RELEASE: Fitch rates Adaro Indonesia at 'BB+'; Outlook stable

Fitch Ratings-Singapore/Jakarta-02 October 2009: Fitch Ratings has today assigned PT Adaro Indonesia (Adaro), the second largest coalminer in Indonesia, 'BB+' Long-term foreign currency and local currency Issuer Default Ratings (IDR). The Outlook is Stable. At the same time, Fitch has assigned an expected rating of 'BB+' to the proposed US dollar fixed-rate senior notes to be issued by Adaro and guaranteed by its parent, PT Adaro Energy Tbk (Adaro Energy). The final rating is contingent upon receipt of documents conforming to information already received.

"Adaro's ratings are supported by its large, low-cost operations, strong track record of growth, longstanding relationships with its leading customers and robust financials. However, risks arising from regulatory uncertainties in the Indonesian coalmining sector and Adaro's single-site operations constrain its ratings," says Jessie Wahab, Associate Director in Fitch's Corporate Ratings team.

Adaro owns and operates the single largest coalmine in Indonesia, with an expected production of 42 million tons (mt) in 2009. The large scale of this mine, the availability of coal in thick seams close to surface, low labour costs and management's continued focus on improving efficiencies have resulted in Adaro enjoying among the lowest cash costs of production in the world, averaging USD28.7/ton (excluding royalty) in H109. Adaro has invested significantly to grow its production to the current level from 20.8mt in 2002. This track record bodes well for management's plans to double its production to 80mt by 2014. Much of the infrastructure required for this growth is either in place or is being developed, while its reserves of 930mt at end December 2008 allow for a mine life of more than 15 years, even at the increased rate of production.

However, the single site operations increase Adaro's disruption risks, particularly due to weather. In 2008, for instance, Adaro incurred after tax demurrage costs of USD38.5m due to weather-related delays, though Fitch acknowledges that this amount is small given the company's scale and is proportionately lower than those experienced by many of its peers.

Adaro's main customers are leading power producers across the world, particularly in developed Asia and Europe, though demand growth is likely to emanate from high growth markets in emerging Asia like India, China and Indonesia. Newer power plants in these countries are designed to burn the lower calorific value coal that Adaro produces. Adaro sells most of its coal via long term fixed volume contracts with index-linked prices that typically reset annually. Fitch views these contracts positively as they allow demand stability and exposure to longer term price trends but not short term price volatility.

Adaro operates under a first generation coal contract of works (1G CCOW) expiring in 2022, which has a lex specialis status, meaning that it will prevail over other Indonesian laws in the event of any conflict. However, a new mining law introduced this year raises some doubts as to whether the terms of the CCOW will be upheld for its remaining tenure. Nonetheless, Fitch believes that the high taxes and royalties paid by the 1G CCOW concessionaires (Adaro paid total taxes and royalties of USD293m in 2008) reduces the risks of adverse changes to the existing scheme.

Fitch also notes that during the spot coal price spike experienced in 2008, the Ministry of Energy and Mineral Resources required certain coal producers, including Adaro, to renegotiate their sales contracts to reflect the higher prevailing prices. While most of Adaro's clients agreed to the renegotiation, it was forced to declare force majeure on a small number of them due to the government's actions.

Despite incurring new debt, Adaro's credit metrics are likely to remain robust given its high and growing cash flows. Fitch expects Adaro, and Adaro Energy on a consolidated basis, to maintain low financial leverage, as measured by net debt/operating EBITDAR, of below 1.0x even after the fundraising exercise is completed. Furthermore, these entities are also likely to generate positive free cash flows on a sustained basis providing ample liquidity and means of reducing debt.

The Stable Outlook reflects Fitch's expectations that Adaro will maintain its growth while retaining its strong financial metrics. A positive rating action on the local currency IDR will be considered only when Adaro's scale of operations increases meaningfully. On top of this, an upgrade of Indonesia's 'BB+' Country Ceiling is a pre-condition for a positive action on Adaro's foreign currency IDR.

On the other hand, a negative rating action may be taken if Adaro and Adaro Energy's financial profiles weaken such that financial leverage is sustained above 1.0x or if they fail to generate positive free cash flows on a sustained basis. Events that could lead to these weaker financial metrics include prolonged disruption of operations and adverse changes in the global thermal coal industry dynamics. Other event driven negative rating drivers include material adverse changes in the company's business and financial policies and the regulatory environment. (end of release)