Fitch Affirms Indonesia's Inalum at 'BBB-'; Outlook Stable; SCP Revised to 'bb-'

(Fitch Ratings - Singapore - 30 Mar 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), in line with Fitch's Government-Related Entities (GRE) Rating Criteria. This is based on our assessment of strong linkages between Inalum and the state as well as the state's incentive to provide support.

We have revised Inalum's Standalone Credit Profile (SCP) to 'bb-', from 'b-' as we expect its financial metrics to improve significantly. We forecast Inalum's debt/EBITDA leverage, based on proportional consolidation of three key subsidiaries, at around 3.5x in 2023-2024 and standalone EBITDA/interest coverage, including net dividends, to be above 3.0x.

Inalum continues to benefit from robust commodity prices, while the outlook for sustained large dividends from the Grasberg mine has improved with the successful ramp-up of operations and start of dividend payments in 2021. Inalum's robust business profile is underpinned by its commodity diversification and healthy mining cost positions.

Key Rating Drivers

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 (PTBA), PT Aneka Tambang Tbk (ANTAM) and PT Timah Tbk (Timah) - to Inalum. Inalum now owns around 65% in each subsidiary. The government also mandated Inalum to acquire additional shares in PT Freeport Indonesia (PT FI), which operates the strategically important Grasberg mine.

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 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.

Commodity Diversification, Healthy Cost Positions: Inalum is the sole aluminium producer in Indonesia and it also produces other commodities, including thermal coal, nickel, bauxite, tin, copper and gold through PTBA, ANTAM and Timah, and its stake in PT FI. The copper, nickel and thermal coal mines have healthy positions in the first half of global cost curves, according to CRU, along with long reserve lives of around 20 years or more. The Grasberg mine is one of the largest assets globally for copper and gold, while Timah is among the top tin producers in the world.

Increasing Dividends from PT FI: We estimate PT FI will pay Inalum dividends of around USD1 billion by 2023, from USD234 million in 2021. Grasberg's annualised copper and gold output in 4Q21 reached almost 100% of the ramp-up target, from 68% in 4Q20. Inalum's share of PT FI's dividends will also rise to 41.2% from 2023, from below 20.0%, assuming Inalum transfers a 10% stake in PT FI to regional stakeholders. Our dividend estimate factors in PT FI's plans to build a USD3 billion smelter and invest in smaller downstream projects, such as a precious-metal refinery.

Capex to Increase: We expect capex to jump with projects to increase capacity and improve vertical integration, such as additional aluminium smelting capacity, a new smelter-grade alumina refinery to process its bauxite output, an increase in ferronickel processing and tin smelting capacity, and a coal-fired power plant. Inalum's capex in 2020-2021 was lower than we expected, in part because execution was hampered by Covid-19-related restrictions. We expect project execution to pick up in 2022. Inalum may also make acquisitions to boost its share of domestic reserves of mineral resources.

Leverage to Decline: We forecast Inalum's debt/EBITDA leverage, based on proportional consolidation of the three key subsidiaries to account for significant minority interest and including dividends from PT FI, to fall to below 3.0x in 2022 (2021 estimate: 5.2x, 2020: 16.8x), with high commodity prices driving higher consolidated EBITDA. We estimate leverage will rise to around 3.5x from 2023 on lower EBITDA as commodity prices decline. We also expect Inalum's consolidated free cash flow (FCF) to turn neutral to negative by 2024, from positive in 2021-2023, on weaker EBITDA.

Minimal Impact Likely from Reorganisation: The government plans to reorganise Inalum by making it a fully owned subsidiary of a new entity, likely to be named Mining Industry Indonesia (MIND ID), according to news reports in September 2021 quoting Inalum's former president director, Orias Moedak. MIND ID would be fully owned by the government and the holding company for the state's interests in various mining assets.

