(The following statement was released by the rating agency) Fitch Ratings-Singapore-November 12: Fitch Ratings has assigned a final rating of 'BBB-' to PT Indonesia Asahan Aluminium (Persero)'s (Inalum, BBB-/Stable) USD1.0 billion 5.23% notes due 2021, USD1.25 billion 5.71% notes due 2023, USD1.0 billion 6.53% notes due 2028 and USD750 million 6.757% notes due 2048. The final rating on the senior unsecured notes is in line with the expected rating assigned on 26 October 2018, and follows the receipt of final documents conforming to earlier information. Government-owned Inalum is Indonesia's only primary aluminium producer and owns 65% stakes in three subsidiaries - PT Bukit Asam Tbk, PT Aneka Tambang Tbk (ANTAM) and PT Timah Tbk - which are mainly engaged in the production of coal, nickel and tin, respectively. Inalum's Issuer Default Rating and senior unsecured rating are 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. Fitch assesses Inalum's standalone credit profile at 'B+', factoring in its operating strengths of a favourable cost position, long mine lives for key minerals and commodity diversification, which are offset by a weak financial profile over 2019-2020, a key constraint on the standalone profile. Fitch estimates leverage at above 6x and coverage, defined as Inalum's standalone EBITDA to interest coverage, including free cash flow generation at subsidiaries on a proportionate basis and recurring dividends after netting off capex commitments for Grasberg, at below 1x. However, robust banking relationships, especially with state-owned domestic banks, support Inalum's liquidity, despite its weak coverage metrics. We expect Inalum's financial position to improve from 2021 once it starts receiving meaningful dividends from PT Freeport Indonesia (PTFI), the operator of the Grasberg mine. Inalum and the regional governments will increase their combined stake in PTFI to a majority using proceeds from the notes. Dividends from Grasberg should jump further from 2023. However, Inalum's capex contribution for expansion of operations is likely to offset dividend receipts in the interim. KEY RATING DRIVERS Strong State Linkage: Fitch sees Inalum's status, ownership and control by the Indonesian sovereign as strong. The company is fully owned by the government and has been appointed as the mining sector's holding company, after the government transferred its shares in the three subsidiaries to Inalum. The government also mandated Inalum to acquire additional shares in the strategically important Grasberg mine. The sovereign's support record is strong, with a 2015 capital injection of IDR3.5 trillion in ANTAM via a rights issue and consolidation of mining assets under Inalum to improve its business profile. We expect the strong support to continue. State's Incentive to Provide Support: Fitch sees 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 we do not believe it would result in severe social-political fallout at the existing 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 (SOE) and we believe a financial default could very strongly affect investor confidence in the sovereign and other SOEs. Favourable Cost Position, Reserve Lives: Key operations for Inalum and subsidiaries, such as aluminium smelting and production of coal and ferronickel, benefit from favourable positions in the first half of global cost curves. The Grasberg mine is among the world's largest and lowest-cost copper assets and also contains large gold reserves. Inalum's subsidiary, Timah, is the world's second-largest tin producer. Inalum's aluminium smelter benefits from captive power production, while coal operations benefit from low stripping ratios. We expect coal and nickel reserves to last over 50 and 30 years, respectively, while Grasberg should produce at least until 2041. Weak Financials, Likely to Improve: We estimate weak adjusted debt/EBITDAR leverage, based on proportionate consolidation of the three subsidiaries, of above 6x over 2019-2020. We use proportionate consolidation to account for significant minority interest of 35% each in the subsidiaries, which are also listed and abide by domestic securities regulations. We estimate standalone EBITDA/interest coverage for Inalum, which does not have material rental expense, to remain below 1x over 2019-2020. Inalum's liquidity, which is underpinned by strong relationships with domestic and international banks and capex-related financing from Indonesian state-owned banks, and positive outlook on its financial metrics support its standalone credit profile, despite weak ratios over the next two years. We expect leverage to decline to around 4x from 2021 and coverage to increase to around 2x on higher dividend contributions