Release: Fitch affirms PT Berau Coal (Berau)'s 'B+'; outlook stable

Rating Rationale
? PT Berau Coal?s ratings are supported by the cost competitiveness of its coal mining operations, its ability to secure long-term contracts from its long term buyers, and the debt reduction it aims to achieve in the short term due to its strong cash flow position. This position is due to robust coal demand. The ratings also take into account the company?s natural hedge on US dollar borrowings due to nearly 80% of its revenue being denominated in US dollars.
? At the same time, Berau?s rating is constrained by its relatively high financial leverage, with an estimated net debt to annualised EBITDA ratio of 3.5x at end September 2007. The ratings are also constrained by its exposure to constant fluctuations in the coal price, high buyer concentration with its top 10 customers contributing nearly 90% of revenue in the first nine months of 2007, and reliance on only two contractors for all its mining operations with particularly heavy dependence on PT Bukit Makmur Mandiri Utama (BUMA), which carries out 80% of its mining works.
? Fitch Ratings nevertheless takes comfort that Berau has long standing business relationships with its major buyers and contractors. To date, there have been no reports of conflict with the buyers and contractors.
? Fitch expects growth prospects to remain positive given growing global dependence on coal fired power plants and the relatively high coal price.

Key Rating Drivers
? The Stable Outlook reflects Fitch?s expectation that the de-leveraging will proceed as planned, aided by medium term price and order visibility. If Berau?s leverage as measured by net debt/EBITDA remains above 3.0x at end 2008, a negative rating action may be taken. Conversely, sustained net debt/EBITDA below 2.5x may result in a positive rating action.

Liquidity and Debt Structure
Given that the USD325m notes issued in 2006 are proposed to be repaid via bullet and amortised repayments, Berau needs to amortise about USD25m of debt per year during 2008-2010, followed by USD250m when the notes mature in 2011.

Berau?s liquidity is more than adequate to meet immediate debt amortisation, as it has set aside USD21.2m for interest and loan repayments. Berau also had total cash and cash equivalents of USD45.2m at end-September 2007. An increase in cash flow from operations, boosted by the stable to positive outlook in coal demand, would be likely to support the company?s liquidity further.

Profile
Established in 1983, Berau is the fifth-largest coal producer in Indonesia. Having operated under the first-generation 30-year Coal Contract of Work (CCOW), a structured contract, Berau has higher privileges due to its ?lex specialis? status, which means that the CCOW will prevail above other Indonesian laws in an event of conflict.

Berau has concession areas of about 118,400 hectares in the Berau region (East Kalimantan) that expire in 2023. Through its three mines, Berau produced 10.6 million tonnes (mt) of coal in 2006 of which about 7.2mt were exported.

Mr Rizal Risjad has a 70.4% beneficial interest in the company, while Sojitz Corporation of Japan holds 10%.

Outlook for Indonesian Coal Producers
Fitch expects the global demand for coal to remain high in the medium term, with an increasing number of companies throughout the Asia Pacific region relying on coal as a source of power given its relatively lower cost compared with oil and gas. In addition to regional demand, domestic demand is also likely to increase, due to the Indonesian government?s plans to build additional coal fired power plants with a total capacity of 10 gigawatts by 2010.

Although regional coal demand is expected to grow, supply is expected to lag behind, as major coal exporters such as Australia and South Africa are experiencing infrastructure bottlenecks. China, which in the past was also a major coal exporter, is now reducing coal exports to meet the growing domestic needs. Furthermore, the rain and snowstorm ? the worst in the past 50 years that affected China in early February 2008 has severely disrupted its coal mining operations. There is, therefore, a possibility that China will be a net importer of coal, as it was in H107. The consequent supply gap means that Indonesia, the world largest coal exporter, has potential to expand its coal production given its abundant coal reserves, low cost and geographical proximity to the large north Asian markets.

Coupled with the tight coal supply, the rising crude oil price has pushed the benchmark McCloskey Newcastle 6700kcal GAD FOB coal price to a record high of USD142 per tonne in February 2008. Fitch expects coal prices to remain high, with the medium term downside appearing to be limited, in line with the scheduled start of operations at several newly built large coal based power plants, primarily in the Asia Pacific region, in the next few years.

Owing to the high coal price, the major Indonesian coal producers are continuing to invest their operating cash flow in mining and related infrastructure to increase their production capacity. However, these efforts may be slowed by higher operational costs (particularly fuel), shortages in mining equipment, and unfavorable weather conditions.

Overall, Fitch expects the outlook for Indonesian coal producers to remain stable to positive in 2008 owing to strong global coal demand, Indonesia?s ability to increase its export volume, and the relatively high coal price.

Business Update
Beneficiary of Upward Trends in Coal Price
During 2002-2006, Berau?s revenue and EBITDA grew at compound annual growth rates (CAGRs) of about 23% and 42%, respectively, reflecting its improving profitability, as the average selling price grew faster than production costs. Since 2004 Berau has vastly expanded its coal production to take advantage of the high coal price environment. In Q307 Berau?s new mine next to Sambarata?s facility began operations. Production at the new mine is expected to remain minimal at about 0.5mt.

