Moody's revises outlook on Indika to negative

(Singapore, May 20, 2020)--Moody's Investors Service has affirmed the Ba3 corporate family rating (CFR) of Indika Energy Tbk (P.T.) ("Indika").

At the same time, Moody's has affirmed the Ba3 ratings on the $285 million backed senior secured notes due 2023 issued by Indo Energy Finance II B.V., the $265 million backed senior secured notes due 2022 issued by Indika Energy Capital II Pte. Ltd, and the $575 million backed senior secured notes due 2024 issued by Indika Energy Capital III Pte. Ltd. All notes are unconditionally and irrevocably guaranteed by Indika and rank pari passu.

Moody's has also revised the outlook on these ratings to negative from stable.

RATINGS RATIONALE

"The change in Indika's outlook to negative from stable reflects our expectation that its credit metrics will deteriorate over the next 12 months, amid a challenging operating environment including weak thermal coal prices," says Maisam Hasnain, a Moody's Assistant Vice President and Analyst.

"At the same time, the affirmation of Indika's Ba3 ratings reflects its diversified operations, large cash balance with manageable near-term debt maturities, and an adherence to prudent financial policies," adds Hasnain, who is also Moody's Lead Analyst for Indika.

The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented.

More specifically, Indika is exposed to weak thermal coal prices, which are likely to remain low over the next 12 months as the coronavirus-led economic downturn reduces demand for thermal coal.

Moody's regards the coronavirus outbreak as a social risk under its environmental, social and governance (ESG) framework, given the substantial implications for public health and safety. Today's action reflects the impact on Indika of the breadth and severity of the shock, and the broad deterioration in credit quality it has triggered.

Based on its medium-term price assumptions for Newcastle thermal coal of $60-$65 per ton, Moody's estimates Indika's adjusted leverage will increase to 5.2x-6.5x over the next 12-18 months from 3.5x as of 31 December 2019.

The earnings contraction will primarily be driven by lower earnings at its 91%-owned mining subsidiary, Kideco Jaya Agung (P.T.), due to lower coal prices. Kideco is the largest earnings contributor, accounting for 52% of Indika's reported revenue in 2019.

In addition, in light of weak coal prices and slowing economic growth, the downside risk to Indika's credit metrics worsening beyond Moody's current expectations is elevated, particularly if Indika's sales volume declines this year, or if prices remain low for a prolonged period.

Earnings growth will also be muted at Indika's contract mining subsidiary PT Petrosea Tbk and engineering subsidiary PT Tripatra Multi Energi, which contributed 16% and 15% of consolidated revenue in 2019. The contract order book for both subsidiaries has been declining in recent years, and given low prevailing energy prices, the likelihood of winning new contracts this year is low.

Indika has sufficient liquidity to meet its cash needs for the next 12-18 months, and Moody's expects Indika will continue to proactively refinance its debt maturities well ahead of its large $1.1 billion debt maturity wall between 2022 and 2024. The company's large consolidated cash balance of around $569 million as of 31 December 2019 affords it flexibility to manage volatility in its operations amid low coal prices.

Given the weak coal price environment, Indika will likely breach one of its existing financial maintenance covenants on its bank loans -- gross debt/EBITDA not exceeding 3.75x - in 2Q 2020. Moody's expects Indika will address this risk by either obtaining waivers or renegotiating its covenants, in the first instance.

However, an inability to obtain covenant relief from banks prior to the breach will likely result in ratings downgrade. This is because the breach would lead to acute refinancing risk if it triggers cross-default provisions and accelerated repayments across Indika's debt, including its $1.1 billion US dollar bonds.

The rating also considers Indika's exposure to ESG risks as follows.

First, Indika faces elevated environmental risks associated with the coal mining industry, including carbon transition risk as countries seek to reduce their reliance on coal power. However, this risk is somewhat mitigated by (1) Indika's geographically diversified customer base, which includes state-owned utilities across Asia, a region with growing energy demand and where thermal coal is still a relatively low-cost source of energy, and (2) its good coal quality, with low ash and sulfur content.

Second, Indika is also exposed to social risks associated with the coal mining industry, including health and safety, and responsible production. To address these risks, Indika initiates sustainability initiatives under its health, safety and environment programs, and carries out corporate social responsibility activities via the Indika Foundation.

Third, with respect to governance, Indika's ownership is concentrated in its major shareholders, who own around 68% of the company. However, this risk is somewhat mitigated by Indika's listed status and long track record of maintaining prudent financial policies.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

An upgrade of Indika's ratings is unlikely over the next 12-18 months, given the negative outlook.

The outlook could return to stable if Indika improves its credit metrics on a sustained basis, and maintains sufficient liquidity to cover its cash needs over the next 12-18 months.

Specific indicators that Moody's would consider for a change in outlook to stable include adjusted debt/EBITDA below 4.0x and adjusted EBIT/interest above 2.0x, both for an extended period.

Moody's could downgrade the ratings if (1) Indika's credit metrics weaken due to a sustained decline in coal prices or reduced production volumes; (2) Kideco fails to extend its Coal Contract of Work (CCoW) mining license on substantially similar terms; (3) Indika's liquidity weakens or it is unable to cure a covenant breach; or (4) Indika engages in aggressive shareholder distributions or investments, demonstrating a departure from its track record of liquidity preservation.

Specific indicators Moody's would consider for a downgrade include adjusted debt/EBITDA above 4.0x or adjusted EBIT/interest below 2.0x, both for an extended period.

The principal methodology used in these ratings was Mining published in September 2018 and available at https://www.moodys.com/research/Mining--PBC_1089739. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Indika Energy Tbk (P.T.) is an Indonesian integrated energy group listed on Indonesia's Stock Exchange, with a market capitalization of around IDR3.8 trillion ($250 million) as of 15 May 2020. Its principal investment is a 91% stake in Kideco Jaya Agung (P.T.), one of Indonesia's largest domestic coal producers. (ends)