per annum thereafter.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- Fitch does not expect an upgrade in the near term as the company's business profile is still evolving as it transitions towards a more diversified earnings base;

- An upgrade may be considered if Indika demonstrates a track record of successful execution of non-coal investments while keeping a prudent financial structure.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- Net debt to EBITDA of less than 2.5x and FFO net leverage of less than 3.0x; and/or

- Indications of an overly aggressive approach in achieving its non-coal-related diversification strategy.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity: Indika's liquidity profile is comfortable as it does not have any major debt maturities until November 2024, when its USD575 million senior unsecured notes are due. Indika had about USD126 million in short-term debt as of December 2021 versus a cash balance of USD867 million. Indika has USD1.46 billion in total consolidated debt, including USD1.25 billion due in 2024 and 2025.

Issuer Profile

Indika is an integrated and diversified company in Indonesia that owns 91% of Kideco, one of the country's largest coal mines. Most of the group's earnings will be from Kideco after it sells its contract mining operations in 2022. Indika is diversifying away from coal over the long run.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria. (ends)