Fitch Revises Freeport Indonesia's Outlook to Positive; Affirms at 'BBB-'

(Fitch Ratings - Jakarta/Singapore - 29 Mar 2023)-- Fitch Ratings has revised the Outlook of Indonesia-based copper and gold producer PT Freeport Indonesia's (PTFI) Long-Term Issuer Default Rating (IDR) to Positive from Stable and affirmed the rating at 'BBB-'. The agency has also affirmed the instrument ratings of PTFI's US dollar senior unsecured notes at 'BBB-'.

The Outlook revision follows the revision on the rating outlook of its 48.76% shareholder, Freeport-McMoRan Inc. (FCX, BBB-/Positive) to Positive from Stable on 9 March 2023. Fitch currently rates PTFI on a standalone basis as we believe the company has the same credit strength as FCX. However, positive rating action on FCX may lead to positive rating action on PTFI. This is because a one-notch uplift to PTFI's standalone credit profile (SCP) will be provided if FCX has a stronger credit profile than PTFI, based on our Parent and Subsidiary Linkage (PSL) Rating Criteria.

PTFI's ratings continue to be underpinned by its robust asset quality with large production scale, low-cost position, long-lived mine and conservative leverage. This is counterbalanced by the concentration risk from its single mining asset in Indonesia, which exposes PTFI to the prevailing regulatory risks of the country.

Key Rating Drivers

Positive Outlook Follows Parent's: The Positive Outlook captures the potential positive rating action on PTFI if there is a positive rating action on FCX, following the recent Outlook revision on the latter to Positive. We currently rate PTFI on its SCP because we assess PTFI's credit strength to be the same as that of FCX. However, we believe FCX has high strategic and operational incentives to provide support if its credit profile were stronger than that of PTFI. Therefore, a one-notch uplift from PTFI's SCP may be provided if FCX's rating is upgraded, so long as their linkages remain intact.

Fitch treats FCX as the parent company for our PSL analysis despite its non-majority ownership. This is because FCX holds operating control through majority representation on PTFI's operating committee 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 credit facility.

High Strategic, Operational Support Incentives: PTFI is a substantial contributor to FCX's cash flow. Its Grasberg mine accounted for 37% of FCX's 2022 copper output and 28% of its copper reserves. It provides competitive advantages as FCX's lowest-cost mining asset and gives access to Indonesia's mines. PTFI holds FCX's largest gold asset, providing commodity diversification. There is also significant management overlap. FCX's credit facility, in which PTFI is a co-borrower, has joint liability and cross-default clauses. However, PTFI's sublimit is small and undrawn, which increases the ease of refinancing.

Regulatory Risks: PTFI is exposed to regulatory risks in Indonesia. Its ability to continue exporting copper concentrate is subject to the Ministry of Energy and Mineral Resources' (MEMR) approval of the export license renewal. The license renewal also depends on PTFI meeting an agreed-upon level of progress in domestic smelter construction. Similarly, its current special mining license (IUPK) grants mining rights until 2031, which will be extended until 2041 on condition that PTFI completes smelter projects based on an agreed timeline and fulfils several fiscal obligations.

Exports to Continue in 2023: PTFI has received approval from the MEMR to extend its export license to 10 June 2023. Fitch's base case assumes PTFI will continue to export concentrate beyond June 2023. An outright ban on copper concentrate exports, associated with Indonesia's industry policy for development of downstream processing facilities, by June 2023 will require a significant cut to production, as domestic copper smelting capacity would not be sufficient. The ban may also adversely affect the government's export earnings and tax or royalty revenues and lead to worker layoffs.

However, PTFI's financial profile would be temporarily affected by revenue delays from insufficient downstream processing capacity, prior to its own smelter completion, should the government decide to ban concentrate exports by June 2023.

Smelter Development Underway: PTFI has made progress on its domestic downstream processing projects, with 54.5% completion at end-January 2023. The projects include construction of a greenfield smelter for USD3 billion and precious metal refinery (PMR) for USD400 million. PTFI is also engaged in expanding the capacity of its associate company, PT Smelting, by 30%. PTFI aims to complete the greenfield smelter and PMR by 2024, and the expansion by 2023. It has secured funding for these projects and will be able to process all its outputs domestically once the smelters reach full capacity.

Large Scale, Robust Cost Position: Fitch expects PTFI to produce around 1.6 billion lbs of copper and 1.8 million oz of gold in 2023. We project an EBITDA of USD5 billion-6 billion, with 60%-70% margin in 2023-2024 (2022: 69%) under our price deck of USD3.6-USD4.0/lb for copper and USD1,600-USD1,700/oz for gold. PTFI's position in the first quartile of the copper cost curve ensures resilient profit at various metal prices. Inflationary pressure on mining costs in 2022 was offset by PTFI's rising output and significant gold credits. This led to lower unit net cash cost of USD0.09/lb copper in 2022 (2021: USD0.19/lb).

Low Leverage, Negative FCF: Fitch forecasts EBITDA leverage to remain under 1.0x in 2023-2024 (2022: 0.5x). Strong cash flow, driven by stable outputs and a low-cost position, will help PTFI maintain a conservative balance sheet through periods of high capex. We estimate capex will stay elevated at USD3.5 billion-4 billion in 2023 (2022: USD2.3 billion), with negative free cash flow (FCF). We expect excess cash flow after debt repayments to be largely distributed as dividends in line with shareholder agreement. We believe dividends will be paid in a manner that is not detrimental to PTFI's credit profile.

