Fitch Assigns Freeport Indonesia First-Time 'BBB-' Rating with Stable Outlook; Rates Notes

(Fitch Ratings - Singapore/Jakarta - 05 Apr 2022)--Fitch Ratings has assigned a Long-Term Issuer Default Rating (IDR) of 'BBB-' to Indonesia-based copper and gold producer PT Freeport Indonesia (PTFI). The Outlook is Stable. The agency has also assigned PTFI's proposed US dollar senior unsecured notes a 'BBB-' rating.

The ratings reflect PTFI's large production scale and reserves, long mine life, solid cost position and robust financial metrics. These are counterbalanced by its single asset in Indonesia, which exposes PTFI to the prevailing regulatory risks of the country.

Strong cash flow generation, underpinned by low costs, high commodity prices and increasing output from its underground production, will help PTFI to maintain a solid financial profile as it progresses through its smelter development projects. Free cash flow (FCF) will turn negative in the medium term on dividends and rising capex, as PTFI intends to fund the smelter projects with debt. However, we expect PTFI to continue managing its dividend plan to avoid damaging its strong leverage profile.

Fitch rates PTFI on a standalone basis as we believe the company has the same credit strength as its shareholder, Freeport-McMoRan Inc. (FCX, BBB-/Stable), which owns 48.76%. We believe there are high strategic and operational incentives for FCX to support PTFI.

The proposed notes are rated in line with the IDR because they constitute unconditional, unsecured and unsubordinated obligations of PTFI. The net proceeds of the proposed notes will be used to finance the smelter projects and for general corporate purposes.

Key Rating Drivers

Rising Output: PTFI moved to full underground mining in 2020. Its annualised ramp-up target output of 1.5 billion pounds (lbs) of copper and 1.6 million ounces (oz) of gold was reached in 4Q21. We expect PTFI to produce 1.5 billion-1.6 billion lbs of copper in 2022 (2021: 1.3 billion lbs) and 1.5 million-1.6 million oz of gold (2021: 1.4 million oz). Annual output fell to under 850 million lbs for copper (2018: 1.2 billion lbs) and under 900,000 oz for gold (2018: 2.4 million oz) in 2019-2020 during the transition after the Grasberg open pit was mined out in 2019.

Advancing Smelter Development: PTFI is progressing on its domestic downstream processing projects as part of its commitment to the Indonesian government. The projects include the construction of a greenfield smelter for around USD2.8 billion and a precious metal refinery (PMR) for about USD250 million. PTFI is also engaged in the 30% capacity expansion of its associate company, PT Smelting, that will cost USD250 million. PTFI aims to complete the greenfield smelter by 2024 and PT Smelting's expansion by end-2023 through debt financing.

Single-Site, Licensing and Regulatory Risks: The location of PTFI's mines exposes it to the operational and regulatory risks in Indonesia, but we think potential business disruptions associated with its single mine site operation is manageable in light of its long operational history since the 1970s. The risk is also alleviated by the company's large reserves of 32.2 billion lbs of copper, 26.6 million oz of gold and 129.5 million oz of silver at end-2021 and long mine life of 19 years up to 2041, based on its licence.

Its current special mining licence grants mining rights until 2031, which will be extended until 2041 with the condition that its smelter projects are completed based on an agreed timeline and it fulfils several fiscal obligations. The annual renewal of PTFI's export licence also depends on meeting the agreed smelter construction progress. It is also subject to environmental regulations under the Ministry of Environment and Forestry.

Negative FCF, Low Leverage: We expect PTFI to generate average annual EBITDA of about USD5 billion-6 billion and average annual operating cash flows of around USD4 billion for 2022-2023. We estimate FCF will turn negative as capex, including for the smelter and refinery projects, will rise to around USD2.5 billion-3.5 billion per year in 2022-2023 from USD1.5 billion in 2021. We also expect excess internal cash flow generation to be largely distributed as dividends after considering debt repayment needs in line with shareholder agreements.

Nonetheless, we expect dividends will continue to be distributed in a manner that will not be detrimental to PTFI's strong leverage profile. PTFI's financial profile will remain conservative with debt/EBITDA of below 1.0x in 2022-2023 (2021: 0.1x).

Solid Cost Position: PTFI's cost in the low first quarter of the global copper cost curve ensures its profitability and reasonable cash flow generation during periods of lower prices. PTFI's reported copper cash production cost of USD0.19/lb in 2021, net of by-products, is lower than the industry average of USD1.3/lb, according to Wood Mackenzie. We expect its EBITDA margin to widen to 68%-75% in 2022-2023 from 67% in 2021, assuming stable mining unit costs and price deck of USD3.9-USD4.3/lb for copper and USD1,600-USD1,800/oz for gold.

Rated on Standalone Basis: Fitch rates PTFI on its standalone credit profile (SCP) in accordance with our Parent and Subsidiary Linkage Rating Criteria. This is because we assess PTFI's credit strength to be the same as that of FCX, which holds operating control as it has more representatives in the operating committee than another shareholder and consolidates PTFI into its financial statements. FCX has also provided tangible support in the form of a shareholder loan facility and the inclusion of PTFI as a co-borrower in its banking facility.

