Fitch Affirms GEMS at 'B+'; Outlook Stable

(Fitch Ratings - Singapore/Jakarta - 12 May 2020)--Fitch Ratings has affirmed Golden Energy Mines Tbk's (GEMS) Long-Term Issuer Default Rating (IDR) at 'B+' with a Stable Outlook. At the same time, Fitch Ratings Indonesia has affirmed GEMS's National Long-Term Rating of 'A(idn)' with a Stable Outlook.

We assess GEMS's linkage with its 67% shareholder, Golden Energy and Resources Limited (GEAR, B+/Stable), as moderate and consequently rates GEMS based on the consolidated credit profile of GEAR, based on our Parent and Subsidiary Linkage criteria. The affirmation reflects our assessment that the group's credit profile remains adequate for its rating level, even as we have lowered our coal price and volume assumptions. Fitch cut GEMS's selling prices following our commodity price assumptions (see "Fitch Ratings Cuts Some Metals, Mining Price Assumptions on Coronavirus Hit", dated 6 April 2020, available at www.fitchratings.com/site/pr/10117162).

We have also revised down our sales volume forecast to 27.5 million tonnes (mt) in 2020 following our expectations of weakening demand due to the coronavirus. We expect volume to rise to 32.5mt in 2021 and increase by about 4mt over the following two years, reaching 40mt by FY23. We assess GEMS's standalone profile at 'b+', reflecting its healthy reserve life, the low-cost position of its key mine, PT Borneo Indobara (BIB), and adequate financial profile. This is partially offset by mine concentration, regulatory risks and the cyclical nature of the coal industry.

'A' National Long-Term Ratings denote expectations of low default risk relative to other issuers or obligations in the same country. However, changes in circumstances or economic conditions may affect the capacity for timely repayment to a greater degree than is the case for financial commitments denoted by a higher rated category.

KEY RATING DRIVERS

Moderate Linkage with GEAR: Fitch maintains its assessment of moderate linkages between GEAR and GEMS under Fitch's Parent and Subsidiary Rating Linkage criteria. GEAR retains majority representation over GEMS's board, and is involved in managing GEMS's operation. GEAR's standalone operations are not significant and it solely depends on dividends from its subsidiaries, primarily GEMS, to service the debt at its level.

An agreement between GEMS's shareholders ensures that the company will maximise profit distribution by paying at least 80% of its free cash flow as dividends. However, GMR Coal Resources Pte. Ltd, which owns 30% of GEMS, has also appointed key management personnel and has veto power in major corporate transactions.

Temporary Volume Decline at GEMS: We expect GEMS's sales volume to fall by about 10% to 27.5mt in 2020 (2019: 30.8mt) due to weaker demand on account of the economic slowdown caused by the coronavirus pandemic. This is down from our original expectation of a growth to 36mt in 2020. We expect the company to maintain its growth trajectory after 2020, reaching close to its target peak production volumes of around 40mt by 2023.

GEMS's production base has grown significantly over the last few years, expanding by about 8mt in just 2019 from 22.6mt in 2018. GEMS does not require any significant infrastructure enhancement to support its volume growth as its own port is able to support shipping of about 44mt a year. We expect the company to reduce capex to about USD10 million in 2020 (2019: USD23 million) and then increase it to about USD25 million a year starting 2021, mainly to upgrade the capacity of the hauling roads and crushers.

Decline in Profitability: We expect GEMS's EBITDA per tonne to be between USD3.1/tonne-USD3.5/tonne in 2020 based on our revised price assumptions before rising back to remain between USD4/tonne and USD5/tonne (2019: USD4/tonne, 2018: USD6.8/tonne), over the next three years. The decline in the profitability is in line with the industry, although this is partially offset by the decline in fuel prices. Consequently, we expect GEMS to have a net debt position starting 2020 through our forecast period, as opposed to a neutral position in 2019.

GEMS Limited Mine Diversity: BIB accounts for more than 90% of GEMS's total production and above 65% of the proven and probable (2P) reserves. BIB's production ramp-up plans means the contribution from GEMS's other mines will remain small. The reserve concentration risk is partly offset by the geographical diversification of their reserves, with about 30% of their 2P reserves outside the island of Kalimantan. In terms of operations, we believe the risk is mitigated by its contracts with leading Indonesian mining contractors, such as PT Saptaindra Sejati (a subsidiary of PT Adaro Energy Tbk) and PT Putra Perkasa Abadi. GEMS benefits from BIB's competitive cost structure, given its low strip ratio of 4x, coupled with short haulage requirements.

Long Reserve Life: GEMS has one of the largest reserves compared with its coal-mining peers in Indonesia. GEMS's reserves are the fourth-largest in Indonesia, with proven reserves of around 806mt at end-2019 (end-December 2018: 818mt), or a reserve life of 27 years based on its 2019 total expected production. GEMS's acquisition of the PT Barasentosa Lestari (BSL) mine in the second half of 2018 had further improved its reserve base by adding 150mt of proven reserves. GEMS's BIB mine holds 576mt of the proven reserves, with a second-generation licence valid until 2036.

Adequate Financial Profile at GEAR: We expect GEAR's consolidated financial profile to improve from 2021 after weakening marginally in 2020. GEAR's has acquired a majority stake in Stanmore Coal Limited - an Australia-based metallurgical coal-mining company - which supports its efforts to diversify its business profile. Stanmore's net cash position and modest earnings expectations post 2020 should support the group's financial profile over the medium term, in Fitch's view.

We expect GEAR's consolidated group leverage (with proportionate consolidation of GEMS and full consolidation of Stanmore adjusted for minority interests) (net debt/EBITDA) to fall to below 1.5x in 2021, after rising to around 2.0x in 2020 (2019: 1.8x). We also expect GEAR's holding company standalone interest cover to improve to about 3.0x in 2021, after weakening in 2019 and 2020 to around 1.5x.

GEMS Standalone at 'b+': GEMS's standalone profile benefits from its modest yet increasing coal volumes and competitive cost position. However, the calorific value (CV) of GEMS's coal is lower than the Indonesian average, resulting in a lower selling price and a lower EBITDA size compared with its peers. We view GEMS's financial profile as stronger than its current standalone profile, but its scale of operations constrains the standalone profile at 'b+'. Fitch assesses that scale of operations to be an important factor in this industry, because the companies with larger scale in terms of revenue, EBITDA and cash flow have greater ability to withstand the inevitable industry downturns.

DERIVATION SUMMARY

The ratings of GEMS are based on the consolidated financial metrics of the GEAR group. The ratings factor in the group's adequate financial profile, large reserve base, low-cost position but improving scale of operations and track record.

PT Indika Energy Tbk's (BB-/Negative) has more integrated operations across the thermal coal value chain, but GEAR benefits from improving diversification after acquiring Stanmore, although the latter's contribution to cash flow will be minimal in the next two to three years. However, Indika's larger scale and well-established operations justify the one-notch difference in their IDRs, as GEAR's key assets, GEMS and Stanmore, are still boosting production. The Negative Outlook on Indika reflects the limited headroom in its rating because of our expectations of weakening financial profile following our revision in coal price and volume assumptions.

In comparison with PT Bayan Resources Tbk (BB-/Stable), GEAR's business profile benefits from diversification into hard coking coal. Bayan's similar scale as GEMS but better cost structure supports its stronger operating cash flow, explaining the one-notch differential in their ratings. Both companies have strong financial profiles. (ends)