Single Asset, Long Reserve Life: PTFI's single-site concentration exposes it to operational risks. Its operations were temporarily disrupted in mid-February 2023 due to flood and landslides, but have been fully restored by end-February 2023. We believe the risk of business disruption associated with the single asset is alleviated by its long operational record since the 1970s. PTFI's asset has a long mine life of up to 2041, driven by its IUPK terms. It had significant mineral reserves of 30.8 billion lbs of copper, 26.3 million oz of gold, and 121.3 million oz of silver at end-2022.

Derivation Summary

PTFI's rating is comparable to the rating of Indonesia-based coal producer PT Adaro Indonesia (AI, BBB-/Stable). AI's rating reflects the consolidated credit profile of its parent company PT Adaro Energy Indonesia Tbk (AEI). Both PTFI's and AI's ratings reflect their leading market position as one of the largest copper and coal producers in Indonesia, respectively. AEI similarly faces asset concentration risk, with 80% of its coal production coming from AI. Both companies are also exposed to commodity price fluctuations.

AEI, like PTFI, benefits from a competitive cost position and has a solid reserve life of about 20 years. PTFI has less capex flexibility than AEI, given its smelter construction commitment, which leads to negative FCF in the near term. However, both of them maintain conservative leverage with below 1.0x EBITDA net leverage for PTFI and a net cash position for AEI.

PTFI is rated lower than iron ore producer Vale S.A. (BBB/Stable) due to Vale's significantly larger scale. Vale generates more than USD15 billion EBITDA annually, against USD5 billion-6 billion for PTFI. Vale has commodity concentration on iron ore but also has significant copper and nickel operations.

Both PTFI's and Vale's ratings reflect their low-cost operations and leading market positions. Vale is the largest producer of iron ore and iron ore pellets and one of the largest nickel producers. PTFI is concentrated in a single asset and country, but Vale has greater exposure to a higher-risk jurisdiction, Brazil (BB-/Stable). Both PTFI and Vale have strong capital structures with below 1.0x EBITDA leverage.

Key Assumptions

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

- Copper price of USD8,800/tonne in 2023, USD8,000/tonne in 2024-2025, and USD7,000/tonne thereafter following Fitch's price deck;

- Gold price of USD1,700/oz in 2023, USD1,600/oz in 2024-2025, and USD1,300/oz thereafter based on Fitch's price deck;

- Annual copper production of 1.6 billion-1.7 billion lbs and gold production of 1.8 million-1.9 million oz in 2023-2024;

- EBITDA margin of 65%-70% in 2023 and 60%-65% in 2024;

- Capex of USD3.5 billion-4.0 billion in 2023 and USD2.0 billion-2.5 billion in 2024.

RATING SENSITIVITIES

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

- Positive rating action on FCX may lead to positive rating action on PTFI, provided there is no weakening in PTFI's SCP and linkages between the companies remain intact.

Factors that could, individually or collectively, lead to Outlook revision to Stable:

- Revision of FCX's rating Outlook to Stable

For the rating of FCX, the following sensitivities were outlined by Fitch in a rating action commentary on 9 March 2023:

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

- EBITDA leverage 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.

- EBITDA leverage sustained above 2.8x.

- Expectations of negative FCF on average.

Sensitivities for PTFI's SCP:

Factors that could, individually or collectively, lead to upward revision on the SCP:

- Upward revision on PTFI's SCP is unlikely in the near-to-medium term due to the constraints of geographical diversification.

Factors that could, individually or collectively, lead to downward revision on the SCP:

- Adverse material changes to PTFI's licences, including failure to maintain approval to export concentrate on reasonable terms.

- Sustained increase in EBITDA leverage to above 2.3x.

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

Robust Liquidity, Funding Access: PTFI's solid liquidity is underpinned by its strong operating cash flow generation, robust funding access and long-dated debt maturity. It had USD2.5 billion available cash and USD1.8 billion undrawn committed credit facilities from banks, against USD3 billion of total debt at end-2022. PTFI issued USD3 billion of senior unsecured bonds in April 2022 to fund its smelter projects and for refinancing and general corporate purposes. They comprise USD750 million 4.763% notes due in 2027, USD1.5 billion 5.315% notes due in 2032, and USD750 million 6.2% notes due in 2052.

PTFI upsized its syndicated credit facility to USD1.3 billion in April 2022. The facility will mature in July 2026 and is available to fund general corporate needs and costs related to PT Smelting's expansion and PMR construction. PTFI also has a USD500 million sub-limit under FCX's USD3 billion syndicated revolving credit facility maturing in October 2027. All of PTFI's bank borrowings are unsecured and remained undrawn at end-2022. In addition, the company receives a USD2 billion shareholder loan facility from FCX, which was undrawn at end-2022.

Issuer Profile

PTFI, a copper producer with a significant gold by-product, 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 mines. 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.

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

Fitch currently rates PTFI on a standalone basis, but a one-notch uplift to PTFI's SCP would be provided if FCX's credit profile were stronger than PTFI's, provided that linkages remain the same based on our PSL assessment.

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)