Fitch Affirms Inalum's 'BBB-' Ratings on Proposed Reorganisation; Outlook Stable

(Fitch Ratings - Singapore - 20 Dec 2022)--Fitch Ratings has affirmed PT Indonesia Asahan Aluminium (Persero)'s (Inalum) Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'BBB-' with a Stable Outlook. Fitch has also affirmed Inalum's senior unsecured rating and the rating on its outstanding senior unsecured notes at 'BBB-'.

Inalum's rating is one notch below the rating of Indonesia (BBB/Stable), based on Fitch's Government-Related Entities (GRE) Rating Criteria. We assess Inalum's Standalone Credit Profile (SCP) at 'bb-'.

Fitch sees minimal impact to the group's credit profile from Inalum's reorganisation, under which a new parent company will be created for the state's mining assets, which will be branded as MIND ID. Inalum will transfer the bulk of its assets, including shares in key mining subsidiaries and associates, and liabilities, including its senior unsecured notes and bank debt, to MIND ID. Inalum will become a subsidiary of MIND ID, retaining aluminium smelting operations, certain minor subsidiaries related to the supply chain, and a portion of its cash balance.

The transaction is likely to be completed by 1Q23. Upon the completion of the transaction, Fitch's assessment of strong linkages with the state and its incentive to provide support under the GRE criteria should apply unchanged to MIND ID, and we will transfer Inalum's IDR, senior unsecured rating and SCP to MIND ID.

Key Rating Drivers

Minimal Change from Reorganisation: The reorganisation should enable MIND ID to drive the group's strategy and seek various business opportunities, while Inalum will focus on its core aluminium smelting operations. The proposed structure is also conducive for a potential public offering of Inalum. MIND ID, which will be fully government-owned, would become the parent of the state's mining assets, instead of Inalum.

However, we do not expect a material change to the group's assets, liabilities, consolidated financials and operations. The sovereign's control and support should also be unchanged, along with MIND ID's strategic importance and investor perception of linkages with the state.

Strong State Linkage: Fitch regards Inalum's status, ownership and control by the Indonesian sovereign as 'Strong'. The company is fully owned by the government and is the state's mining holding company. The government transferred its stakes in three companies - PT Bukit Asam Tbk, PT Aneka Tambang Tbk (ANTAM) and PT Timah Tbk - to Inalum, such that Inalum now owns around 65% of each subsidiary. The government also mandated Inalum to acquire additional shares in PT Freeport Indonesia (PTFI, BBB-/Stable), which operates the strategically important Grasberg mine.

Record of Support: We assess the sovereign's support record as 'Strong'. The government injected capital of IDR3.5 trillion into ANTAM in 2015 via a rights issue and consolidated mining assets under Inalum in 2017 to improve its business profile. There has been no direct government support since then, but Inalum and its key subsidiaries have benefited from robust access to state-owned banks to meet financing needs. We expect strong government support to continue, given the importance of the mining sector in government policy-making.

State's Incentive to Provide Support: Fitch regards the socio-political implications of a default by Inalum as 'Moderate'. A default could damage the government's reputation and hamper Inalum's project funding, but is not likely to result in a severe socio-political fallout at the mining operations of Inalum's subsidiaries. We assess the financial implications of a default as 'Very Strong'. Inalum is one of Indonesia's key state-owned enterprises and its default could damage investor confidence in the sovereign and other GREs.

Strong 2022, Weaker Metrics Thereafter: We forecast Inalum's debt/EBITDA leverage - based on proportional consolidation of the three key listed subsidiaries to account for significant minority interest, and including dividends from PTFI - to fall to 2.5x in 2022 (2021: 5.0x), with high commodity prices driving a jump in consolidated EBITDA. We estimate leverage will rise gradually to around 3.5x by 2024 on lower commodity prices and EBITDA.

We also expect consolidated free cash flow (FCF) to turn negative by 2024, from positive during 2021-2023, on weaker EBITDA and substantial capex. These financial forecasts should apply to MIND ID once the transaction is completed.