from Grasberg. This has been factored in Inalum's standalone credit profile. Increase in Grasberg Stake: Inalum, the Papua government and the Mimika Regency will increase their stake in PTFI to 51.2%, from 9.4% for a consideration of USD3.85 billion. Inalum is obligated to fund 40% of expansionary capex for the mine and will in turn receive 40% of the benefit beyond a production threshold until 2022. All economic benefits will be shared among shareholders based on their stakes in PTFI from 2023. Fitch expects Inalum to contribute around USD1.0 billion to finance capex at Grasberg until 2022, offsetting the dividends received. The Grasberg mine, which is operating with a temporary mining permit, is scheduled to receive a new permit with two 10-year terms and a 2041 end date following the acquisition of a majority stake by Inalum. This would provide clarity on issues of taxation, downstream capacity obligations and possible environmental liabilities. We do not expect adverse regulations in the new permit that would significantly affect cash flow from Grasberg. We also assume PTFI will invest in a new smelter for around USD2.7 billion in partnership with another miner, addressing its downstream capacity obligation. Strengthening Integration, Product Profile: Inalum is planning to set up a smelter-grade alumina refinery, which will allow it to process ANTAM's bauxite output and use the produced alumina in its aluminium smelter. The company expects to ramp up output of value-added billets and alloy aluminium products, having started production in 2017. ANTAM is also investing to increase the capacity of its ferronickel processing plant by 50% to 40.5 kilotonnes (kt) by 2019. Higher vertical integration should lower earnings volatility for Inalum. Inalum aims to improve the share of earnings from downstream projects significantly and is likely to make further investments. Acquisition Risk: Inalum is committed to deleveraging, but this could be delayed by significant cash-funded acquisitions that may also not result in a material improvement in its operating profile. Inalum's objective is to obtain a 15%-20% share in domestic reserves of various mineral resources. This could be achieved via acquisitions for commodities such as nickel, coal and bauxite where its share of domestic reserves is less than 15%. However, acquisition costs may not be significant in all cases. For example, ANTAM acquired two mining concessions in August 2018, which were earlier returned by PT Vale Indonesia Tbk to the government, with initial payments and development fully funded by a partner. DERIVATION SUMMARY Inalum's standalone rating of 'B+' can be compared with that of global mining peers, such as Anglo American (LON: AAL ) plc (BBB-/Stable), Freeport-McMoRan Inc. (BB+/Negative), Fortescue Metals Group Limited (BB+/Stable) and First Quantum Minerals Ltd. (FQM, B/Stable). Inalum scores favourably in terms of operating profile parameters of cost position, mine life and commodity diversification relative to higher-rated peers, even though its scale in terms of revenue and EBITDA is significantly smaller. However, Inalum's weak financial profile over the next two years is the main determinant of its lower rating differential compared with those peers. FQM, which is rated lower compared with Inalum's standalone level, has a weaker cost position, lower commodity diversification and higher country-risk for its operations. FQM's weaker operating profile justifies a lower rating, despite a forecast for lower leverage over the next two years. Our assessment of sovereign support for Inalum can be compared with other Indonesian GREs, such as PT Perusahaan Listrik Negara (Persero) (PLN, BBB/Stable), PT Pertamina (Persero) (BBB/Stable) and PT Pelabuhan Indonesia III (Persero) (Pelindo III, BBB-/Stable). The ratings of PLN and Pertamina are equalised with the sovereign, reflecting a 'Very Strong' score on all GRE support parameters related to ownership and control, support record and expectations, socio-political as well as financial implications of default. Inalum scores lower than PLN and Pertamina on factors related to control, support and socio-political implications of default. PLN and Pertamina receive regular subsidies for meeting the government's public-service obligations, which form part of the state budget. In addition, any default by these two SOEs would hamper their ability to provide essential services to the public. In the absence of substitutes, curtailed operations will have a severe socio-political impact. Inalum is rated higher on the parameter of financial implications of default relative to Pelindo III, while being assessed similarly on other factors. Fitch believes a default by Inalum will have a higher impact on investor confidence in the sovereign as well as other SOEs in light of the close involvement of the government in the Grasberg deal. