Fitch Affirms Indika at 'BB-'; Outlook Negative

(Fitch Ratings - Singapore/Jakarta - 06 Oct 2020)--Fitch Ratings has affirmed PT Indika Energy Tbk's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at 'BB-'. The Outlook remains Negative. Fitch has also affirmed the Indonesia-based mining company's outstanding senior unsecured notes at 'BB-.

The Negative Outlook continues to reflect Indika's low rating headroom, as Fitch expects its FFO net leverage to increase to 6.0x in 2020 and remain between 2.7x and 3.2x from 2021 to 2024, relative to its negative sensitivity of 3.0x. Fitch expects Indika's EBITDA to decline by about 30% to USD280 million in 2020 from USD405 million in 2019, mainly due to weaker coal prices, lower coal sales volume and a temporary production stoppage at a client of its contract-mining division. Fitch forecasts Indika's EBITDA will recover to around USD450 million per annum from 2021, factoring in our assumptions on improving coal prices, lower mining costs and higher contract mining volume.

The affirmation of Indika's ratings takes into account its ability to meaningfully curtail operating costs amid weaker coal prices, the improving credit profile at its contract-mining operations, its capex flexibility and the potentially lower sensitivity of the group to weaker coal prices as a result.

KEY RATING DRIVERS

Lower Mining Costs Support Earnings: Indika has been able to meaningfully curtail the operating costs at its 91%-owned key mining subsidiary, PT Kideco Jaya Agung, by around USD4/tonne to USD27.2/tonne in 1H20 from USD31.2/tonne in 2019. The drop was due to a reduction in Kideco's strip ratio to 5.6x in 1H20 from 6.3x in 2019, lower contract mining rates to third-party contractors and declining fuel costs. Fitch expects Kideco's strip ratios to stay at around 5.4x-5.6x over the next seven years, considering Indika's revised mining plans after its exploration activity over the past 24 months.

We expect Kideco's lower mining costs to mitigate the impact of weaker selling prices and volume in 2020. Lower costs will also more than compensate for our weaker price and volume assumptions from 2021. Fitch expects Kideco's EBITDA to decline to USD140 million in 2020 from USD230 million in 2019, but recover to around USD220 million-250 million from 2021 despite the recent revision in our coal price assumptions (see Fitch Ratings Updates Metals and Mining Price Assumptions, published 28 August 2020, at https://www.fitchratings.com/site/pr/10134526). We estimate Kideco's average coal selling price will fall to around USD38/tonne in 2020 and recover to USD41-42/tonne from 2021 (2019: USD45/tonne).

Petrosea's Stronger Customer Mix: Fitch believes the increasing exposure of Indika's 70%-owned contract-mining subsidiary, PT Petrosea Tbk, to Kideco will benefit Indika's credit profile. Petrosea has streamlined its client mix to only Kideco and PT Bayan Resources Tbk (BB-/Stable), two of Indonesia's strongest coal miners. Fitch thinks this will result in a significant improvement in the stability of Petrosea's long-term earnings profile, with considerably lower risks of a rate reduction during renegotiations in a downturn.

Petrosea's contract-mining EBITDA, however, fell by 22% in 1H20 on an annualised basis due to the production stoppage at Bayan for around two months until May 2020 due to caution over the coronavirus at the mine site. Nevertheless, Petrosea was able to curtail its operating costs by more than Fitch expected, resulting in a lower impact on its EBITDA. Petrosea will account for only about 40% of Kideco's volume, leaving potential for further integration although the group has no immediate plans. Fitch would consider any significant increase in integration between Kideco and Petrosea as credit positive.

Capex Flexibility: Indika has been able to curtail capex during coal-price downcycles as most of its capex was for the expansion of Petrosea's contract-mining capacity. Indika cut back capex to USD23 million in the previous coal downturn in 2016. Fitch, however, does not forecast any significant cuts to its long-term capex as we expect a coal-price recovery from 2021.

Evolving Investment Strategy: Indika plans to increase its earnings from more non-coal-related operations. Fitch thinks Indika's recent investments in fuel-storage facilities are less risky as the earnings of these projects with oil majors are under take-or-pay contracts. Indika also recently invested in a greenfield gold project, although its investment is small. We expect the company to continue to evaluate non-coal investments. Fitch considers these latest investments as credit neutral but will regard any major investments as event risks.

License Renewals: Fitch expects the mining license of Kideco to be extended upon its expiry in 2023 without any major impact on its credit profile, and will consider any significant negative development in concession renewals, including non-renewal, as an event risk. Indonesia in June clarified some license aspects, including the continuation of acreage and the extension of licenses over two 10-year periods, but have not yet clarified revised tax and royalty structures. Fitch expects some clarity over the next few months in light of the License expiry of PT Arutmin Indonesia, another coal miner, in November 2020.

DERIVATION SUMMARY

Indika's ratings are driven by Kideco's moderate-cost position, production flexibility, reasonable reserves and large capacity, which require little capex. The similar ratings of Bayan reflect its lower-cost position, larger reserves and a healthier financial profile with considerably lower sensitivity to price and volume assumptions than Indika. Bayan has faced operational disruptions due to bottlenecks in its transport infrastructure, which constrain its ratings. Indika's operations are more integrated and have a stronger record of uninterrupted production.

The energy-adjusted cost position of Indika's mining operations is stronger than that of Golden Energy and Resources Limited (GEAR, B+/Stable). Indika's operations are also more integrated than that of GEAR. Indika's higher ratings reflect its large scale of earnings, robust operational record and more integrated operations. GEAR's ratings are constrained until it is able to sustainably improve the scale of operations for the group.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer

- Kideco's average coal selling price to decline to USD38/tonne in 2020 from USD45/tonne in 2019. Prices to recover to USD41-42/tonne from 2021

- Kideco's coal mining volume to decline to 32 million tonnes in 2020 from 35 million tonnes in 2019. Volume to recover to 33-34 million tonnes from 2021

- Kideco's cash production costs to drop to between USD32/tonne and USD33/tonne starting 2020 from USD37/tonne in 2019

- EBITDA at Petrosea to decline to USD110 million in 2020 from USD127 million in 2019. Petrosea EBITDA forecast to increase to over USD140 million from 2021.

- Consolidated investment and capex of USD100 million in 2020 and USD110 million-180 million per annum from 2021 to 2024. Majority of capex from 2020 to be incurred for equipment purchases at Petrosea and the completion of its fuel-storage project

RATING SENSITIVITIES

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

- Fitch does not expect an upgrade as the company's Outlook is Negative. The Outlook will be revised to Stable if Indika is able to sustain credit metrics at levels stronger than our negative sensitivities from 2021, which would be driven by a recovery of coal prices and volume.

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

- Indika's FFO net leverage is sustained above 3.0x and/or its FFO fixed-charge coverage falls below 3.5x in 2021 and beyond

- Any weakness or challenges in successfully addressing lumpy debt maturities

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

Refinancing Required in Medium Term: Indika does not have any major debt maturities until 2022. Its senior unsecured notes of USD265 million, USD285 million and USD575 million are due April 2022, January 2023 and November 2024, respectively. Indika has debt maturities of less than USD100 million per annum in 2020 and 2021. Indika's consolidated cash balance is healthy, at USD488 million as of June 2020, although a large part of this is held under its operating subsidiaries.

Fitch expects Indika to pay USD210 million in 2022 to the previous shareholders of Kideco upon the extension of its mining license. The company is considering plans to refinance its US dollar bonds due 2022 and 2023. We think Indika's refinancing risk is low due to its proactive liquidity and liability management, and a record of raising funds.

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.

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.