Higher Dividends from PTFI: Inalum's stake in PTFI will also be transferred to MIND ID under the reorganisation. We estimate that PTFI will pay dividends of around USD1 billion from 2023, increasing from USD234 million in 2021. PTFI moved to full underground mining in 2020 and reached its annualised ramp-up target output in 4Q21. We assume the group's share of PTFI's dividends will rise to 41.2% from 2023, from below 20.0%, factoring in a transfer of 10% stake in PTFI to regional stakeholders.

Derivation Summary

Our assessment of sovereign support can be compared with that for other GREs, such as PT Pertamina (Persero) (BBB/Stable), PT Telekomunikasi Indonesia Tbk (Telkom, BBB/Stable) and China Minmetals Corporation (Minmetals, BBB+/Stable).

The ratings on Indonesia's national oil company, Pertamina, are equalised with that of the sovereign, reflecting a 'Very Strong' score on all GRE support parameters: ownership and control, support record, and socio-political as well as financial implications of default. Inalum scores lower on control, support and socio-political implications of default.

The government effectively controls the prices of most of the fuels distributed by Pertamina and supports it through various mechanisms, including subsidy reimbursements for fuels sold under the public-service obligation mandate. A default by Pertamina would damage Indonesia's energy security, by affecting the sizeable investments needed in the oil and gas sector, and the state's ability to import crude oil and refined products.

The ratings on majority state-owned telecommunications company, Telkom, are constrained by the sovereign rating. Similar to Inalum, we assess Telkom at 'Strong' for ownership and control, and support record, and 'Moderate' for socio-political implications of default. Fitch does not think a financial default by Telkom would result in a major disruption to service provision. We assess the financial implications of default at 'Strong', against 'Very Strong' for Inalum. Telkom is not seen as a proxy state borrower due to its low reliance on debt in light of its strong cash flow generation and healthy balance sheet.

We assess Minmetals, which is fully owned by the government of China (A+/Stable) and has received support in the form of share capital and subsidies, as 'Strong' for ownership and control, and support record. Similar to Inalum, we regard the socio-political implications of a default by Minmetals as 'Moderate'. A default would cause a medium-term shortage in base materials domestically, but the gap is likely to be filled by other suppliers in the long run.

We assess the financial implications of a default by Minmetals as 'Strong', because even though a default would make funding difficult for other GREs, the impact would not be as significant as that of closer proxies to the government, such as key oil and power GREs.

Inalum's SCP can be compared with those of mining peers Freeport-McMoRan Inc. (FCX, BBB-/Stable), First Quantum Minerals Ltd. (FQM, B+/Positive) and PT Indika Energy Tbk (Indika, BB-/Stable).

Inalum's lower SCP than FCX, which is a top three global producer of copper with world-class mines in Indonesia, Peru and the US, can mainly be attributed to a smaller EBITDA scale and weaker leverage and coverage metrics. FCX's geographic diversification is largely offset by Inalum's better commodity diversification.

Inalum benefits from higher commodity diversification compared with FQM, which is among the top-10 global copper companies. FQM has significant operations in Zambia, where it faces tax-related uncertainties. Fitch also expects the cost position of FQM's mining portfolio to weaken. A stronger business profile results in a better SCP for Inalum, despite higher leverage and weaker coverage.

Indika is an integrated coal company in Indonesia that owns 91% of Kideco, one of the country's largest coal mines. Inalum benefits from exposure to diverse commodities and is larger than Indika in terms of EBITDA. However, we estimate that Inalum's 2022 gross leverage will be higher.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case:

- Average annual aluminium sales of around 250 kilotonnes (kt) over 2022-2024 (2021: 219kt)

- Coal sales volume to increase to 32 million tonnes by 2024, from 28 million tonnes in 2021

- Average nickel ore sales volume to increase to 8.3 million wet metric tonnes (WMT) over 2022-2024, from 7.6 million WMT in 2021; ferronickel sales to increase to 36kt by 2024 (2021: 26kt)

- Annual tin sales to increase to 41kt by 2024, from 27kt in 2021

- Consolidated capex and equity investments of USD3.4 billion over 2022-2024, including contribution for Grasberg

- No acquisition-related outflow or inflow from divestitures.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- Positive rating action on the sovereign, provided there is no significant weakening of the likelihood of the government extending support to Inalum.