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Aluminium production of around 250kt on average each year over 2018-2021 (2017: 219 kt) - Coal sales volume to increase to 34 million tonnes (mt) in 2021 (2018E: 25mt) - Nickel ore sales volume to increase to 8 million wet metric tonnes (wmt) in 2021 (2018E: 6 million wmt) and ferronickel sales to increase to 40kt in 2021 (2018E: 25kt) - Tin sales to increase to 35kt in 2021 (2018E: 31kt) - Prices for aluminium, coal, nickel, copper, gold and tin from 2019 based on Fitch's mid-cycle price assumptions - Total capex of USD2.3 billion for Inalum and subsidiaries over 2018-2020 - No dividend payout from Inalum to the government - No acquisition-related cash outflow apart from consideration for higher stake in PTFI - Minimal dividend inflow from Grasberg operations over 2019-2020. RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action - Positive rating action on the sovereign, provided there is no significant weakening of Inalum's linkages with the state. - Strengthening of linkages with the sovereign as per Fitch's GRE Rating Criteria. Developments that May, Individually or Collectively, Lead to Negative Rating Action - Negative rating action on the sovereign. - Weakening of linkages with the sovereign as per Fitch's GRE Rating Criteria. For the Standalone Credit Profile: Developments that May Lead to Positive Rating Action - Inalum's standalone credit profile incorporates an improved coverage ratio to around 2x from 2021, reflecting a higher dividend contribution from Grasberg. On this basis, Fitch does not anticipate positive rating action over the next two years. However, coverage improving to above 2.5x on a sustained basis could lead to positive rating action. Developments that May Lead to Negative Rating Action - Weakening of Inalum's credit profile, such that coverage is estimated to remain below 1.5x beyond 2020. For the sovereign rating of Indonesia, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 2 September 2018: The main factors that, individually or collectively, could trigger positive rating action are: - Strengthening of external finances, for instance, by an increase in foreign-exchange reserves, expansion of the manufacturing export base and lower dependence on volatile portfolio flows. - Continued improvement of structural indicators, such as governance standards. - An improvement in the government revenue ratio, for example, from better tax compliance and a broader tax base. The main factors that, individually or collectively, could trigger negative rating action are: - A sharp and sustained external shock to foreign and/or domestic investor confidence, leading to a decline in foreign-exchange reserves. - A material increase in the overall public debt burden, for example resulting from relaxation of the budget deficit ceiling. - A weakening of the policy framework that could undermine macroeconomic stability. LIQUIDITY AND DEBT STRUCTURE Adequate Liquidity: Inalum reported cash and cash equivalents of IDR20.9 trillion on a consolidated basis as of 30 June 2018, while we estimate long-term debt due within the next 12 months to be around IDR1.6 trillion. On a standalone basis, Inalum had cash of around IDR10.2 trillion and no debt. Inalum's free cash flow is likely to be negative over the next two years on a consolidated and standalone basis, but robust banking relationships support its liquidity position. Inalum is engaging with state-owned banks to help finance its capex commitments and we do not anticipate significant risk to securing such funding. SUMMARY OF FINANCIAL STATEMENT ADJUSTMENTS Summary of Key Financial Statement Adjustments: - Fitch has used a 5x multiple to capitalise Inalum's rent expense - Non-current time deposit amount has been treated as cash - Unamortised issuance costs have been added back to debt - Advances from customers have been included under working capital liabilities - Dividends paid to minorities have been separated out from total cash outflow for dividends DATE OF RELEVANT COMMITTEE 23 October 2018 PT Indonesia Asahan Aluminium (Persero) ----senior unsecured; Long Term Rating; New Rating; BBB- ----senior unsecured; Long Term Rating; New Rating; BBB- Contacts: Primary Rating Analyst Akash Gupta, Director +65 6796 7242 Fitch Ratings Singapore Pte Ltd. One Raffles Quay #22-11, South Tower Singapore 048583 Secondary Rating Analyst Salman Alamsyah, Associate Director +62 21 2988 6818 Committee Chairperson Vicky Melbourne, Senior Director +61 2 8256 0325
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