High Strategic, Operational Support Incentives: PTFI is a large contributor to FCX's profitability and dividend income. It provides competitive advantages as FCX's lowest-cost mining asset due to the ore body's high gold content. PTFI holds FCX's largest gold asset, which gives commodity diversification. We also assess that there is major avoidance cost and management overlap. FCX's credit facility, in which PTFI is a co-borrower, has joint liability and cross-default clauses. PTFI does not use the facility. It will mature in 2024, unless refinanced by FCX.

Derivation Summary

PTFI's rating is comparable with that of South Africa-based gold producer, AngloGold Ashanti Limited (AGA, BBB-/Stable). AGA's operational diversification across 10 operating mines is better than PTFI's single operation in Grasberg. PTFI has larger scale with EBITDA of USD5 billion-6 billion, against USD1 billion-2 billion for AGA. AGA has higher gold output of 3 million oz than PTFI's 1.3 million-1.5 million, but it lacks the diversification into copper.

AGA is significantly more exposed to jurisdiction risks as it has operations in Tanzania, Guinea, Ghana (B-/Negative), Brazil (BB-/Negative), Democratic Republic of Congo and Argentina (CCC) in addition to Australia (AAA/Stable). The company's reserve life of around nine years is shorter than PTFI's close to 20 years. AGA also operates at a higher cost than PTFI, as it sits on the fourth quartile of the global gold cost curve. This explains AGA's weaker profitability with an EBITDA margin of 35%-45%, which is narrower than PTFI's 65%-75%. Both AGA and PTFI have low leverage.

PTFI is comparable in size with Teck Resources Ltd. (BBB-/Stable), which has an EBITDA of USD4 billion-5 billion, but PTFI has a better cost position and financial profile. PTFI is less diversified by product and less exposed to favourable mining jurisdictions, as Teck operates in Canada (AA+/Stable), the United States of America (AAA/Negative), Peru (BBB/Stable) and Chile (A-/Stable).

Southern Copper Corporation (SCC, BBB+/Stable) is a comparable peer, given the spread of its copper assets. SCC is top among global companies with copper reserves of 67.7 million tons of contained copper, compared with PTFI's equivalent of 16 million tons, and 68 years in mine life. SCC is larger with comparable cash costs although their financial profiles have similar leverage.

Key Assumptions

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

- Copper price of USD9,500/tonne in 2022, USD8,500/tonne in 2023 and USD7,500/tonne thereafter following Fitch's price deck;

- Gold price of USD1,800/oz in 2022, USD1,600/oz in 2023, USD1,400/oz in 2024 and USD1,300/oz in 2025 based on Fitch's price deck;

- Copper production of 1.5 billion-1.6 billion lbs and gold production of 1.5 million-1.6 million oz in 2022;

- EBITDA margin of 65%-75% in 2022-2023;

- Capex of USD3 billion-3.5 billion in 2022 and USD2.5 billion-3 billion in 2023.

RATING SENSITIVITIES

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

- Positive rating action is unlikely in the near-to-medium term due to the constraints of geographical diversification. However, positive rating action on FCX may lead to positive rating action on PTFI, provided the linkages between the companies remain intact.

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

- Adverse material changes to PTFI's licences

- Sustained increase in debt/EBITDA to above 2.3x

However, a one-notch uplift from its SCP will be provided if PTFI is downgraded, provided there is no weakening in FCX's credit profile and linkages remain intact.

For the rating of FCX, the following sensitivities were outlined by Fitch in a rating action commentary on 5 January 2022:

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

- Expectations of FFO leverage below 2.3x on a sustained basis.

- Total debt/EBITDA sustained below 1.8x.

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

- Failure to maintain approval to export concentrate on reasonable terms from Indonesia.

- FFO leverage above 3.3x on a sustained basis.

- Total debt/EBITDA sustained above 2.8x

- Expectations of negative FCF on average.

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

Strong Liquidity and Funding Access: PTFI's liquidity is robust, with USD1.49 billion in available cash against USD443 million in total debt at end-December 2021. It paid USD850 million of its 2021 ending cash balance as dividend in 1Q22. Around USD133 million of the debt will mature in 2025, and the remaining USD310 million will be due in 2026.

The outstanding debt is part of the USD1 billion syndicated loan obtained in July 2021 to fund PT Smelting's expansion, the PMR construction and general corporate needs. The loan comprises a USD667 million term loan and a USD333 million revolving credit facility (RCF). PTFI also has a USD500 million sub-limit under FCX's USD3.5 billion RCF from JP Morgan Chase Bank N.A and others, mostly available to 2024. It also has the USD2 billion shareholder loan facility from FCX.

Issuer Profile

PTFI, a copper producer with a significant gold byproduct, holds the rights to the exploration and mining operations of the Grasberg mineral district in Papua. It is one of the world's largest copper and gold mine. The remaining 51.24% stake is held by PT Indonesia Asahan Aluminium (Persero) (BBB-/Stable), a state-owned entity that acts as Indonesia's mining industry holding company.

Date of Relevant Committee

31 March 2022

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. (ends)