Details have yet to be finalised, but we think most of Inalum's assets and liabilities, except those pertaining to its aluminium smelting operations, could be transferred to MIND ID. The assets and liabilities may include Inalum's outstanding US dollar bonds, most of its cash and the stakes in the three key subsidiaries and PT FI. In that case, the ratings on the outstanding bonds are likely to be unaffected.

Derivation Summary

Our assessment of sovereign support can be compared with that for other GREs, such as PT Pertamina (Persero) (BBB/Stable), PT Hutama Karya (Persero) (HK, 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 the sovereign, reflecting a 'Very Strong' score on all GRE support parameters: ownership and control, support record, 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 the majority of fuels distributed by Pertamina, and supports Pertamina 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.

Indonesian construction company, HK, is rated at the same level as Inalum using a top-down approach, at one notch below the Indonesian sovereign. We assess HK at 'Very Strong' for ownership and control as well as support record. The government, which fully owns HK, has close oversight of HK's boards of directors and commissioners and has provided equity injections, asset securitisation and construction assistance to support HK's order-book growth and toll-road investments in the last five years. The government also guarantees the bulk of HK's debt and we expect support to continue, with the company investing in Indonesia's longest toll road in Sumatra. However, we regard HK's financial implications of default as 'Strong', as we believe investors do not view the company as a proxy financing vehicle for the state.

The ratings on majority state-owned telecommunications company, Telkom, are constrained by the sovereign's rating. Similar to Inalum, we assess Telkom at 'Strong' for ownership and control, and support record, and 'Moderate' for socio-political implications of default. We believe there would be a limited political and economic impact from any service disruption in network connectivity. However, we assess the financial implications of default at 'Strong', compared with 'Very Strong' for Inalum, as Telkom is not seen as a proxy state borrower due to 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 Chinese government 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 Minmetals' socio-political implications of default as 'Moderate'. While a default by Minmetals would cause a medium-term shortage in base materials domestically, 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, like key oil and power GREs.

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

Inalum's lower SCP than FCX, which is a top three global producer of copper with world-class mines in Indonesia, Peru and the U.S, 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.

Compared with FQM, which is among the top-10 global copper companies, Inalum benefits from higher commodity diversification. 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 and 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, Inalum's leverage and coverage metrics are weaker.

Key Assumptions

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

- Average annual aluminium sales of 250 kilotonnes (kt) over 2021-2023 (2021: 219kt)

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

- Average nickel ore sales volume to increase to 9 million wet metric tonnes over 2022-2024, from 8 million in 2021; ferronickel sales to increase to 36kt by 2024 (2021: 26kt)

- Average annual tin sales of around 45kt over 2022-2024 (2020: 27kt)

- Total capex of USD3.5 billion for Inalum and subsidiaries 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 subsidiaries and dividend inflows from PT FI and associates, is below 3.5x on a sustained basis, and consolidated FCF is neutral or positive for 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 22 November 2021:

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

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

- 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.

- 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:

- Public Finances: A continued increase in the overall public debt burden over the next few years to levels well beyond our current forecasts, for example, resulting from failure to reduce the fiscal deficit to pre-crisis levels or further accumulation of debt by publicly owned entities.

- 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.

- 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.

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 IDR40 trillion on a consolidated basis as of end-2021, compared with IDR13 trillion in short-term bank borrowings and current maturities of long-term debt. Inalum also has USD250 million undrawn from a revolving credit facility (RCF), which expires in June 2024, and USD250 million undrawn from a term loan facility, which can be drawn until July 2023. We expect the group's substantial cash balance, supported by the undrawn facilities and free cash flows, to be sufficient to address its maturing debt in 2022-2024. Inalum's robust banking relationships also mitigate residual refinancing risk from weak cash flows if commodity prices fall sharply or capex is higher-than-expected.

Our expectations are similar at the standalone level; we estimate that reported readily available cash, including time deposits, at around USD1.2 billion as of end-2021 and positive free cash flows should allow Inalum to address its next debt maturity in 2023 of USD674 million in US dollar bonds.

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.

- 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 PT FI 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)