Standard & Poor's: Berau lowered to 'B' on thin prospective cash flows and rising refinancing risk

(Sept. 25, 2014)--Standard & Poor's Ratings Services said today that it had lowered its long-term corporate credit rating on Indonesia-based coal mining company PT Berau Coal Energy Tbk. (Berau Energy) to 'B' from 'BB-'. The outlook is negative. At the same time, we lowered our long-term ASEAN regional scale rating on the company to 'axB+' from 'axBB'. We also lowered our long-term issue rating on the company's senior notes to 'B' from 'BB-'. We removed all the ratings from CreditWatch, where they were placed with negative implications on June 24, 2014.

"We lowered the ratings because we expect Berau Energy's cash flow adequacy ratios to be materially weaker than we anticipated through 2015 following a sharp correction in coal prices over the past three months," said Standard & Poor's credit analyst Xavier Jean. "In addition, Berau Energy's failure to refinance its bonds maturing July 2015 and the lack of a firm timeline to complete the refinancing will heighten refinancing risk over the next 12 months."

We estimate that Berau Energy's ratio of debt to EBITDA will increase to close to 5.5x in 2014 and to up to 8.0x in 2015 following a near 10% decline in coal prices over the past three months and a near 25% fall since the beginning of the year. We had expected the ratio to be less than 5.0x in our base case for 2014. We also project the ratio of funds from operations (FFO) to debt to be 2%-5% in 2014 and turn negative in 2015. We are therefore lowering our assessment of the company's financial risk profile to "highly leveraged" from "aggressive."

We expect Berau Energy's cost reduction measures earlier this month to reduce its full-year cash costs by about US$2 per ton. The company announced lowered contractor rates at its large Lati mine, retroactive from January 2014, and we expect the full-year stripping ratios (the ratio of soil removed to obtain a ton of mineral) to be lower in 2014 than in 2013. These measures could limit the fall in EBITDA to US$155 million-US$170 million in 2014 compared with US$281 million in 2013, despite weakening average selling prices. That said, we believe most of the EBITDA decline will take place in 2015 because of a typical lag between a decline in Newcastle benchmark prices and the average selling prices for Indonesian coal companies. We forecast Berau Energy's EBITDA to be US$100 million-US$110 million in 2015. We also believe the company has limited options to materially reduce costs further in 2015, leading to our base-case forecast of gross profit per ton before depreciation and amortization of about US$9.

Refinancing risk has increased for Berau Energy, in our view, and will remain high until the company refinances its US$450 million in senior secured notes due in July 2015. We estimate that Berau Energy's liquidity sources will be insufficient to meet its liquidity needs over the next 12 months. As a result, we are revising our assessment of the company's liquidity to "less than adequate" from "strong," as our criteria define the terms. We expect the company's sources of liquidity to be lower than its uses over the next 12 months, given the maturity of US$450 million in senior notes in July 2015.

We understand that Berau Energy is contemplating other funding options to refinance the maturing notes, including bonds, bank loans, or partial repayment with cash balances. Nevertheless, the company has not yet provided us with details on its refinancing strategy or a precise timeframe under which the refinancing would be completed. We also believe that coal prices will remain weak over the next 12 months, which, along with the lack of clarity on the financial intentions of Mr. Samin Tan, a 47.4% shareholder in Berau Energy's parent company Asia Resources Minerals PLC (ARMS), could make a sizable refinancing more challenging and costly for Berau Energy.

"The negative outlook on Berau Energy reflects the company's growing refinancing risk over the next 12 months because of strained cash flows and the lack of clarity on the financial intentions of its major shareholder," said Mr. Jean.

We could lower the rating by one notch if Berau Energy fails to refinance its US$450 million senior secured notes by the beginning of 2015. A cash balance of less than US$200 million by the end of 2014, excluding outflows for debt repayment, could also indicate weakened liquidity. We could also lower the rating if we expect the company's FFO interest coverage to weaken below 1.0x within the next 12 months, with no prospects of recovery toward the end of 2015.

We could revise the outlook to stable if Berau Energy stabilizes its liquidity by refinancing its maturing notes by the end of 2014. The outlook revision would also hinge on the company maintaining a liquidity cushion of more than US$250 million and not engaging in related-party transactions that could be credit negative.

We view an upgrade as unlikely at this stage, even if the company refinances its notes. An upgrade would hinge on a lasting improvement in the company's cash flow. We estimate that would require average selling prices to increase to more than US$65 per ton and a gross profit per ton to exceed US$20 on a sustainable basis. We view those levels as unlikely within the next 12-18 months in the light of the weak demand and oversupply for coal. (ends)