- Strengthening of the likelihood of state support.

- Improvement in Inalum's SCP. Inalum's SCP may be revised upwards if total debt/EBITDA leverage, based on proportional consolidation of key listed subsidiaries and dividend inflows from PTFI and associates, is below 3.5x on a sustained basis, and consolidated FCF is neutral or positive for a sustained period. A higher SCP, potentially driven by better-than-expected commodity prices, lower-than-expected capex, better operating cost control and use of cash for debt repayment, would lead to an upgrade of the IDR based on equalisation with the sovereign rating, as per Fitch's criteria.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- Negative rating action on the sovereign.

- Weakening of the likelihood of state support.

For the sovereign rating of Indonesia, the following sensitivities were outlined by Fitch in its rating action commentary of 14 December 2022:

The main factors that could, individually or collectively, lead to positive rating action/upgrade are:

- Public Finances: A marked improvement in the government revenue ratio in the next few years closer to the level of 'BBB' category peers, including from better tax compliance or a broader tax base, which would strengthen public finance flexibility.

- External Finances: A material reduction in external vulnerabilities, for instance, through a sustained increase in foreign-exchange reserves, a further decline in the dependence on portfolio flows or lower exposure to commodity price volatility.

- Structural: Significant improvement of structural indicators, such as governance standards, closer to those of 'BBB' category peers.

The main factors that could, individually or collectively, lead to negative rating action/downgrade:

- External Finances: A sustained decline in foreign-exchange reserve buffers, resulting, for example, from outflows stemming from a deterioration in investor confidence or large foreign-exchange interventions.

- Macroeconomic: A weakening of the policy framework that could undermine macroeconomic stability, for instance, resulting from continued monetary financing of the deficit in the next few years.

- Public Finances: A material increase in the overall public debt burden closer to the level of 'BBB' category peers, for example, resulting from failure to reduce the fiscal deficit to pre-crisis levels or accumulation of debt by publicly owned entities.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Comfortable Liquidity: Inalum had readily available cash, including time deposits, of around IDR38 trillion on a consolidated basis as of end-June 2022. The group also had IDR5 trillion in short-term bank borrowings and current maturities of long-term debt, excluding the amount outstanding under a revolving credit facility (RCF) that expires in June 2024. Inalum repaid around USD1.2 billion of its outstanding notes under a tender offer in July 2022, using undrawn loan facilities and cash.

We expect the group's substantial remaining cash balance to be sufficient to address remaining debt maturities over the next two years, despite our estimate of FCF turning negative. Inalum's robust banking relationships should also help the group address residual liquidity risks.

Our expectations are similar at the parent level; we estimate that a robust cash balance and substantial dividend inflows should allow it to address maturities of USD311 million of US dollar bonds in 2023 and the USD750 million RCF in 2024.

Issuer Profile

Inalum is fully owned by the Indonesian government and acts as the parent company for the state's mining assets. It operates Indonesia's sole aluminium smelter, and its various subsidiaries and associates are involved in mining and processing diverse commodities. Its EBITDA (including dividends) was over USD1.6 billion in 2021.

Summary of Financial Adjustments

Material adjustments include the following:

- Unamortised borrowing costs have been added back to debt. Supplier financing liabilities have also been treated as debt.

- Impairment losses have been excluded from EBITDA.

- Customer advances have been included in working-capital liabilities, while accruals for bond interest expense and construction-in-progress have been excluded.

- Additional investment in PTFI and other associates and joint ventures has been treated as part of capex.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

Inalum's IDR, senior unsecured rating and ratings on outstanding bonds are one notch below the rating of Indonesia.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. (ends)