Among the Lowest-Cost Coal Producers
Berau?s production costs of USD20.3 per tonne in 2006 and USD20.5 per tonne in the first nine months of 2007 are considerably lower than those of global peers due to the low domestic wages, proximity of its mining pits to the ports and the use of open pit mining. Furthermore, as Berau outsources its entire coal production activities, it has benefited from long-term contracts for each tonne produced or each cubic metre of overburden removed by its contractors, and the increasing coal price and rising costs. Fitch expects production costs to increase due to the further rise in oil price.

High Customer Concentration Risk
Berau?s top 10 customers contributed nearly 90% of its earnings during the first nine months of 2007. Nevertheless, these customers are mainly power generating companies with long track records of dealing with the company. At present, the largest customers are PT Jawa Power, followed by PT Indonesia Power, China Light Power and Guangzhou Da You Coal Sell.

2007, Berau exported 68% and 61% of the total coal sold, respectively. Berau does not expect its sales composition to change in the near future.

Good Track Record but High Reliance on Contractors
Since the start of its commercial operations, Berau has consistently increased production at a CAGR of 40.1%, with no supply disruption or force majeure declarations. However, Fitch notes that Berau outsources its entire coal production activities to only two contractors, BUMA and PT Saptaindra Sejati. Berau is therefore highly exposed to the risk of non-performance by its contractors, which could be highly detrimental to its operations, as BUMA produced about 80% of Berau?s total output.

Financial Analysis
Berau report its financials under Indonesian GAAP. The accounts are audited by the local affiliate of Moores Rowland.

Good Revenue Growth Supported by Higher Production and Coal Prices
In line with buoyant coal demand, Berau?s revenue grew 25.3% to USD312.8m in 2006, as sales volume and coal price had both recorded moderate increases. Despite the higher operating expenses, the company generated a higher EBITDA margin of 21.8% in 2006, up from 20.6% in 2005.

In the first nine months of 2007, Berau?s revenue and EBITDA further increased to USD262.1m and USD56.4m, respectively, given the higher sales volume. Despite the 40% increase in coal benchmark prices during the same period, the company?s average selling price remained USD28.4 per tonne given that its contracted agreements with the buyers are mostly priced in advance.

Fitch notes that Berau?s growth prospects remain positive given the increasing global dependence on coal for power generation, and the relatively high coal price. Berau?s growth is expected to be driven by higher sales volume. However, profitability is likely to come under pressure as contractors demand better terms to cover their own rising costs.

Capex to be Primarily Channelled into Exploration
The agency expects Berau?s capital expenditure to remain low, as the company is very likely to continue outsourcing all its production activities, leaving contractors to bear the burden of new capital spending on mining machinery and equipment. Planned capex will be primarily be channelled into exploration activities.

Although capex at end-September 2007 was much lower than initially projected for 2007, Fitch expects capex to remain at historical levels to support further exploration and development of new mines to aid growth. Berau is planning to begin exploration in the Kelai area in Q108 once government permits have been obtained.

Strong Cash Flows to Continue
Berau?s funds from operations (FFO) reached USD56.7m in 2006 (compared with USD43.1m in 2005). The FFO/gross interest expense ratio therefore improved to 4.3x in 2006 compared with 2.1x in 2005. The low level of capital expenditure in the past has kept free cash flow consistently positive.

After the USD325m notes issuance in December 2006, Berau?s total debt rose to USD326.5m in 2006, with financial leverage as measured in net debt/EBITDA deteriorating to 4.0x in 2006 from 0.5x in 2005. However, Berau recorded muchimproved annualised net debt/EBITDA of 3.5x in the first nine months of 2007, in line with the improvement of its operating performance.

Fitch expects the company to continue to generate strong cash flows given the strong demand and coal price visibility in the short to medium term.

Adequate Liquidity; and Leverage Expected to Improve Further
Given that it proposes to repay its USD325m notes in two parts ? bullet and amortised repayments, Berau needs to amortise about USD25m of debt per year during 2008‐2010, followed by the USD250m when the notes mature in 2011.

Berau?s liquidity is more than adequate to meet immediate debt amortisation, as it has set aside USD21.2m for interest and loan repayments. Berau also had total cash and cash equivalents of USD45.2m at end-September 2007. An increase in cash flow from operations, boosted by the stable to positive outlook in coal demand, is likely to support to the company?s liquidity further. Leverage is also expected to improve in the short term, as debt amortisation is expected to proceed as planned.

Although nearly 40% of Berau?s first nine months of 2007 sales went to the domestic market, about 80% of its receivables are denominated in US dollars. This reduces FX exposure against its dollar borrowings in case of depreciation of the Indonesian rupiah. (end of edited release)