Fitch revises outlook on Perusahaan Gas Negara to positive; Affirms 'BBB-'

(Fitch Ratings-Singapore/Jakarta-22 December 2016)--Fitch Ratings has revised the Outlook on Indonesia-based PT Perusahaan Gas Negara Tbk's (PGN) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to Positive from Stable and affirmed the IDRs at 'BBB-'. Fitch has also affirmed PGN's senior unsecured rating and the rating on its USD1.35bn bonds due 2024 at 'BBB-'.

The rating action follows Fitch's revision of the Outlook on Indonesian's sovereign to Positive from Stable on 21 December 2016 (see Fitch Revised Indonesia's Outlook to Positive; Affirms at 'BBB-').

Financial Profile Weaker, Still Robust: PGN's IDR is constrained by the rating of the Republic of Indonesia (BBB-/Positive) as the state owns 57% of the company. We expect PGN's credit metrics to remain appropriate for its standalone 'BBB' rating, even though its FFO-adjusted net leverage deteriorated to 2.5x in 2015 (2014: 0.6x) due to a sharp decline in distribution spread and volumes. Fitch does not expect PGN's credit metrics to further worsen materially over 2016-2017, even though some risks remain. We estimate the company's financial leverage will increase slightly to around 2.7x by 2017, based on our assumptions of moderate volume growth and further decline in spread.

Volumes Likely to Rebound: PGN's gas distribution volumes improved marginally to 793 million cubic feet per day (mmcf/d) during 3Q16 (3Q15: 789 mmcf/d), reflecting muted industrial demand. However, we expect industrial demand to improve and forecast PGN's volumes to grow by 5% annually, with increasing contribution from regasified liquefied natural gas (R-LNG).

Use of R-LNG in Indonesia has been minimal because its oil-linked price is higher compared with piped gas. However, the sharp oil price falls have narrowed the price gap and PGN now plans to blend R-LNG with piped gas, instead of seeking separate contracts. Lower oil prices have also reduced the cost of gas substitutes, such as fuel oil and diesel, diminishing the attractiveness of gas. This is a risk to PGN's volume growth projections. However, Fitch expects a recovery in oil prices as the market gradually balances over time.

Spread to Shrink Further: PGN's gas distribution spread, a key determinant of its operating cash generation, declined to USD3.4 per million British thermal units (mmbtu) in 2015, from USD3.7/mmbtu in 2014. The decline was due to a weaker Indonesian rupiah against the US dollar and lack of cheap prepaid gas volumes in 2015. Around 20% of the company's realised sales revenue is in Indonesian rupiah, with the rest in US dollars, but its gas purchase costs are entirely in US dollars. This exposes PGN's spread to currency risk. We expect PGN's spread to decline further based on increasing R-LNG volumes in the sales mix and a gradual recovery in oil prices, which would raise its blended gas cost.

Sustained High Capex: PGN's capex, including acquisitions, has risen over the last three years to an average of USD1.3bn in 2014-2015, from less than USD200m in 2012. This was driven by the acquisition of upstream assets and domestic gas infrastructure investments. We expect PGN's capex to remain high, at around USD1bn each year in 2016 and 2017, as the company continues to expand pipeline infrastructure and develop its upstream asset base. If PGN makes further upstream acquisitions, its spending could increase and risk our leverage estimates.

Regulatory Risks: PGN is susceptible to regulatory interventions aimed at restricting its influence on Indonesia's gas market. Fitch will treat regulatory developments that affect PGN's financial profile as an event risk, even though PGN's standalone credit profile incorporates general regulatory risks in Indonesia. (ends)